Prepared by Debby Bloom-Hill CMA, CFM

CHAPTER 5 Variable Costing

Full (Absorption) Costing Required by GAAP for external reporting purposes Inventory costs include: Direct materials used Generally variable Direct labor incurred Manufacturing overhead Includes both fixed and variable costs Learning objective 1: Explain the difference between full (absorption) and variable costing

Variable Costing Inventory costs includes: Direct materials used Direct labor incurred Variable manufacturing overhead Fixed manufacturing overhead treated as a period cost Helpful for internal decision making Not allowed for GAAP reporting Learning objective 1: Explain the difference between full (absorption) and variable costing

Test Your Knowledge 1 Answer: Which of the following complies with GAAP for external reporting purposes? Absolute costing Variable costing Fixed costing Full costing Answer: d. Full costing, also known as absorption costing Learning objective 1: Explain the difference between full (absorption) and variable costing

Full (Absorption) Costing Learning objective 1: Explain the difference between full (absorption) and variable costing

Variable Costing Learning objective 1: Explain the difference between full (absorption) and variable costing

Difference Between Full and Variable Costing The only difference between full and variable costing is their treatment of fixed manufacturing overhead Under full costing, fixed manufacturing overhead is included in inventory These costs enter into the determination of expense only when the inventory is sold Under variable costing, fixed manufacturing overhead becomes a period expense Learning objective 1: Explain the difference between full (absorption) and variable costing

Variable Costing Income Statement Classifies all expenses in terms of their cost behavior, either fixed or variable With variable and fixed expenses separated, the contribution margin can be presented Contribution margin is revenues minus total variable expenses The contribution margin allows users to make reasonable estimates of how much profit will change with changes in sales Learning objective 2: Prepare an income statement using variable costing.

Variable Costing Income Statement Sales are $100,000 and contribution margin is $65,000 Calculate the contribution margin ratio: 𝐜𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐬𝐚𝐥𝐞𝐬 = $𝟔𝟓,𝟎𝟎𝟎 $𝟏𝟎𝟎,𝟎𝟎𝟎 =𝟎.𝟔𝟓 𝐨𝐫 𝟔𝟓% Calculate the change in contribution margin if sales change by $10,000 $10,000 * 0.65 = $6,500 Learning objective 2: Prepare an income statement using variable costing.

Variable Costing Income Statement Example Learning objective 2: Prepare an income statement using variable costing.

Full Costing Income Statement Example Learning objective 2: Prepare an income statement using variable costing.

Variable Costing vs. Full Costing Income Statement The full costing income statement cannot be used to estimate the increase in profit due to an increase in sales The reason is that cost of goods sold includes both fixed and variable costs The fixed costs will not increase when sales increase Under full costing we do not know how much of cost of goods sold is fixed or variable Learning objective 2: Prepare an income statement using variable costing.

Example - Clausen Tube Selling price $2,000 Variable costs (per unit): Materials = $600/unit Labor = $225/unit Variable mfg. overhead = $75/unit Variable selling expense = $40/unit Fixed mfg. overhead = $1,200,000 Production = 5,000 units Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube Full Cost per Unit Full cost per unit for 5,000 units is calculated as follows: Total Material Costs $600 per unit Total labor costs $225 per unit Total variable OH $75 per unit Fixed Overhead $1,200,000/5,000 units $240 per unit Full Cost per Unit = $1,140 per unit Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube Variable Cost per Unit Variable cost per unit for 5,000 units is calculated as follows: Total Material Costs $600 per unit Total labor costs $225 per unit Total variable OH $75 per unit Variable Cost per Unit = $900 per unit Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube – Income Statement Selling price = $2,000/unit Full cost = $1,140/unit Variable cost = $900/unit Variable selling expense = $40/unit Fixed overhead = $1,200,000 Fixed selling expense = $100,000 Fixed administrative expense= $500,000 Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube – Income Statements Production equals sales (5,000 units) Learning objective 3: Discuss the effect of production on full and variable costing income.

Quantity Produced Equals Quantity Sold When the quantity produced equals the quantity sold, there is no difference between net income calculated using full cost versus variable costing Since all units produced are sold, no fixed cost ends up in ending inventory The only difference is that variable costing calculates the contribution margin Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube – Income Statements Production (6,000 units) is greater than sales (4,800 units) Learning objective 3: Discuss the effect of production on full and variable costing income.

Quantity Produced is Greater Than Quantity Sold When the quantity produced is greater than the quantity sold income will be greater under full costing as opposed to variable costing Under full costing, inventory cost includes fixed manufacturing overhead Under variable costing, fixed manufacturing overhead is a period cost Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube – Income Statements Production (6,000 units) is less than sales (7,200 units) Learning objective 3: Discuss the effect of production on full and variable costing income.

Quantity Produced is Less Than Quantity Sold Then the quantity produced is less than the quantity sold, income will be greater under variable costing as opposed to full costing Beginning inventory under fixed costing includes fixed manufacturing overhead When the beginning inventory is charged to cost of goods sold the charge will be higher under full costing Learning objective 3: Discuss the effect of production on full and variable costing income.

Variable Costing for External Reporting Learning objective 3: Discuss the effect of production on full and variable costing income.

Test Your Knowledge 2 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Production is 42,000 snow shovels. Calculate full cost per unit. Learning objective 3: Discuss the effect of production on full and variable costing income.

Test Your Knowledge 2 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Production is 42,000 snow shovels. Full cost is $13 per unit. Learning objective 3: Discuss the effect of production on full and variable costing income.

Test Your Knowledge 3 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Production is 42,000 snow shovels. Calculate variable cost per unit. Learning objective 3: Discuss the effect of production on full and variable costing income.

Test Your Knowledge 3 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Production is 42,000 snow shovels. Variable cost is $9 per unit. Learning objective 3: Discuss the effect of production on full and variable costing income.

Impact of Method Selection on Income Statement Units produced = units sold No difference in net income Units produced greater than units sold Full costing yields higher net income Units Produced less than units sold Variable costing yields higher net income Learning objective 3: Discuss the effect of production on full and variable costing income.

Reducing Production Learning objective 3: Discuss the effect of production on full and variable costing income.

Test Your Knowledge 4 Kincade Faucets produces a variety of faucets. During the year, the company incurred $400,000 of depreciation expense on its manufacturing equipment. How much depreciation expense will be in Finished Goods Inventory under variable costing? $400,000 $285,714 $0 None of the above Answer: Depreciation is a fixed cost which is expensed as a period cost under variable costing Learning objective 3: Discuss the effect of production on full and variable costing income.

Impact of JIT on Income Companies using JIT typically have low levels of inventory Units produced are approximately equal to units sold Difference between full costing and variable costing is likely to be very small. Learning objective 4: Explain the impact of JIT on the difference between full and variable costing income

Benefits of Variable Costing for Internal Reporting Variable costing facilitates cost-volume-profit (CVP) analysis Separates fixed and variable costs Allows managers to accurately estimate the impact of changes in volume on cost and profit Cannot be answered using full costing Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes

Benefits of Variable Costing for Internal Reporting Variable costing limits management of earnings via production volume Managers are often compensated based on income in their division Full costing produces higher income when production is greater than sales Managers have an incentive to manage earnings under full costing Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes

Impact of Changes in Sales Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes

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