CHAPTER 5 Variable Costing

Full (Absorption) Costing Inventory Costs Include: Direct Material Direct Labor All Manufacturing Overhead Variable and Fixed Cost elements are combined in Manufacturing Overhead Required for GAAP

Full (Absorption) Costing

Variable Costing Inventory Includes: Direct Material Direct Labor Variable Manufacturing Overhead Enables organization to perform “what if” analysis Not allowed for GAAP

Variable Costing

Differences Between Full and Variable Costing Fixed Manufacturing Overhead Under Full Costing, it is included in inventory and expensed when product is sold. Under Variable Costing, it is considered a period expense and expensed on the income statement in the period incurred.

Variable Costing Income Statement Utilizes contribution margin approach All costs are classified as fixed or variable costs

Variable Costing Income Statement Example

Full Costing Income Statement Example

Study Break #1 Which of the following complies with GAAP for external reporting purposes? Absolute costing Variable costing Fixed costing Full costing Answer: d. Full costing

Study Break #2 Which of the following lends itself well to internal decision making? Absolute costing Variable costing Fixed costing Full costing Answer: b. Variable costing

ClausenTube Example - Facts

ClausenTube Example Quantity Produced = Quantity Sold Full Costing Income Statement

ClausenTube Example Quantity Produced = Quantity Sold Variable Costing Income Statement

ClausenTube Example Quantity Produced > Quantity Sold Full Costing Income Statement

ClausenTube Example Quantity Produced > Quantity Sold Variable Costing Income Statement

Variable Costing for External Reporting

Example Exercise Information Summit Manufacturing, Inc. produces snow shovels. The selling price per snow shovel is $25. Costs involved in production are: Direct material $4 Direct labor $3 Variable manufacturing overhead $2 Total variable manufacturing cost per unit $9 Fixed manufacturing overhead per year $168,000 Fixed selling and administrative costs $152,000

Example Exercise #1 During the year, Summit produces 42,000 snow shovels and sells 38,500 snow shovels. What is net income using full costing?

Example Exercise #1 Solution Net Income using Full Costing Sales ($25 x 38,500) $962,500 Cost of Goods Sold ($13 x 38,500) $500,500 Gross Margin $462,000 Less Selling and Administrative Expense $152,000 Net Income $310,000

Example Exercise #2 During the year, Summit produces 42,000 snow shovels and sells 38,500 snow shovels. What is net income using variable costing?

Example Exercise #2 Solution Net Income using Variable Costing Sales ($25 x 38,500) $962,500 Less Variable COGS ($9 x 38,500) $346,500 Contribution Margin $616,000 Less Fixed Costs: Fixed Manufacturing Overhead $168,000 Fixed Selling and Administrative $152,000 Net Income $296,000

Impact of Method Selection on Income Statement Units Produced = Units Sold No difference in income Units Produced > Units Sold Full costing yields higher income Units Produced < Units Sold Variable costing yields higher income

Reducing Production

Impact of JIT on Income Effects Companies using JIT typically have low levels of inventory. Units produced are approximately equal to units sold Difference between full and variable costing is likely to be very small.

Benefits of Variable Costing for Internal Reporting Variable Costing Facilitates C-V-P Analysis Separates fixed and variable costs Variable Costing Limits Management of Earnings with Production Volume Does not allow management to inflate earnings

Study Break #3 If units produced exceed units sold: Answer: Full costing yields a higher income than variable costing Full costing yields a lower income than variable costing Full costing and variable costing yield the same income Variable costing yields a higher income than full costing Answer: a. Full costing yields a higher income than variable costing

Study Break #4 If units produced are less than units sold: Answer: Full costing yields a higher income than variable costing Full costing yields a lower income than variable costing Full costing and variable costing yield the same income Variable costing yields a lower income than full costing Answer: b. Full costing yields a lower income than variable costing

Impact of Changes in Sales

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