Variable Costing for Management Analysis 20 Variable Costing for Management Analysis

Absorption Costing 20-1 Under absorption costing, all manufacturing costs are included in finished goods and remain there as an asset until the goods are sold.

20-1 7

20-1 Absorption costing is necessary in determining historical costs for financial reporting to external users and for tax reporting.

Variable Costing 20-1 Variable costing (also called direct costing) may be more useful to management in making decisions. In variable costing, the cost of goods manufactured is composed only of variable manufacturing costs.

20-1 10

Cost of Goods Manufactured Cost of Goods Manufactured Costs of Goods Manufactured Comparison 20-1 Absorption Costing Cost of Goods Manufactured Direct Materials Direct Labor Variable Factory OH Fixed Factory OH Period Expense Cost of Goods Manufactured Variable Costing 11

Variable Costing Income Statement Compared to Absorption Costing Income Statement 20-1 Assume that Belling Co. manufactured 15,000 units at the following costs: 12

Variable Costing Income Statement 20-1 13

Absorption Costing Income Statement 20-1 16

20-1 The absorption costing income statement does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of good sold. Deducting cost of goods sold from sales yields gross profit. Deducting selling and administrative expenses then yields income from operations.

Leone Company has the following information for March: 20-1 Example Exercise 20-1 Leone Company has the following information for March: Sales $450,000 Variable cost of goods sold 220,000 Fixed manufacturing costs 80,000 Variable selling and administrative expenses 50,000 Fixed selling and administrative expenses 35,000 Determine the March (a) manufacturing margin, (b) contribution margin, and (c) income from operations for Leone Company. 18

20-1 Follow My Example 20-1 $230,000 ($450,000 – $220,000) $180,000 ($230,000 – $50,000) $65,000 ($180,000 – $80,000 – $35,000) 19 For Practice: PE 20-1A, PE 20-1B

20-2 Frand Manufacturing Company has no beginning inventory and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels.

Proposal 1: 20,000 Units to be Manufactured and Sold 20-2 40

Proposal 2: 25,000 Units to be Manufactured; 20,000 Units to be Sold 20-2 41

Absorption Costing Income Statements for Two Production Levels 20-2 $35V 20F $55 42

Absorption Costing Income Statements for Two Production Levels 20-2 20-2 $35V 16F $51 43 43

20-2 The $80,000 increase in income from operations would be caused by allocating the fixed manufacturing costs of $400,000 over a greater number of units of production.

20-2 Now, assume that Frand Manufacturing uses variable costing and has sales of 20,000 units. Exhibit 6 illustrates that net income remains a constant $200,000 at the three levels of production.

Variable Costing Income Statements for Two Production Levels 20-2 46

20-2 Example Exercise 20-4 Variable costs are $100 per unit, and fixed costs are $50,000. Sales are estimated to be 4,000 units. (a) How much would absorption costing income from operations differ between a plan to produce 4,000 units and a plan to produce 5,000 units? (b) How much would variable costing income from operations differ between the two production plans? 47

20-2 Follow My Example 20-4 $10,000 greater in producing 5,000 units 4,000 units x ($12.50 – $10.00), or [1,000 units x ($50,000/5,000 units)]. There would be no difference in variable costing income from operations between the two plans. 48 For Practice: PE 20-4A, PE 20-4B

20-3 Objective 3 Describe and illustrate management’s use of variable costing and absorption costing for controlling costs, pricing products, planning production, analyzing contribution margins, and analyzing market segments.

Controllable and Noncontrollable Costs 20-3 For a specific level of management, controllable costs are costs that can be influenced by management at that level, and noncontrollable costs are costs that another level of management controls.

Pricing Products 20-3 Many factors enter into determining the selling price of a product. The cost of making the product is clearly significant. In the short run, pricing decisions should be based upon making the best use of existing manufacturing facilities.

20-3 In the long run, plant capacity can be increased or decreased. If a business is to continue operating, the selling prices of its products must cover all costs and provide a reasonable income.

Analyzing Contribution Margins 20-3 Managers can plan and control operations by evaluating the differences between planned and actual contribution margin.

Analyzing Market Segments 20-3 A market segment is a portion of a business that can be analyzed using sales, costs, and expenses to determine its profitability.

20-4 Objective 4 Use variable costing for analyzing market segments including product, territories, and salespersons segments.

Analyzing Market Segments 20-4 Camelot Fragrance Company manufactures and sells the Gwenevere perfume for women and the Lancelot cologne line for men. The inventories are negligible.

Camelot Fragrance Company 20-4 58

Contribution Margin by Sales Territory Report 20-4 60

Sales Mix 20-4 Sales mix, sometimes referred to as product mix, is defined as the relative distribution of sales among the various products sold.

Product Profitability Analysis 20-4 Some products are more profitable than others due to differences with respect to pricing, manufacturing costs, advertising support, or salesperson support. Exhibit 9 shows the contribution margin by product for Camelot Fragrance Company.

Contribution Margin by Product Line Report 20-4 64

Salesperson Profitability Analysis 20-4 Sales managers may wish to evaluate the performance of salespersons. This may be done with a report that shows contribution margin by salesperson. Such a report is shown in Exhibit 10 for the Northern Territory salespersons.

Contribution Margin by Salesperson Report 20-4 66

East West 20-4 Example Exercise 20-5 20-4 Example Exercise 20-5 The following data are for Moss Creek Apparel: East West Sales volume (units): Shirts 6,000 5,000 Shorts 4,000 8,000 Sales price: Shirts $ 12 $ 13 Shorts $ 16 $ 18 Variable cost per unit: Shirts $ 7 $ 7 Shorts $ 10 $ 10 Determine the contribution margin for (a) Shorts and (b) the West Region. 66 67

$88,000 [4,000 units x ($16 – $10)] + [8,000 units x ($18 – $10)] 20-4 Follow My Example 20-5 $88,000 [4,000 units x ($16 – $10)] + [8,000 units x ($18 – $10)] $94,000 [5,000 units x ($13 – $7)] + [8,000 units x ($18 – $10)] 68 For Practice: PE 20-5A, PE 20-5B