CHAPTER 5 Variable Costing

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

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

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

Difference Between Full and Variable Costing Treatment of fixed manufacturing overhead Under full costing, it is included in inventory and expensed when the product is sold Under variable costing, it is considered a period cost and expensed in the period incurred. Learning objective 1: Explain the difference between full (absorption) and variable costing

Variable Costing Income Statement Utilizes the contribution margin approach - Contribution margin ratio = contribution margin/sales Can help in decision making - Contribution margin ratio x change in sales = change in contribution margin - Fixed costs stay the same when sales change Learning objective 2: Prepare an income statement using variable costing.

Review 2 Answer: b. Variable costing Absolute costing Variable costing Which of the following provides information helpful to internal decision making? Absolute costing Variable costing Fixed costing Full costing Answer: b. Variable costing Learning objective 2: Prepare an income statement using variable costing.

Exercise 1 Sales are $100,000 and contribution margin is $65,000 Calculate the contribution margin ratio: $65,000 / $100,000 = 0.65 or 65% Calculate the change in contribution margin if sales change by $10,000 $10,000 X 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.

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/Unit Full cost/unit (5,000 units) is calculated as follows: Total Material Costs $600/unit Total labor costs $225/unit Total variable OH $75/unit Fixed Overhead $1,200,000/5000 units $240/unit Full Cost/Unit = $1,140/unit Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube – Variable Cost/Unit Variable unit cost is calculated as follows: Unit materials cost = $600 Unit labor cost = $225 Unit variable overhead = $75 Variable cost per unit = $600 + $225 + $75 = $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.

Clausen Tube – Income Statements Production (5,000) is greater than sales (4,000) Learning objective 3: Discuss the effect of production on full and variable costing income.

Clausen Tube – Income Statements Production (5,000) less than sales (6,000) 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.

Exercise 2 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Production is 42,000 snow shovels. Calculate full cost/unit. (4 x 42,000) + (3 x 42,000) + (2 x 42,000)+ 168,000) = 546,000 / 42,000 = $13/unit Learning objective 3: Discuss the effect of production on full and variable costing income.

Exercise 3 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Production is 42,000 snow shovels. Calculate variable cost/unit. (4 + 3 + 2) = 9 per unit Learning objective 3: Discuss the effect of production on full and variable costing income.

Exercise 4 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Sales are 38,500 snow shovels. Calculate net income using full cost. Learning objective 3: Discuss the effect of production on full and variable costing income.

Exercise 5 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Sales are 38,500 snow shovels. Calculate net income using variable cost. 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.

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

Review 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: 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.

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 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 -easily calculate the change in income when sales change 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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