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3. Homework assignment 760Chapter 5  Using Connect – 7 Questions for 60 Points; Chapter 5. Variable Costing and Analysis  Prepare chapter 6 “ Variable Costing and Analysis.” Happiness is having all homework up to date Atef Abuelaish3

4. Chapter 06 Variable Costing and

5. Chapter 06 Variable Costing and Analysis

6. Compute unit cost under both absorption and variable costing. Compute unit cost under both absorption and variable costing. 3

7. Absorption Costing & Variable Costing Absorption costing (also called full costing), assumes that products absorb all costs incurred to produce them. While widely used for financial reporting (GAAP), this costing method can result in misleading product cost information for managers’ business decisions. Absorption costing (also called full costing), assumes that products absorb all costs incurred to produce them. While widely used for financial reporting (GAAP), this costing method can result in misleading product cost information for managers’ business decisions. 7 P 1

8. Absorption Costing & Variable Costing Under variable costing, only costs that change in total with changes in production level are included in product costs. 8 P 1

9. Distinguishing between Absorption Costing and Variable Costing: Absorption Costing Absorption Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product Cost 9 P 1

10. Distinguishing between Absorption Costing and Variable Costing: Variable Costing Distinguishing between Absorption Costing and Variable Costing: Variable Costing Variable Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product CostPeriod Cost 10 P 1

11. Difference between Absorption Costing and Variable Costing: Computing Unit Cost 11 P 1

12. Difference between Absorption Costing and Variable Costing: Computing Unit Cost 12 $180,000/ 60,000 units = $3/unit $600,000/ 60,000 units = $10/unit Variable OH cost per unit: Fixed OH cost per unit: P 1

13. Copyright © 2015 McGraw-Hill Education NEED-TO-KNOW A manufacturer reports the following data. Direct materials $6.00 per unit Direct labor$14.00 per unit Overhead costs: Variable overhead$220,000 per year Fixed overhead$680,000 per year Expected units produced20,000 units 1) Compute the total product cost per unit under absorption costing. $220,000 / 20,000 units = $11 per unit $680,000 / 20,000 units = $34 per unit 2) Compute the total product cost per unit under variable costing. $6.00 $14.00 $11.00 $34.00 $6.00 $14.00 $11.00 $34.00 $ 65.00 per unit $ 31.00 per unit P 1 13

14. Analysis of Income Reporting for Both Absorption and Variable Costing 14 P 1

15. Prepare and analyze an income statement using absorption costing and using variable costing. Prepare and analyze an income statement using absorption costing and using variable costing. 15

16. Analysis of Income Reporting for Absorption Costing: Units Produced Equal Units Sold Notice that the net income is $580,000 16 P 2

17. Analysis of Income Reporting for Variable Costing: Units Produced Equal Units Sold 17 P 2 A performance report that excludes fixed expenses and net income is a contribution margin report. It’s bottom line is contribution margin. We can see that the income under variable costing is also $580,000. This is because the number of units produced are equal to the number of units sold.

18. Contribution Margin Report Sales - Variable expenses = Contribution margin **Contribution margin contributes to covering fixed costs and earning income 18 P 2

19. Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Equal Units Sold 19 P 2

20. Analysis of Income Reporting for Absorption Costing: Units Produced Exceed Units Sold Income for 2014 is $320,000 20 P 2

21. Analysis of Income Reporting for Variable Costing: Units Produced Exceed Units Sold Under variable costing, the net income is only $120,000 21 P 2

22. Analysis of Income Reporting for Variable Costing: Units Produced Exceed Units Sold Under absorption costing,$200,000 of fixed overhead is allocated to the 20,000 units in ending inventory and is not expensed until future periods. Variable costing expenses the entire $600,000 of fixed overhead. 22 P 2

23. Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Exceed Units Sold 23 P 2

24. Analysis of Income Reporting for Absorption Costing: Units Produced Are Less Than Units Sold Income is now $840,000 24 P 2

25. Income under variable costing is $1,040,000 25 Analysis of Income Reporting for Variable Costing: Units Produced Are Less Than Units Sold P 2

26. Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Are Less Than Units Sold 26 P 2

27. 10 Minutes Break Atef Abuelaish27

28. Summarizing Income Reporting 28 P 2

29. Copyright © 2016 McGraw-Hill Education NEED-TO-KNOW Zbest Manufacturing reports the following costing data for the current year. 20,000 units were produced, and 14,000 units were sold. Direct materials per unit$6per unit Direct labor per unit$11per unit Variable overhead per unit$3per unit Fixed overhead for the year$680,000per year Sales price$80per unit Variable selling and administrative cost per unit$2per unit Fixed selling and administrative cost per year$112,000per year 1. Prepare an income statement for the year using absorption costing. Product cost per unit using Absorption Costing: Direct materials per unit Direct labor per unit Variable overhead per unit Fixed overhead per unit ($680,000 / 20,000 units produced) Cost per unit Sales (14,000 units @ $80 per unit)$1,120,000 Cost of goods sold (14,000 units @ $54 per unit)756,000 Gross margin364,000 Selling, general and administrative expenses: Variable selling and administrative expenses (14,000 x $2)$28,000 Fixed selling and administrative expenses112,000 Total selling, general and administrative expenses140,000 Net income (loss)$224,000 34.00 $54.00 Zbest Manufacturing Absorption Costing Income Statement $6.00 11.00 3.00 29

30. NEED-TO-KNOW 2. Prepare an income statement for the year using variable costing. Product cost using Variable Costing: Direct materials per unit Direct labor per unit Variable overhead per unit Cost per unit Sales (14,000 units @ $80 per unit)$1,120,000 Less: Variable costs Variable production costs (14,000 x $20 per unit)$280,000 Variable selling and administrative expenses (14,000 x $2)28,000 Total variable costs308,000 Contribution margin812,000 Less: Fixed expenses Fixed overhead costs680,000 Fixed selling and administrative expenses112,000 Total fixed expenses792,000 Net income (loss)$20,000 Zbest Manufacturing Variable Costing Income Statement $6.00 11.00 3.00 $20.00 Zbest Manufacturing reports the following costing data for the current year. 20,000 units were produced, and 14,000 units were sold. Direct materials per unit$6per unit Direct labor per unit$11per unit Variable overhead per unit$3per unit Fixed overhead for the year$680,000per year Sales price$80per unit Variable selling and administrative cost per unit$2per unit Fixed selling and administrative cost per year$112,000per year 30 P 2

31. Copyright © 2016 McGraw-Hill Education NEED-TO-KNOW Sales (14,000 units @ $80 per unit)$1,120,000 Less: Variable costs Variable production costs (14,000 x $20 per unit)$280,000 Variable selling and administrative expenses (14,000 x $2)28,000 Total variable costs308,000 Contribution margin812,000 Less: Fixed expenses Fixed overhead costs680,000 Fixed selling and administrative expenses112,000 Total fixed expenses792,000 Net income (loss)$20,000 Number of units added to inventory6,000 Fixed overhead per unit ($680,000 / 20,000 units)$34.00 Change in income (Absorption vs. Variable)$204,000 Zbest Manufacturing Variable Costing Income Statement Sales (14,000 units @ $80 per unit)$1,120,000 Cost of goods sold (14,000 units @ $54 per unit)756,000 Gross margin364,000 Selling, general and administrative expenses: Variable selling and administrative expenses (14,000 x $2)28,000 Fixed selling and administrative expenses112,000 Total selling, general and administrative expenses140,000 Net income (loss)$224,000 Zbest Manufacturing Absorption Costing Income Statement 31 P 2

32. Convert income under variable costing to the absorption cost basis. Convert income under variable costing to the absorption cost basis. 32

33. Converting Reports under Variable Costing to Absorption Costing 33 Income under Absorption costing = Income under variable costing + Fixed overhead cost in ending inventory ▬ Fixed overhead cost in beginning inventory Income under variable costing is restated to that under absorption costing utilizing the following formula: Exhibit 6.11 Converting Variable Costing Income to Absorption Costing Income P 3

34. Converting Reports under Variable Costing to Absorption Costing 34 To restate variable costing income to absorption costing income for 2014, we must add back the fixed overhead cost deferred in ending inventory. Similarly, to restate variable costing income to absorption costing income for 2015, we must deduct the fixed overhead cost recognized from beginning inventory, which was incurred in 2014, but expensed in the 2015 cost of goods sold when the inventory was sold. P 3

35. Describe how absorption costing can result in overproduction. Describe how absorption costing can result in overproduction. 35

36. Planning Production Producing too much inventory Excess inventory Higher storage and financing costs Greater risk of obsolescence Producing too little inventory Lost sales Customer dissatisfaction 36 C 1

37. Planning Production: Income under Absorption Costing for Different Production Levels Why is income under absorption costing affected by the production level when that for variable costing is not? The answer lies in the different treatment of fixed overhead costs within the two methods. 37 So…under absorption costing, if excess units are produced, the fixed overhead cost allocated to those units is not expensed until a future period when those units are sold. Exactly! C 1

38. Planning Production 38 When 60,000 units are produced: Fixed overhead per unit is: $600,000/ 60,000 units = $10/unit When 100,000 units are produced: Fixed overhead per unit is: $600,000/ 100,000 units = $6/unit What would happen if IceAge’s manager decided to produce 100,000 units instead of 60,000? The 40,000 extra units would be stored in inventory and the total production cost PER UNIT is $4 less !

39. Planning Production: Income under Absorption Costing for Different Production Levels 39 Note: Income under absorption costing is $240,000 greater if management produces 40,000 more units than necessary and builds up ending inventory. This shows that a manager can report increased income merely by producing more and disregarding whether the excess units can be sold or not. C 1

40. Planning Production: Income under Variable Costing for Different Production Levels Planning Production: Income under Variable Costing for Different Production Levels 40 Under variable costing, even if I produce more units, it doesn’t effect the reported net income. I actually have to SELL more units to increase my net income. C 1

41. Determine product selling price based on absorption costing. Determine product selling price based on absorption costing. 41

42. How does management determine the sales price of a product? Although many factors impact pricing, cost is a crucial factor! all costs Over the long run, price must be high enough to cover all costs. Absorption cost information is useful because it reflects the full costs that sales must exceed for the company to be profitable. P 4P 4 42

43. We can use a three-step process to determine product selling prices: Step 1: Determine the product cost per unit using absorption costing. Step 2: Determine the target markup on product cost per unit. Step 3: Add the target markup to the product cost to find the target selling price P 4P 4 43

44. Example: IceAge will use absorption costing to determine a target selling price. Exhibit 6.16 Determining Selling Price with Absorption Costing Step 1Absorption cost per unit (from Exhibit 6.3)$25 Step 2Target markup per unit ($25 times 60%) 15 Step 3Target selling price per unit$40 1) Start with product cost. 2) Then, management needs to determine a target markup. 3) In this example, they chose a markup of 60% of cost. So the target selling price is $40 per unit. P 4P 4 44

45. Controllable vs. Uncontrollable Costs? Managers are responsible for their controllable costs. controllable o A cost is controllable if a manager has the power to determine the amount incurred. o Examples vary depending on the manager’s level in the company. Uncontrollable Uncontrollable costs are not within the manager’s control or influence. o Example would be production capacity. P 4P 4 45

46. Limitations of Reports Using Variable Costing 46 For income tax purposes, absorption costing is the only acceptable basis for filings with the Internal Revenue Service (IRS) under the Tax Reform Act of 1986. Absorption costing is the only acceptable basis for external reporting under both U.S. GAAP and IFRS. Top executives are often awarded bonuses based on income computed using absorption costing. Realities that contribute to the widespread use of absorption costing by companies: P 4P 4

47. Use variable costing in pricing special orders. Use variable costing in pricing special orders. 47

48. Setting Prices Long Run Over the Long Run: Price must be high enough to cover all costs, including variable costs and fixed costs, and still provide an acceptable return to owners 48 A 1A 1

49. Setting Prices Short Run Over the Short Run: Fixed production costs such as the cost to maintain plant capacity do not change with changes in production levels. With excess capacity, increases in production level would increase variable production costs, but not fixed costs. While managers try to maintain the long-run price on existing orders, which covers all production costs, managers should accept special orders provided the special order price exceeds variable cost. 49

50. A 1 Setting Prices (Special Orders Illustration) 50 Should the company accept a special order for 1,000 pairs of skates at an offer price of $22 per pair? Variable production cost = $15 ($4DM + $8DL + $3 VOH) Order should be accepted because the $22 order price exceeds the $15 variable cost of the product.

51. SUM MORE EQUATIONS 1 1)Contribution Margin Per Unit = Selling Price Per Unit – Total Variable Cost Per Unit 2)Contribution Margin Ratio = Contribution Margin Per Unit / Selling Price Per Unit 3)Break-Even Point in Units = Fixed Cost / Contribution Margin Per Unit 4)Margin of Safety ( %) = Expected Sales – Break-even Point / Expected Sales 5)Dollar Sales at Target Income = Fixed Cost + Target Income / Contribution Margin Ratio Atef Abuelaish51

52. SUM MORE EQUATIONS 2 6) Unit Sales at Target Income = Fixed Cost + Target Income / Contribution Margin Per Unit 7) Revised Break-Even Point = Revised Fixed Costs / Contribution Margin Ratio 8) Break-Even Point in Composite Unit = Fixed Costs / Contribution Margin Per Composite Unit 9) Income Under Absorption Costing = Income Under Variable Costing + Fixed Overhead Cost in Ending Inventory - Fixed Overhead Cost in Beginning Inventory Atef Abuelaish52

53. Homework assignment 760Chapter 6  Using Connect – 7 Questions for 60 Points; Chapter 6. Master Budgets and Performance Planning  Prepare chapter 7 “ Master Budgets and Performance Planning.” Happiness is having all homework up to date Atef Abuelaish53

54. Thank you and See You Next Week at the Same Time, Take Care Thank you and See You Next Week at the Same Time, Take Care Atef Abuelaish54

55. Analysis of Income Reporting for Variable Costing: Units Produced Exceed Units Sold 55 P 2