1. CHAPTER 9
INVENTORY COSTING

2. Absorption costing The cost of a unit of product consists of:
Direct materials
Direct labor
Manufacturing overhead

3. Variable costing Direct materials
The cost of a unit of product consists of only variable manufacturing costs:
Direct materials
Direct labor
Variable manufacturing overhead

4. Overview of Absorption and Variable Costing
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
Variable Costing
Absorption Costing
Product Costs
Period Costs

5. Note: Manufacturing Cost Flows
Balance Sheet Costs Inventories
Income Statement Expenses
Material Purchases
Work in Process
Finished Goods
Raw Materials
Direct Labor
Variable Manufacturing Overhead
Absorption costing
Cost of Goods Sold
Selling and Administrative
Fixed Manufacturing Overhead
Variable costing
Selling and Administrative
Period Costs

6. Harvey Co. Variable costs per unit: Direct materials $5 Direct labor 3
Variable manufacturing overhead 2
Variable selling & admin. expenses 2
Monthly fixed costs:
Fixed manufacturing overhead $50,000
Fixed selling & admin. expenses 35,000
Selling price per unit: $30
Assume normal output is 10,000 units per month.

7. Harvey Co.

8. Product cost - Absorption costing
Harvey Co.
Product cost - Absorption costing
Direct materials
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead
Total cost per unit

9. Harvey Co.

10. Product cost - Variable costing
Harvey Co.
Product cost - Variable costing
Direct materials 5
Direct labor 3
Variable manufacturing overhead 2
Total cost per unit 10

11. Harvey Co.

12. Income Comparison of Absorption and Variable Costing
Let’s compare the methods (February).

13. Harvey Co. Income reconciliation

14. Extending the Example Let’s look at the second quarter of operations
for Harvey
Company.

15. Harvey Co.

16. Harvey Co.

17. Harvey Co.

18. Harvey Co. Income reconciliation

19. Summary

20. Quick Check 1
Which method will produce the highest values for work in process and finished goods inventories?
a. Absorption costing.
b. Variable costing.
c. They produce the same values for these inventories.
d. It depends. . .

21. Quick Check 2 Which method will produce the highest retained earnings?
a. Absorption costing
b. Variable costing
c. There would be no difference in retained earnings under the two methods.
d. It depends ...

22. Quick Check 3 Which method will produce the highest cumulative profit?
a. Absorption costing
b. Variable costing
c. There would be no difference in cumulative profit under the two methods.
d. It depends ...

23. Advantages of the Variable Approach
Management finds it
easy to understand.
Consistent with
CVP analysis.
Net operating income
is closer to net cash flow.
Profit is not affected by changes in inventories.
Consistent with standard costs and flexible budgeting.
Impact of fixed
costs on profits
emphasized.
Easier to estimate profitability of products and segments.

24. Advantages of the Absorption Approach
They are the numbers that
appear on our external reports.
All manufacturing costs must be assigned to products to properly match revenues and costs.
Depreciation, taxes, insurance and salaries are just as essential to products as variable costs.

25. Which approach should we follow? Variable or Absorption costing?

26. Impact of JIT Inventory Methods
In a JIT inventory system . . .
Production tends to equal sales . . .
So, the difference between variable and
absorption income tends to disappear.

27. End of chapter 9