1. Managerial Accounting by James Jiambalvo
Chapter 5:
Variable Costing
Slides Prepared by:
Scott Peterson
Northern State University

2. Objectives
Explain the difference between full (absorption) and variable costing.
Prepare an income statement using variable costing.
Discuss the effect of production on full and variable costing income.
Explain the impact of JIT (just-in-time) on the difference between full and variable costing income.
Discuss the benefits of variable costing for internal reporting purposes

3. Full (Absorption) Costing
Full (Absorption) Costing includes:
Direct material
Direct labor
Manufacturing overhead (both variable and fixed)
Decision making and “what-if” decisions are difficult because of the commingling of fixed and variable overhead.
Required for GAAP.

4. Variable Costing Variable Costing includes: Direct material
Direct labor
Variable Manufacturing overhead
Variable Costing lends itself well to decision making and “what-if” analyses.
Not allowed for GAAP.

5. Differences Between Full (Absorption) and Variable Costing
Fixed manufacturing overhead (included in Full Costing).
Fixed manufacturing costs, like depreciation, are a period expense on the income statement under variable costing.
Fixed manufacturing costs, like depreciation, are inventoried until sold under full costing.

6. Variable Costing Income Statement
The format uses a contribution margin approach.
All costs, manufacturing, selling and administrative, are classified as either fixed or variable.

7. Variable Costing Income Statement Example
Sales $100,000
Less Variable:
Variable COGS $20,000
Variable Selling 10,000
Variable Admin , ,000
Contribution Margin ,000
Less Fixed:
Fixed Mfg ,000
Fixed Selling ,000
Fixed Admin , ,000
Net Income ,000

8. Full (Absorption) Costing Income Statement Example
Sales $100,000
Less COGS ,000
Gross Margin ,000
Less Selling and Admin:
Selling ,000
Admin , ,000
Net Income ,000

9. Effects of Production on Income for Full Versus Variable Costing: Clausen Tube
Facts:
5,000 units produced and sold
Selling Price: $2,000 per unit
Variable Manufacturing:
Direct Materials: $600 per unit
Direct Labor: $225 per unit
Variable MFG: $75 per unit
Fixed Manufacturing: $1,200,000 per year
Selling Expense: $40 per unit variable plus $100,000 fixed.
Administrative: $500,000 per year (fixed)

10. Clausen Tube Income Statement: Full Costing
Sales $10,000,000
Less COGS ,700,000
Gross Margin ,300,000
Less Selling and Admin:
Selling $300,000
Admin , ,000
Net Income $3,500,000

11. Clausen Tube Income Statement: Variable Costing
Sales $10,000,000
Less Variable:
Variable COGS $4,500,000
Variable Selling
and Admin ,000
Contribution Margin ,300,000
Less Fixed:
Fixed Mfg. 1,200,000
Fixed Selling ,000
Fixed Admin , ,800,000
Net Income $3,500,000

12. Variable Costing Income Statement: Considerations
When sales volume and production volume are exactly equal, net income is the same under either full or variable costing.
Contribution margin is easily calculated under variable costing: 2,000 – 940 = 1,060.
Contribution margin ratio is: 1,060 / 2,000 = 53%

13. Clausen Tube: Production is Greater Than Sales
Facts:
6,000 units produced and 4,800 units sold
Selling Price: $2,000 per unit
Variable Manufacturing:
Direct Materials: $600 per unit
Direct Labor: $225 per unit
Variable MFG: $75 per unit
Fixed Manufacturing: $1,200,000 per year
Selling Expense: $40 per unit variable plus $100,000 fixed.
Administrative: $500,000 per year (fixed)

14. Clausen Tube Income Statement: Full Costing-- Production > Sales
Less COGS ,280,000
Gross Margin ,320,000
Less Selling and Admin:
Selling $292,200
Admin , ,200
Net Income $3,528,000

15. Clausen Tube Income Statement: Variable Costing-- Production > Sales
Less Variable:
Variable COGS $4,320,000
Variable Selling
and Admin ,000
Contribution Margin ,088,000
Less Fixed:
Fixed Mfg. 1,200,000
Fixed Selling ,000
Fixed Admin , ,800,000
Net Income $3,288,000

16. Variable Costing Income Statement: Considerations-- Production > Sales
Net income is higher under full costing than variable costing.
$3,528,000 vs. $3,288,000 = $240,000
The $240,000 difference is due to the 1,200 (6,000 – 4,800) additional units produced and unsold.
Fixed manufacturing $1,200,000 / 6,000 units x 1,200 units remaining = $240,000

17. Summary of Effects of Production on Net Income
If units produced = units sold, then no difference between full costing and variable costing net income.
If units produced > units sold, then full costing net income is greater than variable costing net income.
If units produced < units sold, then full costing net income is less than variable costing net income.

18. Impact of JIT on the Income Effects of Full Versus Variable Costing
JIT (Just-In-Time) inventory systems lead to low inventories.
Results in little difference between production and sales.
Variable versus absorption net income differences negligible.

19. Benefits of Variable Costing for Internal Reporting
Variable costing facilitates C-V-P analysis because it uses a “contribution” approach.
Variable costing mitigates the effects of earnings management because fixed manufacturing costs are not inventoried. Thus, merely increasing production volume relative to sales will not boost net income.

20. Quick Review Question #1
Which of the following lends itself well to C-V-P Analysis?
Full Costing
Absorption Costing
Variable Costing
Average Costing

21. Quick Review Answer #1
Which of the following lends itself well to C-V-P Analysis?
Full Costing
Absorption Costing
Variable Costing
Average Costing

22. Quick Review Question #2
Units produced = 2,000, units sold = 1,800, contribution margin ratio is 37%, fixed S & A expenses are $90,000. Fixed mfg. Expenses are $80,200 By how much is net income greater under full costing than variable costing?
$8,020
$80,200
$9,000
$17,020

23. Quick Review Answer #2
Units produced = 2,000, units sold = 1,800, contribution margin ratio is 37%, fixed S & A expenses are $90,000. Fixed mfg. Expenses are $80,200 By how much is net income greater under full costing than variable costing?
$8,020
$80,200
$9,000
$17,020

24. Quick Review Question #3
Which of the following complies with GAAP for external reporting purposes?
Absolute costing
Variable costing
Fixed costing
Absorption costing

25. Quick Review Answer #3
Which of the following complies with GAAP for external reporting purposes?
Absolute costing
Variable costing
Fixed costing
Absorption costing

26. Quick Review Question #4
Which of the following lends itself well to internal decision making?
Full costing
Variable costing
Absorption costing
None of these

27. Quick Review Answer #4
Which of the following lends itself well to internal decision making?
Full costing
Variable costing
Absorption costing
None of these

28. Copyright
© 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.