1. Profit Reporting for Management Analysis

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3. Objectives
1. Describe and illustrate income reporting under variable costing and absorption costing.
2. Describe and illustrate income analysis under variable costing and absorption costing.
3. Describe and illustrate management’s use of variable costing and absorption costing for controlling costs, pricing products, planning production, analyzing market segments, and analyzing contribution margins.

4. Objectives
4. Illustrate contribution margin reporting for products, territories, and salespersons.
5. Explain changes in contribution margin as a result of quantity and price factors.
6. Describe and illustrate contribution margin reporting and analysis for service firms.

5. Two Costing Methods
Absorption Costing
Used for external financial reporting
Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost

6. Two Costing Methods
Variable Costing
Used for internal planning and decision making
Does not include fixed factory overhead as a product cost

7. Absorption Costing Compared to Variable Costing
Cost of Goods Manufactured
Direct
Materials
Direct
Labor
Variable
Factory OH
Fixed
Factory OH
Period Expense
Cost of Goods Manufactured
Variable Costing

8. Variable Costing Income Statement
Units Manufactured Equal Units Sold
Variable Costing Income Statement
Sales (15,000 x $50) $750,000
Variable cost of goods sold:
Variable cost of goods mfg.
(15,000 x $25) $375,000
Less ending inventory
Variable cost of goods sold ,000
Manufacturing margin $375,000
Variable selling and administrative
expenses (15,000 x $5) ,000
Contribution margin $300,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and administrative
expenses , ,000
Income from operations $100,000

9. Units Manufactured Equal Units Sold
Absorption Costing Income Statement
Sales (15,000 x $50) $750,000
Cost of goods sold:
Cost of goods manufactured
(15,000 x $35) $525,000
Less ending inventory
Cost of goods sold ,000
Gross profit $225,000
Selling and administrative expenses
($75,000 + $50,000) ,000
Income from operations $100,000
Income from operations $100,000
When the number of units manufactured equals the number of units sold, income from operations will be the same under both methods.

10. Variable Costing Income Statement
Units Manufactured Exceed Units Sold
Variable Costing Income Statement
Sales (12,000 x $50) $600,000
Variable cost of goods sold:
Variable cost of goods manufactured
(15,000 x $25) $375,000
Less ending inventory (3,000 x $25) ,000
Variable cost of goods sold ,000
Manufacturing margin $300,000
Variable selling and admin. expenses ,000
Contribution margin $240,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and admin. expenses , ,000
Income from operations $ 40,000

11. Absorption Costing Income Statement
Units Manufactured Exceed Units Sold
Absorption Costing Income Statement
Sales (12,000 x $50) $600,000
Cost of goods sold:
Cost of goods manufactured
(15,000 x $35) $525,000
Less ending inventory (3,000 x $35) 105,000
Cost of goods sold ,000
Gross profit $180,000
Selling and administrative expenses
[(12,000 x $5) + $50,000] ,000
Income from operations $ 70,000

12. Units Manufactured Exceed Units Sold
Operating Income:
Absorption costing $70,000
Variable costing ,000
Difference $30,000
Why is absorption costing income higher when units manufactured exceed units sold?

13. Units Manufactured Exceed Units Sold
Operating Income:
Absorption costing $70,000
Variable costing 40,000
Difference $30,000
Analysis:
Units manufactured 15,000
Units sold 12,000
Ending inventory units 3,000
Fixed cost per unit x $10
Difference $30,000

14. Variable Costing Income Statement
Units Manufactured Are Less Than Units Sold
Variable Costing Income Statement
Sales (15,000 x $50) $750,000
Variable cost of goods sold:
Beginning inventory (5,000 x $25) $125,000
Variable cost of goods manufactured (10,000 x $25) , ,000
Manufacturing margin $375,000
Variable selling and admin. expenses ,000
Contribution margin $300,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and admin. expenses 50, ,000
Income from operations $100,000

15. Units Manufactured Are Less Than Units Sold
Variable Costing Income Statement
Sales (15,000 x $50) $750,000
Variable cost of goods sold:
Beginning inventory (5,000 x $25) $125,000
Variable cost of goods manufactured (10,000 x $25) , ,000
Manufacturing margin $375,000
Variable selling and admin. expenses ,000
Contribution margin $300,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and admin. expenses , ,000
Income from operations $100,000

16. Absorption Costing Income Statement
Units Manufactured Are Less Than Units Sold
Absorption Costing Income Statement
Sales (15,000 x $50) $750,000
Cost of goods sold:
Beginning inventory (5,000 x $35) $175,000
Cost of good manufactured (10,000 x $45) ,000
Cost of goods sold ,000
Gross profit $175,000
Selling and administrative expenses
($75,000 + $50,000) ,000
Income from operations $ 50,000

17. Units Manufactured Are Less Than Units Sold
Operating Income:
Variable costing $100,000
Absorption costing ,000
Difference $ 50,000
Why is variable costing income higher when units manufactured are less than units sold?

18. Units Manufactured Are Less Than Units Sold
Operating Income:
Variable costing $100,000
Absorption costing ,000
Difference $ 50,000
Analysis:
Units sold 15,000
Units manufactured 10,000
Ending inventory units 5,000
Fixed cost per unit x $10
Difference $50,000

19. Income Income Units Sold < Units produced IF
THEN
Variable Costing < Absorption Costing
Income Income

20. Income Income Units Sold > Units produced IF
THEN
Variable Costing > Absorption Costing
Income Income

21. Income Analysis Under Variable Costing and Absorption Costing
Frand Manufacturing Company has no beginning inventory and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels.

22. Income Analysis Under Variable Costing and Absorption Costing
Proposal 1: 20,000 Units to Be Manufactured and Sold
Total Cost
Unit Cost
Manufacturing costs:
Variable $ 700,000 $35
Fixed ,
Total costs $1,100,000 $55
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed ,000
Total expenses $ 200,000

23. Income Analysis Under Variable Costing and Absorption Costing
Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold
Total Cost
Unit Cost
Manufacturing costs:
Variable $ 875,000 $35
Fixed ,
Total costs $1,275,000 $51
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed ,000
Total expenses $ 200,000

24. Frand Manufacturing Company Absorption Costing Income Statements
20,000 Units Manufactured
25,000 Units Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured (20,000 units x $55) $1,100,000
$35 + ($400,000 ÷ 20,000)

25. Frand Manufacturing Company Absorption Costing Income Statements
20,000 Units Manufactured
25,000 Units Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured (20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
$35 + ($400,000 ÷ 25,000)

26. Frand Manufacturing Company Absorption Costing Income Statements
20,000 Units Manufactured
25,000 Units Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured (20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
Less ending inventory: (5,000 units x $51) ,000
Cost of goods sold $1,100,000 $1,020,000
Gross profit $ 400,000 $ 480,000
Selling and administrative expenses ($100,000 + $100,000) , ,000
Income from operations $ 200,000 $ 280,000

27. Now, assume that Frand Manufacturing uses variable costing.

28. Frand Manufacturing Company Variable Costing Income Statements
20,000 Units Manufactured
25,000 Units Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured: (20,000 units x $35) $ ,000
(25,000 units x $35) $ 875,000
Direct materials, direct labor, and variable manufacturing overhead only.

29. Frand Manufacturing Company Variable Costing Income Statements
20,000 Units Manufactured
25,000 Units Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured: (20,000 units x $35) $ ,000
(25,000 units x $35) $ 875,000
Less ending inventory:
(0 units x $35) 0
(5,000 units x $35) ,000
Variable cost of goods sold $ 700,000 $ 700,000
Manufacturing margin $ 800,000 $ 800,000
Continued

30. Frand Manufacturing Company Variable Costing Income Statements
20,000 Units Manufactured
25,000 Units Manufactured
Manufacturing margin $ 800,000 $ 800,000
Variable selling and administrative expenses , ,000
Contribution margin $ 700,000 $ 700,000
Fixed costs: Fixed manufacturing costs $ 400,000 $ 400,000
Fixed selling and administrative expenses , ,000
Total fixed costs $ 500,000 $ 500,000
Income from operations $ 200,000 $ 200,000

31. What would be the income from operations if the firm manufactured 30,000 units?

32. Frand Manufacturing Company Variable Costing Income Statements
30,000 Units Manufactured
Sales $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured: (30,000 units x $35) $1,050,000
Less ending inventory: (10,000 units x $35) ,000
Variable cost of goods sold $ 700,000
Manufacturing margin $ 800,000
Continued

33. Frand Manufacturing Company Variable Costing Income Statements
30,000 Units Manufactured
Manufacturing margin $ 800,000
Variable selling and administrative expenses ,000
Contribution margin $ 700,000
Fixed costs: Fixed manufacturing costs $ 400,000
Fixed selling and administrative expenses ,000
Total fixed costs $ 500,000
Income from operations $ 200,000

34. Management’s Use of Costing Methods
Variable costing reports and absorption costing reports are useful in the following situations:
1. Controlling costs
2. Pricing products
3. Planning production
4. Analyzing market segments
5. Analyzing contribution margins

35. Accounting Reports and Management Decisions
Absorption Costing and Variable Costing
MANAGEMENT

36. MANAGEMENT DECISIONS Controlling Costs Pricing Planning Production
Analyzing Market Segments
Analyzing Contribution Margins
ACTUAL
PLANNED

37. Pricing Products
In the short run, we are committed to our existing manufacturing facilities.

38. Pricing Products
That is correct. The pricing decision should be based upon making the best use of our existing capacity.

39. Pricing Products
Even in the long-run where plant capacity can be changed, the selling prices of our products must cover all costs and provide a reasonable income.

40. Analyzing Market Segment
A market segment is a portion of business that can be assigned to a manager for profit responsibility.

41. Contribution Margin Reporting for Market Segments
Camelot Fragrance Company manufactures and sells the Gwenevere perfume for women and the Lancelot cologne line for men. The inventories are negligible.

42. Northern Southern
Territory Territory Total
Sales:
Gwenevere $60,000 $30,000 $ 90,000 Lancelot 20, , ,000
Total territory sales $80,000 $80,000 $160,000
Variable production costs:
Gwenevere (12% of sales) $ 7,200 $ 3,600 $ 10,800
Lancelot (12% of sales) 2, , ,400
Total variable production cost by territory $ 9,600 $ 9,600 $ 19,200
Continued

43. Northern Southern
Territory Territory Total
Promotion costs:
Gwenevere (30% of sales) $18,000 $ 9,000 $ 27,000 Lancelot(20% of sales) 4, , ,000
Total variable production cost by territory $22,000 $19,000 $ 41,000
Sales commissions:
Gwenevere (20% of sales) $12,000 $ 6,000 $ 18,000
Lancelot (12% of sales) 2, , ,000
Total sales commission by territory $14,000 $11,000 $ 25,000

44. Variable cost of goods sold 9,600 9,600
Camelot Fragrance Company Contribution Margin by Sales Territory For the Month Ended March 31, 2006
Northern Southern
Territory Territory
Sales $80,000 $80,000
Variable cost of goods sold 9, ,600
Manufacturing margin $70,400 $70,400
Variable selling expenses:
Promotion costs $22,000 $19,000
Sales commissions 14, ,000
Total $36,000 $30,000
Contribution margin $34,400 $40,400
Contribution margin ratio 43% 50.5%

45. Camelot Fragrance Company Contribution Margin by Product Line
Camelot Fragrance Company Contribution Margin by Product Line For the Month Ended March 31, 2006
Gwenevere Lancelot
Sales $90,000 $70,000
Variable cost of goods sold 10, ,400
Manufacturing margin $79,200 $61,600
Variable selling expenses:
Promotion costs $ 27,000 $14,000
Sales commissions 18, ,000
Total $45,000 $21,000
Contribution margin $34,200 $40,600
Contribution margin ratio 38% 58%

46. Camelot Fragrance Company Contribution Margin by Salesperson—Northern Territory For the Month Ended March 31, 2003
Inez Tom Beth
Rodriquez Ginger Williams Total
Sales $20,000 $20,000 $40,000 $80,000
Variable cost of goods sold 2, , , ,600
Manufacturing margin $17,600 $17,600 $35,200 $70,400
Variable selling expenses:
Promotion costs $ 5,000 $ 5,000 $12,000 $22,000
Sales commissions , , , ,000
$ 8,000 $ 8,000 $20,000 $36,000
Contribution margin $ 9,600 $ 9,600 $15,200 $34,400
Contribution margin ratio 48% 48% 38% 43%
Sales mix (% Lancelot sales) 50% 50% 0% 25%

47. Contribution Margin Analysis
Planned Contribution Margin
Actual Contribution Margin –
Sales
Variable Cost of Goods Sold
Variable Selling and Administrative Expenses
Continued

48. Contribution Margin Analysis
Sales
Variable Cost of Goods Sold
Variable Selling and Administrative Expenses
Quantity Factor
+/–
Price Factor
Quantity Factor
+/–
Unit Cost Factor
Quantity Factor
+/–
Unit Cost Factor

49. Changes in Contribution Margin as a Result of Quantity and Price Factors
Quantity factor
The difference between the actual quantity sold and the planned quantity sold, multiplied by the planned unit sales price or unit cost.
Unit price or unit cost factor
The difference between the actual unit price or unit cost and the planned unit price or unit cost, multiplied by the actual quantity sold.

50. Noble Inc. for Year Ended December 31, 2006
Increase or (Decrease)
Actual
Planned
Sales $937,500 $800,000 $137,500
Less: Variable cost of
goods sold $425,000 $350,000 $ 75,000
Variable selling and
administrative exp , , ,500
Total $587,500 $475,000 $112,500
Contribution margin $350,000 $325,000 $ 25,000
Continued

51. Noble Inc. for Year Ended December 31, 2006
Actual
Planned
Number of units sold 125, ,000
Per unit:
Sales price $7.50 $8.00
Variable cost of
goods sold $3.40 $3.50
Variable selling and
administrative exp. $1.30 $1.25

52. Contribution Margin Report
Blue Skies Airlines Inc. operates a small commercial airline.

53. Food and beverage service exp. 444,000
Blue Skies Airlines Inc.
Contribution Margin and Income from Operations Report
for the Month Ended April 30, 2006
Revenue $19,238,000
Variable costs:
Fuel expense $4,080,000
Wages expense 6,120,000
Food and beverage service exp. 444,000
Selling expenses 3,256, ,900,000
Contribution margin $ 5,338,000
Fixed costs:
Depreciation expense $3,600,000
Rental expense , ,400,000
Income from operations $ 938,000

54. Food and beverage service exp. 240,000
Blue Skies Airlines Inc.
Contribution Margin by Route Report—Chicago/Atlanta
for the Month Ended April 30, 2006
Revenue $6,400,000
Variable costs:
Fuel expense $1,120,000
Wages expense 1,680,000
Food and beverage service exp. 240,000
Selling expenses 1,760, ,800,000
Contribution margin $1,600,000
Contribution Margin Ratio = 0.25

55. Food and beverage service exp. 105,000
Blue Skies Airlines Inc.
Contribution Margin by Route Report—Atlanta/Los Angeles
for the Month Ended April 30, 2006
Revenue $7,525,000
Variable costs:
Fuel expense $1,760,000
Wages expense 2,640,000
Food and beverage service exp. 105,000
Selling expenses , ,275,000
Contribution margin $2,250,000
Contribution Margin Ratio = 0.30

56. Food and beverage service exp. 99,000
Blue Skies Airlines Inc.
Contribution Margin by Route Report—Los Angeles/Chicago
for the Month Ended April 30, 2006
Revenue $5,313,000
Variable costs:
Fuel expense $1,200,000
Wages expense 1,800,000
Food and beverage service exp. 99,000
Selling expenses , ,825,000
Contribution margin $1,488,000
Contribution Margin Ratio = 0.28

57. Blue Skies Airlines Inc. Contribution Margin—Chicago/Atlanta
Actual—May
Planned—May
Revenue $7,600,000 $6,400,000
Less variable expenses:
Fuel expense $1,232,000 $1,120,000
Wages expense 1,680,000 1,680,000
Food and beverage service exp. 300, ,000
Selling expenses and commiss. 2,200, ,760,000
Total $5,412,000 $4,800,000
Contribution margin $2,188,000 $1,600,000
Contribution Margin Ratio
Continued

58. Blue Skies Airlines Inc. Contribution Margin—Chicago/Atlanta
Actual—May
Planned—May
Number of miles flown 56,000 56,000
Number of passengers flown 20,000 16,000
Per unit:
Ticket price $380 $400
Fuel expense 22 20
Wages expense 30 30
Food and beverage service exp
Selling expenses

59. Blue Skies Airlines Inc. Contribution Margin Analysis
Contribution Margin Analysis Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in revenue attributed to:
Quantity factor:
Increase in the number of tickets sold in May (4,000 x $400) $1,600,000
Price factor:
Decrease in the ticket price in May ($20 x 20,000) (400,000)
Net increase in revenue $1,200,000
Continued

60. Blue Skies Airlines Inc. Contribution Margin Analysis
Contribution Margin Analysis Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in fuel costs attributed to:
Unit cost factor:
Increase in unit cost in May times number of miles flown
($2 x 56,000) $112,000
Continued

61. Blue Skies Airlines Inc. Contribution Margin Analysis
Contribution Margin Analysis Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in food and beverage service costs attributed to:
Quantity factor:
Increase in number of tickets sold in May times planned unit cost
in May (4,000 x $15.00) $60,000
Continued

62. Blue Skies Airlines Inc. Contribution Margin Analysis
Contribution Margin Analysis Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in selling costs and commissions attributed to:
Quantity factor:
Increase in number of tickets sold in May times planned unit cost
in May (4,000 x $110) $440,000
Continued

63. Blue Skies Airlines Inc. Contribution Margin Analysis
Contribution Margin Analysis Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Summary:
Net increase in revenue $1,200,000
Net increase in fuel cost (112,000)
Net increase in food and beverage
service costs (60,000)
Net increase in selling costs (440,000)
Increase in contribution margin $ 588,000

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