Chapter 3: Absorption Costing and Variable Costing Example: Per Aircraft Per Month
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tranhakhanh145Chapter 3: Absorption Costing and Variable Costing Example: Per Aircraft Per Month
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tranhakhanh145Chapter 3: Absorption costing and Variable costing Example:
I. General Understanding
Per Aircraft Per Month
Absorption Cost Variable Cost S elling price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
$
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,000
t reats all manufacturing costs as nly those manufacturing costs that
o Direct labor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,000
product costs, regardless of whether vary with output are treated as product Variable manufacturing overhead . . . . . . . . . . . . . . . $1,000
they are variable or fixed. costs. (direct materials, direct labor, Fixed manufacturing overhead . . . . . . . . . . . . . . . . . . $70,000
variable manuf overhead) Variable selling and administrative expenses. . . . $10,000
he cost of a unit of product consist of
T
Fixed selling and administrative expenses. . . . . . . $20,000
direct materials, direct labor, and both ote: Fixed manuf overhead is period
N
variable and fixed manufacturing cost (like admi expens, …)
overhead
t he cost of a unit of product in January February March
Note: absorption costing includes all
manufacturing costs in product costs, it inventory or in cost of goods sold
eginning inventory . . . . . . . . . . . . . .
B
0
0
1
is frequently referred to as the full cost doesnt contain Fixed manuf overhead
Units produced . . . . . . . . . . . . . . . . . . . 1 2 4
method Units sold . . . . . . . . . . . . . . . . . . . . . . . . 1 1 5
Ending inventory . . . . . . . . . . . . . . . . . 0 1 0
II. Variable Costing vs Absorption Costing
ariable Costing Contribution Format Income Statement
V
1. Variable Costing Unit Product Cost → Variable Costing Cost of Goods Sold
2. Selling and Administrative Expenses
3. Putting all together
4. Contribution Margin → for each month
1. Compute 1&2 in Variable costing form
Variable Costing Unit Product Cost
Direct materials $19,000
Direct labor 5,000
Variable manufacturing overhead 1,000
Variable costing unit product cost 25,000
4. Conducting Contribution Margin (Selling price - VC per/total)
Variable Costing Cost of Goods Sold
Contribution Margin per Aircraft Sold
January February March
Selling price per aircraft $100,000
Variable production cost (a) $25,000 $25,000 $25,000
Variable production cost per aircraft $25,000
Units sold (b) 1 1 5
Variable selling and administrative expense per aircraft 10,000 35,000
Variable cost of goods sold (a) × (b). $25,000 $25,000 $125,000
Contribution margin per aircraft $ 65,000
2. Selling and Administrative Expenses
Variable Costing Cost of Goods Sold
January February March
January February March
Number of aircraft sold 1 1 5
ariable selling and administrative expense
V
(@ $10,000 per unit sold) $10,000 $10,000 $50,000 Contribution margin per aircraft x $65,000 $65,000 $65,000
Fixed selling and administrative expense 20,000 20,000 20,000 Total contribution margin $65,000 $65,000 $325,000
Total selling and administrative expense $30,000 $30,000 $70,000 Total fixed expenses 90,000 90,000 90,000
Net operating income (loss) $(25,000) $(25,000) $235,000
3. Putting all together
CONCLUSION
- D ù ng VC method thì sẽ record DL, DC, ManuOver vào Cost of Goods
- Có 2 cách lập IncStatement (nhận biết Net operating income là gain/loss):
+ Dù ng cách cũ : Tính VC per unit product cost → Tính ra VC of cost of goods
+ Dù ng cách CM:
Selling price - VC = CM/unit → CM/unit x Volume = Total CM
Total CM - Total Fixed expenses = Net operating income
ote:IntheVCcontributionformatincomestatement,VSellingandAdminis
N
expens are in Variable expenses (vice versa with fixed)
Absorption Costing Income Statement: Reconciliation of Variable Costing with Absorption Costing Income
1. Conduct Absorption Costing Unit Product Cost → Income statement → There are certain differences between VC and AC in IncStatement:
+ Under absorption costing some fixedmanufacturingoverheadiscapitalized
Absorption Costing Unit Product Cost in inventories (included in Product Cost) rather than expenses on the
IncStatement → some cases net operating income is lower than VC
January February March
→ Differences occurs when Inventories increase or decrease:
Direct materials $19,000 $19,000 $19,000
Direct labor 5,000 5,000 5,000 Cases Details
Variable manufacturing overhead 1,000 1,000 1,000 C > VC
A
inventories because a portion of the fixed
ixed manufacturing overhead
F units produced > number of units sold manufacturing overhead for the
($70,000 ÷ 1 unit produced in January; $70,000 ÷ 2 units increase
period is deferred in inventory
produced in February; $70,000 ÷ 4 units produced in (AC)
March) 70,000 35,000 17,500
C < VC
A
Absorption costing unit product cost $95,000 $60,000 $42,500 because a portion of the fixed
inventories
units produced < units sold manufacturing overhead from
decrease
ote:fixedmanufacturingoverheadcostof$70,000isdividedbythenumber
N previous periods is released
of units produced to determine the fixed manufacturing overhead cost per from inventory.
unit.
no change in AC = VC
2. Conduct income statements units produced = units sold
inventories
Absorption Costing Unit Product Cost
III. Advantages and disadvantages of both variable and absorption costing.
January February March
Sales $100,000 $100,000 $500,000 Negatives of AC
ost of goods sold
C Both Impact on the Manager hose who agaist absorption costing argue
T
($95,000 × 1 unit; $60,000 × 1 unit; $60,000 × 1 unit + that it can distort financial results because
$42,500 × 4 units) 95,000 60,000 230,000 fixed manufacturing overhead costs can be
shifted between periods based on
Gross margin 5,000 40,000 270,000
inventory changes. This may lead to poor
Selling and administrative expenses 30,000 30,000 70,000 decision-making.
Net operating income (loss) $(25,000) $10,000 $200,000 I n contrast, variable costing provides a clearer
picture becausenet operating income is
CONCLUSION directly linked to sales volume rather than
production levels. This makes it easier for
- Có nhiều điểm khác nhau giữ a absorption costing và variable costing
managers to predict profitability, as income
- The selling and administrative expenses equal the amounts reported in the only changes when sales change,aligning
variable costing income statements; however they are reported as one with their expectations.
amount rather than being separated into variable and fixed components -
khô ng report 2 cái variable và fixed
bsorption
A VP Analysis, and Decision
C C treats fixed manufacturing overhead as a
A Variable Costing and Theory of constraint (TOC)
costing Making variable cost. It assigns per unit fixed
I n the Theory ofConstraints(TOC)approach,companiesuseaformofvariable
manufacturing overhead costs to production.
1. Treating fixed manufacturing overhead as a costing but treat direct labor as a fixed cost instead of a variable cost. This is
variable cost can: → Lead tofaulty pricing because:
decisions andfaulty keep-or-dropdecisions. 1. Many companies guarantee employees a minimum number of paid hours,
2. Assigning per unit fixed manufacturing making direct labor costs relatively fixed.
overhead costs to production can: → 2. Direct labor is usuallynotthe main bottleneck (constraint)in production, so
Potentially producepositive net operating
treating it as variable isn’t useful for decision-making.
incomeeven when thenumber of units sold
is less than the breakeven point. 3. TOC focuses on continuous improvement, and layoffs hurt employee morale.
Managers prefer to retain workers to sustain long-term efficiency gains.
bsorption
A xternal Reporting and
E - In many countries, including US, absorption Essentially, TOC sees direct labor as a long-term investment rather than a
costing Income Taxes costing must be used when filling out income short-term cost to cut.
tax returns.
- Absorption costing must be used for external Impact of Lean Production:
financial reports → shareholders may feel that
decisions should be based on absorption WhencompaniesuseLeanProduction,Productiontendstoequalsales→So,the
→
costing data difference between variable and absorption income tends to disappear.
Advantages of VC
PREDETERMINED OVERHEAD RATES - ABSORPTION COSTING Application of Manufacturing Overhead
ow to compute underapplied and overapplied overhead and how to dispose
h
of any balance remaining in the Manufacturing Overhead account at the end
of a period. Overhead applied = POHR x Actual activity
I. Allocation base Based on estimates, Actual amount of
- What? -Manufacturing overhead is applied to products/jobsthat are in and determined before llocation is based upon
a
the period begins. the actual level of activity
process. An allocation base (direct labor hours, direct labor dollars, or
(normal costing system).
machine hours) is used to assign manufacturing overhead to individual
products/jobs. Meaning of POHR
- Why?
1. It is impossible or difficult to trace overhead costs to particular f or example: POHR = $3 per Direct labor hours (DLH)
products/jobs. → For each direct labor hour worked on a particular product, $3.00 of
2. Manufacturing overhead consists of many different items ranging factory overhead will be applied to it
from the grease used in machines to the production manager’s salary. assuming each unit requires 2 direct labor hours
3. Many types of manufacturing overhead costs are fixed even though → each unit of the product absorbs $6 predetermined overhead
output fluctuates during the period.
I II. Implications of basing the predetermined overhead rate on activity at
I I. Manufacturing Overhead Application: The predetermined overhead rate capacity rather than on estimated activity for the period.
(POHR)
raditional POHR is criticized by:
T
1. Product costs fluctuate with activity levels
POHR is based on budgeted activity, if actual production changes, the applied
overheadcostsperunitmayvary.Thisinconsistencycanmakecostcomparisons
difficult and affect pricing and profitability analysis.
2. Products may be charged for unused costs
→ the allocation base is a cost driver that causes overhead. some products may be assigned overhead costs they didn’t actually incur →
overcosting(expensive) orundercosting(poor pricing)
Predetermined overhead rates are calculated using a three-step process:
1. Estimate the level of production for the period. xample: Equipment is leased for $100,000 per year. Running at full capacity,
e
2. Estimate total amount of the allocation base for the period. 50,000 units may be produced. The company estimates that 40,000 units will be
3. Estimate total manufacturing overhead costs. produced and sold next year. What is the predetermined overhead rate?
→ POHR = 3./2.
The Need for a POHR: Traditional Method Capacity Method
+ Using a predetermined rate makes it possibletoestimatetotalproduct/job
costs sooner
+ Actual overhead for the period is not known until the end of the period.
This is why some companies prefertouseactualoverheadratesoradjustfor
→
overhead variances at the end of the period.
IV. Underapplied or overapplied overhead cost
1. General concepts:
Underapplied overhead Overapplied overhead
nderapplied overheadoccurs when
U verapplied overheadoccurs when
O
the overhead applied to products/jobs the overhead applied to products/jobs
(using thepredetermined overhead ismore thanthe actual overhead costs
rate) isless thanthe actual overhead incurred. This means the company
costs incurred. This means the allocated too much overhead, making
companydid not allocate enough product costs appear higher than they
overhead, leading to understated should be.
product costs.
example for overapplied overhead:
a ssume actual overhead for the year was $120,000, the total direct labor hours
incurred were 50,000. The rest remains the same.
HowmuchtotaloverheadwasappliedtoHarveyFresh’sproductsduringtheyear?
Use Harvey’s predetermined overhead rate of $3.00 per direct labor hour
→ Overhead Applied During the Period = POHR x Actual Direct Labor Hours
= 3 x 50,000 = $150,000
→ 150,000 - 120,000 = 30,000Overapplied overhead
2. Disposition of Under/Overapplied Overhead: 2 ways
1. Allocatedintoaccounts(WorkinProcess,FinishedGoods,andCostofGoods
Sold), or
2. Closed out directly to costs of goods sold
losed out directly to costs of goods sold:
C Adjusted on the income statements
take a look back to the Harvey Fresh example Absorption Costing Year 1
T - accounts Produced 25,000 units
Harvey Fresh’s Cost of
Sales (20,000 x 30$) …………………………………… $600,000
Goods
Harvey Fresh Sold
’s Mfg.
Overhead Less Cost of goods sold
Unadjusted
Balance
A ctual Overhead eginning inventory ………………………………….
B $ -
overhead applied to Add COGM (25,000 x 16$)………………………… 00,000
4
costs $
p30,000
roducts Overapplied adjustment…………………………… (30,000)
120,000
A djusted 150,000 oods available for sale ……………………………..
G 370,000
Balance
Ending inventory (5,000 x 3$) …………………… 80,000 290,000
30,000 0,000
3
Overapplied Gross margin ……………………………………………… 310,000
Less Selling & Admin.Exp ……………………………
Entries Variable (20,000 x 3$) ……………………………… $ 60,000
Fixed ………………………………………………………. 100,000 160,000
Cost of Goods Sold 30,000
Net operating income $150,000
Manufacturing Overhead 30,000
verhead Between Accounts
O
Adjusted on balance sheets
Assume: In Year 1, Harvey Fresh ’s overhead applied in ending Work in Process
Unadjusted cost of goods sold $118,500 Inventory, ending Finished Goods Inventory, and Cost of Goods Sold is shown below:
Add underapplied overhead 5,000
Adjusted cost of goods sold $123,500
We would complete the following allocation of $30,000 overapplied overhead:
Allocation of
$30,000
Percent of overapplied
Amount Total overhead
Work in process $ - 0% $ -
Finished Goods 30,000 20% 6,000
20% x 30,000
Cost of Goods Sold 120,000 80% 24,000 IV. Potential problems of using absorption costing:
Total 150,000 100% 30,000 1. Creating Extra Profit Without Increase In Sales: (Overapplied in COGS)
Adjusted on General journal
Description Debit Credit
Manufacturing Overhead 30,000
Work in process Inventory 0
Finished goods Inventory 6,000
Cost of goods sold 24,000
Adjusted on Income Statement
Absorption Costing Year 1
Produced 25,000 units
I n this case, Harvey Fresh applied fixed manufacturing overhead based on actual
Sales (20,000 x 30$) …………………………………… $600,000 production using a predetermined overhead rate (POHR) of $6perunit.However,
the actual fixed overhead costs were only $120,000, leading to overapplied
Less Cost of goods sold
overhead in both scenarios:
eginning inventory ………………………………….
B $ - 1. Original Scenario (25,000 units produced):
Add COGM (25,000 x 16$)………………………… 00,000
4 ○ Applied overhead = 25,000 × $6 = $150,000
Overapplied adjustment………………………… (30,000) ○ Overapplied overhead = $150,000 - $120,000= $30,000
oods available for sale ……………………………..
G 370,000 2. New Scenario (35,000 units produced)
Ending inventory (5,000 x 3$) …………………… $ 80,000 ○ Applied overhead = 35,000 × $6 = $210,000
Overapplied adjustment (6,000) 74,000 296,000 ○ Overapplied overhead = $210,000 - $120,000= $90,000
Gross margin ……………………………………………… 304,000 Additionalprofitof$60,000arisesduetotheincreaseinendinginventory,which
→
carries forward some of the overapplied overhead.
Less Selling & Admin.Exp ……………………………
Variable (20,000 x 3$) ……………………………… $ 60,000 + If the overapplied overhead is written off to COGS, the additional profit
Fixed ………………………………………………………. 100,000 160,000 matches the overapplied difference ($90,000 - $30,000 = $60,000).
+ Iftheadjustmentisdoneusingaproportionalallocationmethod(instead
Net operating income $144,000 of writing it off to COGS directly), the increased profit may not match the
overapplied amount.
→Net Operating Income is different from the one withadjustment directly
REASONS: Overapplied overhead occurs because fixed costs don’t change with
through COGS ($150,000)
production, but applying them using POHR leads to higher applied costs when
more units are produced. The excess applied overhead is carried forward in
inventory, artificially inflating profit.
→ Value of Ending Inventory between 2 types of costing (VC & AC) V. Summary and multiple predetermined overhead rates
Absorption Costing Original New Alternative 1: Alternative 2:
I f Manufacturing Close to Cost of Goods Proportional Allocation
Produced 25,000 units Produced 35,000 units Overhead is . . . Sold
Overapplied adjustment (30,000) (90,000) UNDERAPPLIED INCREASE INCREASE
(applied overhead < Cost of Goods Sold Work in Process
Ending inventory (5,000 x 16$) $ 80,000
actual overhead) Finished Goods
(15,000 x 16$) $ 240,000 Cost of Goods Sold
Net operating income (AC) 150,000 210,000 OVERAPPLIED DECREASE DECREASE
(applied overhead > Cost of Goods Sold Work in Process
Predetermined fixed manufacturing overhead rate = 6$/unit actual overhead) Finished Goods
Cost of Goods Sold
Beginning Inventory/unit - -
ultiple predetermined overhead rates:
M
Ending Inventory/unit 5,000 15,000
a)Plantwide Overhead Rate (Single Rate)
Increase in Inventory 5,000 15,000 ● Asingle predetermined overhead rateis used for theentire factory.
● Common in smaller companiesbecause it is simple andeasy to apply.
Predetermined overhead rate 6$ 6$
● However, it maynot accurately reflecthow differentdepartments incur
S ame value as overapplied 30,000 90,000 overhead costs.
overhead (= difference in the
profit in VC) b) Multiple Predetermined Overhead Rates
● Eachproduction departmenthas itsown predeterminedoverhead rate.
Net income statement (VC) 120,000 120,000
● More complex butmore accuratethan the plantwidemethod.
● Allows overhead allocation to becustomizedbasedon the department’s
2. Comparing with Variable cost method:
operations:
○ Labor-intensive departments→ Overhead allocated basedondirect
labor-hours.
○ Machine-intensive departments→ Overhead allocatedbased on
machine-hours.
c) Benefit of Using Multiple Overhead Rates
● Improves cost accuracy bymatching overhead allocationto actual
resource usage.
● More suitable forlarger companieswith diverse productionprocesses.
● Overhead costs areapplied separatelyin each departmentas jobs move
through production.
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