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Variable & Absorption Costing

The document discusses variable and absorption costing, emphasizing the contribution format for income statements which separates costs into fixed and variable categories. It outlines the uses of the contribution format for internal planning and decision-making, including cost-volume-profit analysis and budgeting. Additionally, it compares net operating income under both costing methods, showing how fixed manufacturing overhead impacts income reporting.

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Erika Bardelosa
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9 views25 pages

Variable & Absorption Costing

The document discusses variable and absorption costing, emphasizing the contribution format for income statements which separates costs into fixed and variable categories. It outlines the uses of the contribution format for internal planning and decision-making, including cost-volume-profit analysis and budgeting. Additionally, it compares net operating income under both costing methods, showing how fixed manufacturing overhead impacts income reporting.

Uploaded by

Erika Bardelosa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Variable and Absorption Costing

McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
5-2

Learning Objective 5

Prepare an income statement


using the contribution format.
5-3

The Contribution Format

Total Unit
Sales Revenue $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Net operating income $ 10,000

The contribution margin format emphasizes


cost behavior, by separating costs into fixed and
variable categories. Contribution margin covers
fixed costs and provides for income.
5-4

Uses of the Contribution Format

The contribution income statement format is used


as an internal planning and decision-making tool.
This approach is used for:
1. Cost-volume-profit analysis.
2. Budgeting
3. Special decisions such as pricing and make-or-
buy analysis.
5-5

The Contribution Format

Used primarily for Used primarily by


external reporting. management.
Variable Costing

McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
5-7

Learning Objective 6

Use variable costing to prepare a


contribution format income statement
and contrast absorption costing and
variable costing.
5-8
Overview of Absorption
and Variable Costing

Absorption Variable
Costing Costing
Direct Materials
Product
Product Direct Labor
Costs
Costs Variable Manufacturing Overhead

Fixed Manufacturing Overhead


Period
Period Variable Selling and Administrative Expenses
Costs
Costs Fixed Selling and Administrative Expenses
5-9

Quick Check ✓

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.
5-10

Quick Check ✓

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.
5-11

Summary of Key Insights

NOI = net operating income


5-12

Unit Cost Computations

Harvey Company produces a single product


with the following information available:
5-13

Unit Cost Computations

Unit product cost is determined as follows:

Selling and administrative expenses are


always treated as period expenses and deducted
from revenue as incurred.
5-14
Income Comparison of
Absorption and Variable Costing

Let’s assume the following additional information


for Harvey Company.
◼ 20,000 units were sold during the year at a price of
$30 each.
◼ There is no beginning inventory.

Now, let’s compute net operating


income using both absorption
and variable costing.
5-15

Absorption Costing
5-16

Variable Costing
Variable
manufacturing
Variable Costing
costs only.
Sales (20,000 × $30) $ 600,000
Less variable expenses:
Beginning inventory $ -
All fixed
Add COGM (25,000 × $10) 250,000
manufacturing
Goods available for sale 250,000
overhead is
Less ending inventory (5,000 × $10) 50,000
Variable cost of goods sold 200,000
expensed.
Variable selling & administrative
expenses (20,000 × $3) 60,000 260,000
Contribution margin 340,000
Less fixed expenses:
Manufacturing overhead $ 150,000
Selling & administrative expenses 100,000 250,000
Net operating income $ 90,000
5-17
Comparing Absorption and
Variable Costing
Let’s compare the methods.
5-18
Comparing Absorption and
Variable Costing

We can reconcile the difference between absorption


and variable net operating income as follows:

Variable costing net operating income $ 90,000


Add: Fixed mfg. overhead costs
deferred in inventory
(5,000 units × $6 per unit) 30,000
Absorption costing net operating income $ 120,000

Fixed mfg. overhead $150,000


= = $6.00 per unit
Units produced 25,000 units
5-19

Extended Comparison of Income Data

Here is information about the operation


of Harvey Company for the second year.
5-20

Unit Cost Computations

Since there was no change in the variable costs


per unit, total fixed costs, or the number of
units produced, the unit costs remain unchanged.
5-21

Absorption Costing

Absorption Costing
Sales (30,000 × $30) $ 900,000
Less cost of goods sold:
Beg. inventory (5,000 × $16) $ 80,000
Add COGM (25,000 × $16) 400,000
Goods available for sale 480,000
Less ending inventory - 480,000
Gross margin 420,000
Less selling & admin. exp.
Variable (30,000 × $3) $ 90,000
Fixed 100,000 190,000
Net operating income $ 230,000

These are the 25,000 units


produced in the current period.
5-22

Variable Costing Variable


manufacturing
costs only.

All fixed
manufacturing
overhead is
expensed.
5-23
Comparing Absorption and
Variable Costing

We can reconcile the difference between absorption


and variable net operating income as follows:

Variable costing net operating income $ 260,000


Deduct: Fixed manufacturing overhead
costs released from inventory
(5,000 units × $6 per unit) 30,000
Absorption costing net operating income $ 230,000

Fixed mfg. overhead $150,000


= = $6.00 per unit
Units produced 25,000 units
5-24
Comparing Absorption and
Variable Costing
5-25

*****END*****

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