Time and Again Company Manufactures Clocks. The Fixed Overhead

Learning Objective

1. Understand how managers use variable costing to make decisions.

In Chapter 2 "How Is Job Costing Used to Track Production Costs?", we discussed how to report manufacturing costs and nonmanufacturing costs following U.S. Generally Accepted Accounting Principles (U.S. GAAP). Under U.S. GAAP, all nonmanufacturing costs (selling and authoritative costs) are treated as flow costs because they are expensed on the income statement in the period in which they are incurred. All costs associated with production are treated as product costs, including direct materials, directly labor, and stock-still and variable manufacturing overhead. These costs are fastened to inventory equally an nugget on the balance canvas until the goods are sold, at which bespeak the costs are transferred to cost of goods sold on the income statement as an expense. This method of accounting is chosen absorption costing considering all manufacturing overhead costs (stock-still and variable) are absorbed into inventory until the goods are sold. (The term full costing is also used to depict absorption costing.)

Question: Although absorption costing is used for external reporting, managers often prefer to apply an culling costing approach for internal reporting purposes called variable costing. What is variable costing, and how does information technology compare to absorption costing?

Answer: Variable costing requires that all variable production costs be included in inventory, and all stock-still production costs (fixed manufacturing overhead) exist reported as menstruum costs. Thus all stock-still product costs are expensed equally incurred.

The only difference betwixt absorption costing and variable costing is in the treatment of fixed manufacturing overhead. Using absorption costing, fixed manufacturing overhead is reported every bit a product toll. Using variable costing, stock-still manufacturing overhead is reported as a period cost. Figure 6.8 "Absorption Costing Versus Variable Costing" summarizes the similarities and differences between absorption costing and variable costing.

Figure six.viii Absorption Costing Versus Variable Costing

Impact of Absorption Costing and Variable Costing on Profit

Question: If a visitor uses simply-in-fourth dimension inventory, and therefore has no beginning or ending inventory, profit will be exactly the same regardless of the costing arroyo used. However, most companies have units of production in inventory at the terminate of the reporting menses. How does the use of absorption costing touch the value of ending inventory?

Respond: Since absorption costing includes fixed manufacturing overhead as a product cost, all products that remain in ending inventory (i.e., are unsold at the end of the catamenia) include a portion of fixed manufacturing overhead costs as an asset on the balance canvas. Since variable costing treats fixed manufacturing overhead costs equally menses costs, all fixed manufacturing overhead costs are expensed on the income statement when incurred. Thus if the quantity of units produced exceeds the quantity of units sold, absorption costing will outcome in college profit.

We illustrate this concept with an example. The following information is for Bullard Company, a producer of clock radios:

Assume Bullard has no finished appurtenances inventory at the get-go of month 1. We will look at absorption costing versus variable costing for three unlike scenarios:

• Month 1 scenario: 10,000 units produced equals 10,000 units sold
• Month two scenario: 10,000 units produced is greater than 9,000 units sold
• Month 3 scenario: 10,000 units produced is less than 11,000 units sold

Month 1: Number of Units Produced Equals Number of Units Sold

Question: During month one, Bullard Company sells all 10,000 units produced during the month. How does operating profit compare using absorption costing and variable costing when the number of units produced equals the number of units sold?

Answer: Effigy 6.9 "Number of Units Produced Equals Number of Units Sold" presents the results for each costing method. Notice that the absorption costing income statement is chosen a traditional income statement, and the variable costing income statement is called a contribution margin income argument.

As you review Effigy 6.nine "Number of Units Produced Equals Number of Units Sold", discover that when the number of units produced equals the number sold, profit totaling $xc,000 is identical for both costing methods. With absorption costing, stock-still manufacturing overhead costs are fully expensed because all units produced are sold (there is no ending inventory). With variable costing, stock-still manufacturing overhead costs are treated as flow costs and therefore are always expensed in the period incurred. Considering all other costs are treated the same regardless of the costing method used, turn a profit is identical when the number of units produced and sold is the aforementioned.

Figure 6.nine Number of Units Produced Equals Number of Units Sold

^a $250,000 = $25 × 10,000 units sold.

^b $110,000 = ($4 per unit fixed production cost × 10,000 units sold) + ($7 per unit variable production cost × 10,000 units sold).

^c $70,000 = $seven per unit variable product cost × x,000 units sold.

^d $fifty,000 = $twenty,000 stock-still selling and admin. toll + ($3 per unit variable selling and admin. price × 10,000 units sold).

^e $30,000 = $3 per unit variable selling and admin. cost × 10,000 units sold.

^f Variable costing treats fixed manufacturing overhead as a period cost. Thus all fixed manufacturing overhead costs are expensed in the menstruation incurred regardless of the level of sales.

^thou Given.

Month ii: Number of Units Produced Is Greater Than Number of Units Sold

Question: During month 2, Bullard Visitor produces 10,000 units but sells only 9,000 units. How does operating profit compare using absorption costing and variable costing when the number of units produced is greater than the number of units sold?

Reply: Effigy half-dozen.x "Number of Units Produced Is Greater Than Number of Units Sold" presents the results for each costing method. Discover that absorption costing results in higher turn a profit. When absorption costing is used, a portion of stock-still manufacturing overhead costs remains in ending inventory as an nugget on the balance canvass until the goods are sold. Still, variable costing requires that all fixed manufacturing overhead costs exist expensed equally incurred regardless of the level of sales. Thus when more units are produced than are sold, variable costing results in higher costs and lower profit.

The difference in profit betwixt the ii methods of $four,000 (= $79,000 − $75,000) is attributed to the $4 per unit fixed manufacturing overhead toll assigned to the 1,000 units in ending inventory using assimilation costing ($4,000 = $4 × ane,000 units).

Effigy 6.x Number of Units Produced Is Greater Than Number of Units Sold

^a $225,000 = $25 × 9,000 units sold.

^b $99,000 = ($iv per unit of measurement fixed production cost × 9,000 units sold) + ($vii per unit variable production cost × 9,000 units sold).

^c $63,000 = $7 per unit variable production cost × 9,000 units sold.

^d $47,000 = $20,000 fixed selling and admin. price + ($3 per unit of measurement variable selling and admin. price × nine,000 units sold).

^e $27,000 = $3 per unit of measurement variable selling and admin. cost × 9,000 units sold.

^f Variable costing always treats fixed manufacturing overhead as a period price. Thus all stock-still manufacturing overhead costs are expensed in the catamenia incurred regardless of the level of sales.

^g Given.

Calendar month 3: Number of Units Produced Is Less Than Number of Units Sold

Question: During month iii, Bullard Visitor produces 10,000 units but sells 11,000 units (1,000 units were left over from calendar month ii and therefore were in inventory at the beginning of month 3). How does operating profit compare using absorption costing and variable costing when the number of units produced is less than the number of units sold?

Reply: Figure half-dozen.11 "Number of Units Produced Is Less Than Number of Units Sold" presents the results for each costing method. Using variable costing, the $40,000 in fixed manufacturing overhead costs continues to be expensed when incurred. However, using absorption costing, the entire $40,000 is expensed because all x,000 units produced were sold; an additional $iv,000 related to the one,000 units produced last month and pulled from inventory this calendar month is as well expensed. Thus when fewer units are produced than are sold, absorption costing results in higher costs and lower turn a profit.

The deviation in profit between the two methods of $4,000 (= $105,000 − $101,000) is attributed to the $4 per unit stock-still manufacturing overhead price assigned to the one,000 units in inventory on the balance sheet at the end of month 2 and recorded as cost of goods sold during month 3 using absorption costing ($4,000 = $iv × ane,000 units).

Effigy 6.11 Number of Units Produced Is Less Than Number of Units Sold

^a $275,000 = $25 × xi,000 units sold.

^b $121,000 = ($4 per unit fixed production cost × 11,000 units sold) + ($7 per unit variable production cost × 11,000 units sold).

^c $77,000 = $7 per unit variable production price × 11,000 units sold.

^d $53,000 = $20,000 fixed selling and admin. cost + ($3 per unit of measurement variable selling and admin. cost × 11,000 units sold).

^e $33,000 = $3 per unit of measurement variable selling and admin. cost × 11,000 units sold.

^f Variable costing e'er treats fixed manufacturing overhead as a period toll. Thus all stock-still manufacturing overhead costs are expensed in the menstruation incurred regardless of the level of sales.

^{one thousand} Given.

Advantages of Using Variable Costing

Question: Why do organizations use variable costing?

Respond: Variable costing provides managers with the information necessary to prepare a contribution margin income statement, which leads to more constructive cost-book-profit (CVP) assay. By separating variable and fixed costs, managers are able to determine contribution margin ratios, pause-fifty-fifty points, and target profit points, and to perform sensitivity analysis. Conversely, assimilation costing meets the requirements of U.S. GAAP, but is not equally useful for internal decision-making purposes.

Another advantage of using variable costing internally is that it prevents managers from increasing production solely for the purpose of inflating profit. For case, presume the manager at Bullard Company will receive a bonus for reaching a certain profit target but expects to be $15,000 brusque of the target. The visitor uses absorption costing, and the manager realizes increasing production (and therefore increasing inventory levels) will increase turn a profit. The managing director decides to produce 20,000 units in month 4, even though merely 10,000 units will be sold. Half of the $twoscore,000 in fixed product cost ($xx,000) will be included in inventory at the terminate of the period, thereby lowering expenses on the income statement and increasing profit by $20,000. At some point, this will catch upward to the manager because the company volition have backlog or obsolete inventory in time to come months. However, in the short run, the director volition increase profit by increasing production. This strategy does not work with variable costing because all fixed manufacturing overhead costs are expensed every bit incurred, regardless of the level of sales.

Key Takeaway

• Equally shown in Figure 6.8 "Absorption Costing Versus Variable Costing", the but divergence between absorption costing and variable costing is in the treatment of fixed manufacturing overhead costs. Absorption costing treats fixed manufacturing overhead every bit a product cost (included in inventory on the balance sheet until sold), while variable costing treats fixed manufacturing overhead equally a menstruation cost (expensed on the income statement as incurred).When comparison absorption costing with variable costing, the following 3 rules apply: (1) When units produced equals units sold, turn a profit is the aforementioned for both costing approaches. (2) When units produced is greater than units sold, absorption costing yields the highest turn a profit. (three) When units produced is less than units sold, variable costing yields the highest profit.

Review Problem 6.8

Winter Sports, Inc., produces snowboards. The visitor has no finished appurtenances inventory at the beginning of year i. The following information pertains to Winter Sports, Inc.,:

1. All 100,000 units produced during year 1 are sold during yr 1.
   1. Prepare a traditional income argument assuming the company uses absorption costing.
   2. Gear up a contribution margin income argument assuming the visitor uses variable costing.
2. Although 100,000 units are produced during year two, merely 80,000 are sold during the year. The remaining 20,000 units are in finished goods inventory at the end of twelvemonth 2.
   1. Prepare a traditional income statement assuming the company uses absorption costing.
   2. Prepare a contribution margin income statement assuming the company uses variable costing.

Solution to Review Problem 6.8

1. 1. Traditional income argument (assimilation costing), year 1:

      ^a $20,000,000 = $200 × 100,000 units sold.^b $13,500,000 = ($5 per unit stock-still production cost × 100,000 units sold) + ($130 per unit variable production cost × 100,000 units sold).^c $1,800,000 = $800,000 fixed selling and admin. cost + ($x per unit variable selling and admin. cost × 100,000 units sold).

   2. Contribution margin income argument (variable costing), year 1:

      ^a $twenty,000,000 = $200 × 100,000 units sold.^b $thirteen,000,000 = $130 per unit variable production cost × 100,000 units sold.^c $i,000,000 = $10 per unit variable selling and admin. cost × 100,000 units sold.

      ^d Variable costing treats stock-still manufacturing overhead as a period toll. Thus all fixed manufacturing overhead costs are expensed in the menstruum incurred regardless of the level of sales.

      ^eastward Given.

2. 1. Traditional income statement (assimilation costing), yr two:

      ^a $16,000,000 = $200 × eighty,000 units sold.^b $10,800,000 = ($five per unit fixed production cost × 80,000 units sold) + ($130 per unit variable production cost × fourscore,000 units sold).

   2. Contribution margin income statement (variable costing), year 2:

      ^a $16,000,000 = $200 × 80,000 units sold.^b $10,400,000 = $130 per unit variable production cost × 80,000 units sold.^c $800,000 = $10 per unit of measurement variable selling and admin. toll × 80,000 units sold.

      ^d Variable costing treats stock-still manufacturing overhead as a catamenia cost. Thus all fixed manufacturing overhead costs are expensed in the period incurred regardless of the level of sales.

      ^east Given.

cunninghampany1953.blogspot.com

Source: https://courses.lumenlearning.com/acctmgrs/chapter/6-7-using-variable-costing-to-make-decisions/

Share this post