Managerial Accounting
2011
First semester
Takayuki Asada
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Chapter5. Variable Costing
After reading this chapter, you will be able to:
Explain the difference between full 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
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1. Introduction
In 2006,the all of tube amplifier produced by Clausen Tube
received rave reviews and company was able to see all 5,000
units it produced and the company profit is $3,500,000.
In 2007 the company increased production to 6,000 units but
was only able to see 4,800 Units.
In early January of 2008,Robert Cluasen ,company president and
founder, reviewed financial performance for 2007. Profit had
actually increased slightly to $3,528,000.
The reason of this good performance must be discussed under
less sales volume in 2007 in comparison with the
performance of 2007.
It is due to the fact that our financial performance statements
are prepared using what’s called full, or absorption costing.
There are a method called variable costing that we could use for
internal reporting purposes which wouldn’t produce such
puzzling.
In this chapter, we will discuss the differences between full
costing and variable costing and gain an understanding of
why profit is up at Clausen Tube even though sales are down.3
2. Full and Variable Costing
1)Income statement of manufacturing firms prepared for external purposes use
full costing(absorption costing). In full costing,inventory costs include direct
material ,direct labor ,and all manufacturing overhead.In this costing
methods,variable costs and fixed costs are commingled ,or combined,and it
is very difficult to untangle the costs to perform what if analysis that
requires separating ficed and variable costs.
2) In variable costing,only variable production costs are included in inventory
costs. All fixed production costs are treated as period costs and expensed in
the period incurred. Under the variable costing method,the total amount of
depreciation(fixed cost component) is treated as an expense of the period.
See Illustration 5-1
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Illustration 5-1 comparison of full and variable costing
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2-1 Variable costing income statement
If variable costing us used , an income statement can be prepared that
classifies all expenses in terms of their cost behavior –either fixed or variable.
With the variable expenses separated from the fixed expenses ,a contribution
margin can be presented.
A contribution margin information will allows readers of the income statement
to make estimates of how much profit will change with change in sales.
The account analysis methid is subjective in that different managers viewing
the same set of facts may reach different conclusions regarding which costs
are fixed and which costs are variable.
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Illustration 5-2 Comparison of income statement
prepared using full and variables csoting
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3 . Effects of Production on income for full versus variable
costing:The Clausen Tube Example
3-1 Quantity produced equals quantity sold
In 2006,there is no beginning inventory of finishhed goods , 5000
units are produced, and 5000 units ar sold. Illustration 5-3
provides a combination of full costing and variable costing
income statement for this situation.
As we have just seen ,when the quantity produced equals the
quantity sold,there is no difference between net income
calculated using full,versus variable,costing. Since all units
produced are sold,no fixed costs ends up in ending inventory.
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3. Effects of Production on income for full versus variable costing;The
Clausen Tube Example
Illustation 5-3
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3-2 Quatity produced is greater than quantity sold
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3-3 Quantity produced is less than quntity sold
Now,what is the case if the quantity produced
is less than the quantity sold? To sell more
than produced,a company must have some
beginning inventory.The recorded value of
that beginning inventory will be greater with
full costing since full costing includes fixed
manufacturing overhead and variable costing
does not. Thus, When the beginning inventory
is charged to cost of goods sold,the charge will
be higher under full costing.
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3-4 Explaining what happened at Clausen Tube
In 2007, the company produced a lot more units than it sold. The high level of
Production reduced cost per unit because fixed manufacturign overhead was
spread out over more units.
3-5 Impact of JIT on the income effects of
full versus variable costing
A company that use JIT may have very low inventory levels since they don’t
produce until they are ready to sell their products.
The result is that the units they produce are approximately equal to the
units they sell and thus, the differece between variable costing income and
Full income is likey to be very small for companies that use JIT.
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4. Benefits of varible costing for
internal reporting.
There are two primary benefits associated with
using variable costing for internal reporting
purposes.
4-1 Variable costing facilitates C-V-P analysis
manager simply can’t estimate accurately the impact of changes in volume
on cost and profit unless they know which costs are fixed and which cost are
variable.
4-2 Variable costing limits management of
earnings with production volume
Another reason why variable costing may be preferred for internal purposes is
that it does not allow managers to artificially inflate profit by producing
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more units than they can sell.
5. Making Business Decisions
Since many decisions affect sales,being able to
estimate the impact of changes in sales on
profit greatly facilitate decisions making.
-----------------------------------------------------------Thus,we try to explain the contribution margin methods by
simple example of Takashima Retails company.
(1)A product contribution margin:sales of “A”– variable mfc.costs
of “A” product -- “A” product sales variable
expenses=contribution margin of “A” sales.
(2)B product contribution margin:Sales of “B” – variable
mfc.costs of “B” product -- “B” product sales variable
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expenses= contribution margin of “B” sales
Under this example,we can see the contribution
margin ratio of two products,however,this
analysis say the margin comparison based on
the assumption about traceable on each sales
variable costs of “A and B” products.
This contribution margin or margin ratios is one
methods for manager to analyze each product
or product group profitability.
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Summary
1.Explain the difference between full and varible
costing.
2.Prepare an income statement using variable
costing.
3.Discuss the effect of production on full and
variable costing income.
4.Explain the impact of JIT on the difference
between full and variable costing income.
5.Discuss the benefits of variable costing for
internal reporting purposes.
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