Variable Costing for
Management Analysis
ACG 2071
Module 8
Chapter 20
Fall 2007
Costing
One of the most important items affecting
a business’ net income is the cost of
goods sold.
Net income can be determined by
Absorption costing
Variable costing or Direct costing
Absorption Costing
all manufacturing costs included in
finished goods and remain an asset until
the good is sold.
Used in financial reporting
Variable Costing
cost of goods manufactured is composed
only of variable manufacturing costs
direct materials
direct labor
variable factory overhead
remaining manufacturing costs (fixed) are generally
related to productive capacity of manufacturing plant
and not affected by changes in the quantity of
product manufacturing
• thus treated as an expense
also called direct costing
Variable costing
More useful to management in making
decisions
Also called direct costing
The cost of goods manufactured is
composed only of variable manufacturing
costs
Fixed costs are below the line
Cost of Goods Manufactured
Absorption Costing
Variable Costing
Direct materials
Direct materials
Direct labor
Direct labor
Variable factory overhead
Variable factory overhead
Fixed factory overhead
Example 1: Joe’s Hose
Manufacturing
costs
Total cost
Per unit
Variable
$375,000
$25 per unit
Fixed
$150,000
$10 per unit
Total
$525,000
$35 per unit
Sales are
15,000
at $50
per unit
Selling and administrative
Variable selling ($5 per
unit)
Fixed
Total
$75,000
$50,000
$125,000
Variable Costing Income Statement
Manufacturing margin =
Sales minus variable cost of goods sold
Contribution margin =
Manufacturing margin minus variable selling
and administrative expenses
Variable Costing Income Statement
Sales (15,000 units @$50)
$750,000
Variable costs (15,000 @ $25)
Manufacturing margin
Variable selling (15,000 unit @$5)
Contribution margin
$375,000
$375,000
-$75,000
$300,000
Fixed costs
Fixed manufacturing
Fixed selling expense
Operating income
$150,000
$50,000
$200,000
$100,000
Absorption Costing Income Statement
Sales (15,000 units @$50)
$750,000
Cost of goods sold (15,000 @ $35)
$525,000
Gross profit
$225,000
Selling and administrative
$125,000
Operating income
$100,000
Note: In the above example the variable costing
and absorption costing income statement results in
the same income. This is due to the fact that no
beginning or ending inventory exists
Ending Inventory Exists
When ending inventory exists, the
operating income for variable costing will
be LOWER than that for absorption
costing. This is due to the fact that the
fixed costs assigned to the ending
inventory is expensed under variable
costing and inventoried under absorption
costing.
Ending Inventory Exists
Units manufactured > Units Sold
Example 2: Joe Hose manufactures
15,000 units and sold 12,000 units at $50
per unit. Using the information on costs
from Example 1, prepare a variable
costing income statement and absorption
costing income statement.
Absorption costing
Sales (12,000 units @$50)
Cost of goods sold
COGSM 15,000 @ $35
Ending inv 3,000 @ $35
Gross profit
$600,000
$525,000
$105,000
Selling and administrative
Operating income
Selling and administrative =
Variable: $5 x 12,000 units = $60,000
Fixed:
$50,000
Total
$110,000
$420,000
$180,000
$110,000
$70,000
Variable costing
Sales (12,000 units @$50)
Variable costs :
Manufactured (15,000 @ $25)
Less ending inventory (3,000 @ $25)
Manufacturing margin
Variable selling (12,000 unit @$5)
Contribution margin
Fixed costs:
Fixed manufacturing
Fixed selling expense
Operating income
$600,000
$375,000
-$75,000
$300,000
$300,000
-$60,000
$240,000
$150,000
$50,000
$200,000
$ 40,000
Difference
Variable costing operating income
Absorption costing operating income
Difference
$40,000
$70,000
$30,000
The difference is account for by the following
Ending inventory
3,000 units
Fixed costs per unit
x $10
Difference in operating income $30,000
Beginning inventory exists
 Units manufactured < Units Sold
 When beginning inventory exists, the operating
income for variable costing will be HIGHER than
that for absorption costing. This is due to the
fact that the fixed costs assigned to the ending
inventory is expensed under variable costing
and inventoried under absorption costing

Absorption Costing
Sales (15,000@$50)
Cost of goods sold
Beg Inv (5,000 units @ $35)
COGM (12,000 @$35)
$750,000.00
$175,000
$400,000
Gross profit
Selling and Administrative
($5 *15,000) + $50,000
Income from operations
Operating income
575,000
$175,000
$125000
$ 70,000
125,000
$50,000
Example 3
Example 3: Joe Hose had beginning
inventory of 5,000 units, 10,000 units were
manufactured during the year. The
company sold 15,000 units at $50 per unit
during the period. Below are the costs of
operations for the period.
Example 3 Data
Manufacturing costs
Variable
Fixed
Total
Total cost
Per unit
$250,000
$150,000
$400,000
$25 per unit
$15per unit
$40 per unit
$125,000
50,000
$175,000
$25 per unit
10 per unit
$35 per unit
Beginning inventory
Manufacturing costs
Variable cost
Fixed cost
Total
Variable Costing
Sales (15,000 units @$50)
$750,000
Variable costs:
Beg inventory ( 5,000 @ $25)
$125,000
Plus cost of goods manufactured ( 10,000 @ $25)
$250,000
$375,000
Manufacturing margin
$375,000
Variable selling (15,000 unit @$5)
-$75,000
Contribution margin
$300,000
Fixed costs
Fixed manufacturing
$150,000
Fixed selling expense
$50,000
Operating income
$200,000
$100,000
Absorption Costing
Sales (15,000 units @$50)
Cost of goods sold
$750,000
Beg inv ( 5,000 units @$35)
$175,000
Manufactured ( 10,000 @ $40)
$400,000
Gross profit
Selling and administrative
Operating income
Selling and administrative =
Variable selling
$5per unit x 15,000 units sold
Fixed selling
Total
$575,000
$175,000
$125,000
$50,000
$75,000
$50,000
$110,000
Difference
 If manufactured units are less than sales then difference in income
of $50,000 comes from difference in Cost of goods sold of $10 per
unit time’s 5,000 units.

Variable costing operating income
$100,000

Absorption costing operating income
$ 50,000

Difference
$ 50,000
 The difference is account for by the following

Beginning inventory
5,000 units

Fixed costs per unit
x $10

Difference in operating income
$50,000

$10 per unit is the fixed costs per unit charged to beginning
inventory.
Income Analysis
 Since absorption costing, inventories fixed cost for the
period, the company may show higher income if it
produces more than it sells.
 For example look at two production levels.
20,000 units
Sales 20,000 units @ $75 per unit
25,000 units
$1,500,000
$1,500,000
COGS
20,000 units @ $55
$ 1,100,000
25,000 units @ #51
Less ending inventory 5,000 units @ $51
$1,275,000
0
$(255,000)
Gross profit
$400,000
$480,000
Selling and administrative
$200,000
$200,000
Operating income
$200,000
$280,000
Under Variable Costing
20,000 units
Sales (20,000 units X $75)
$1,500,000
25,000 units
$1,500,000
Variable Cost of goods sold:
20,000 units x $35
$700,000
25,000 units X $35
$875,000
Less ending inventory:
5,000 units x $35
$350,000
Variable cost of goods sold
$700,000
Manufacturing margin
$800,000
$800,000
Variable selling and administrative
$100,000
$100,000
Contribution margin
$700,000
$700,000
Fixed manufacturing costs
$400,000
$400,000
Fixed selling and administrative
$100,000
$100,000
$200,000
$200,000
Fixed costs
Operating income
Controlling costs
 All costs are controllable in long run by someone in the
business but not all controllable at the same level of
management.
 Controllable – influenced by management at that level
 Noncontrollable – another level of management control
 Used to fix responsibility
 Variable manufacturing costs – controlled by operating
level
 Fixed manufacturing costs – higher level controls it
Pricing Products
Variable costs used in setting prices
because it gives better control over costs
Analyzing market segments
Market analysis is performed by sales and
marketing department in order to
determine the profit contributed by market
segments.
Market segment is a portion of the
business that can be assigned to a
manager for profit responsibility.
Analyzing market segments
Northern
Territory
Southern
Territory
Total
Sales
Shampoo
Conditioner
Total territory sales
$60,000
$30,000
$90,000
20,000
50,000
70,000
80,000
80,000
160,000
$7,200
$3,600
$10,800
2,400
6,000
8,400
9,600
9,600
19,200
$18,000
$9,000
$27,000
4,000
10,000
14,000
22,000
19,000
41,000
$12,000
$6,000
$18,000
2,000
5,000
7,000
Variable production costs
Shampoo 12%
sales
Conditioner 12% of sales
Total variable production costs
Promotion costs
Shampoo 30% of sales
Conditioner 30%
Total promotion costs
Sales commissions
Shampoo 20%
Conditioner 10%
Sales Territory Profit Analysis
Northern
Southern
Sales
$80,000
$80,000
Variable COGS
9,600
9,600
Manufacturing
margin
70,400
70,400
Variable selling
expense
Promotion costs $22,000
Sales commissions
14,000
$19,000
36,000
11,000
30,000
Contribution margin
34,400
40,400
Ratio
43%
50.5%
Product Profitability Analysis
Management should focus its sales efforts
on those products that will provide the
maximum total contribution margin.
 An income statement presenting the
contribution margin by products is often
used by management to guide productrelated sales and promotional efforts
Product Profitability Analysis
Shampoo
Conditioner
$90,000
$70,000
Variable COGS
10,800
8,400
Manufacturing
margin
79,200
61,600
Sales
Variable selling
expense
Promotion costs
Sales
commissions
$27,000
18,000
$14,000
45,000
Contribution margin
$34,200
Ratio
38%
7,000
21,000
$40,600
58.%
Contribution Margin Analysis
The contribution margin concept can be
used to assist managers in planning and
controlling operations by focusing on the
differences between planned and actual
contribution margins.
These differences and their causes are
explained by the contribution margin analysis
Contribution margin = Sales – Variable
Costs
Contribution Margin Analysis
Difference in planned and actual
contribution margin can be caused by
An increase or decrease in the amount of sales
Caused by
• Increase or decrease in units sold
• Increase or decrease in selling price
An increase or decrease in the amount of
variable costs
Caused by
• Increase or decrease in units sold
• Increase or decrease in costs per unit
Contribution Margin Analysis
Explained by
Quantity factor
The effect of a difference in the number of units sold
assuming no change in unit sales price or unit cost
Actual quantity sold – planned quantity sold
Price factor
The effect of a difference in unit sales price or unit
cost on the number of units sold.
Actual unit price or cost – planned unit price or cost
Contribution Margin Analysis
Increase or
(Decrease)
Actual
Planned
Sales
$937,500.00
$800,000.00
$137,500.00
Less: variable cost of goods sold
$425,000.00
$350,000.00
$ 75,000.00
$162,500.00
$125,000.00
$ 37,500.00
$587,500.00
$475,000.00
$112,500.00
$350,000.00
$325,000.00
$ 25,000.00
125,000
100,000
25,000
Sales price
$7.50
$8.00
Variable costs of goods sold
$3.40
$3.50
Variable selling & administrative
$1.30
$1.25
variable selling & administrative
Total variable costs
Contribution margin
Number of units sold
Per unit
Contribution Margin Analysis
The analysis of this data shows a
favorable increase of $25,000 in the
contribution margin was due in large pat to
an increase in the number of units sold.
The increase was partially offset by a
decrease in sales price and increase in
unit cost for variable selling and
administrative expenses. An additional
decrease in unit cost for variable cost of
goods sold occurred.
Contribution Margin Analysis
Increase in Sales
Quantity factor:
Increase in units sold
Planned sales price
25,000
8.00
200,000.00
Price factor:
Decrease in sales price
Number of units sold
Net increase in the amount of
sales
(0.50)
125,000
(62,500.00)
137,500.00
Contribution Margin Analysis
Increase in amount of variable costs of goods sold
Quantity factor
Increase in number of units sold
Planned unit cost
25,000
$
3.50
$ 87,500.00
Unit cost factor
Decrease in unit cost
Number of units sold
Net increase in amount of variable COGS
$
(0.10)
125,000
$ (12,500.00)
$ 75,000.00
Contribution Margin Analysis
Increase in amount of variable selling & administrative
Quantity factor
Increase in number of units sold
Planned unit cost
25,000
$
1.25
$
0.05
$ 31,250.00
Unit cost factor
Increase in unit costs
Number of units sold
Net increase in amount of variable selling
125,000
$
6,250.00
$ 37,500.00
Net increase in variable costs
$ (112,500.00)
Increase in contribution margin
$
25,000.00