Chapter 19
Profit Reporting for
Management Analysis
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
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Objectives
1. Describe and illustrate income reporting
After
studying
this
under variable costing and absorption costing.
chapter,
you
should
2. Describe and illustrate income analysis under
to:
variable costing be
andable
absorption
costing.
3. Describe and illustrate management’s use of
variable costing and absorption costing for
controlling costs, pricing products, planning
production, analyzing market segments, and
analyzing contribution margins.
Objectives
4. Illustrate contribution margin reporting for
products, territories, and salespersons.
5. Explain changes in contribution margin
as a result of quantity and price factors.
6. Describe and illustrate contribution
margin reporting and analysis for service
firms.
Two Costing Methods
Absorption Costing
 Used for external financial
reporting
 Includes direct materials, direct
labor, variable factory overhead,
and fixed factory overhead as
part of total product cost
Two Costing Methods
Variable Costing
 Used for internal planning
and decision making
 Does not include fixed factory
overhead as a product cost
Absorption Costing Compared to
Variable Costing
Absorption Costing
Cost of Goods Manufactured
Direct
Materials
Direct
Labor
Variable
Factory OH
Cost of Goods Manufactured
Variable Costing
Fixed
Factory OH
Period Expense
Units Manufactured Equal Units Sold
Variable Costing Income Statement
Sales (15,000 x $50)
Variable cost of goods sold:
Variable cost of goods mfg.
(15,000 x $25)
Less ending inventory
Variable cost of goods sold
Manufacturing margin
Variable selling and administrative
expenses (15,000 x $5)
Contribution margin
Fixed costs:
Fixed manufacturing costs
Fixed selling and administrative
expenses
Income from operations
$750,000
$375,000
0
375,000
$375,000
75,000
$300,000
$150,000
50,000 200,000
$100,000
Units Manufactured Equal Units Sold
Absorption Costing Income Statement
Sales (15,000 x $50)
Cost of goods sold:
Cost of goods manufactured
(15,000 x $35)
Less ending inventory
Cost of goods sold
Gross profit
Selling and administrative expenses
($75,000 + $50,000)
Income from operations
$750,000
$525,000
0
525,000
$225,000
125,000
$100,000
When the number of units manufactured equals the
number of units sold, income from operations will be
the same under both methods.
Units Manufactured Exceed Units Sold
Variable Costing Income Statement
Sales (12,000 x $50)
$600,000
Variable cost of goods sold:
Variable cost of goods manufactured
(15,000 x $25)
$375,000
Less ending inventory (3,000 x $25)
75,000
Variable cost of goods sold
300,000
Manufacturing margin
$300,000
Variable selling and admin. expenses
60,000
Contribution margin
$240,000
Fixed costs:
Fixed manufacturing costs
$150,000
Fixed selling and admin. expenses
50,000 200,000
Income from operations
$ 40,000
Units Manufactured Exceed Units Sold
Absorption Costing Income Statement
Sales (12,000 x $50)
$600,000
Cost of goods sold:
Cost of goods manufactured
(15,000 x $35)
$525,000
Less ending inventory (3,000 x $35)
105,000
Cost of goods sold
420,000
Gross profit
$180,000
Selling and administrative expenses
[(12,000 x $5) + $50,000]
110,000
Income from operations
$ 70,000
Units Manufactured Exceed Units Sold
Operating Income:
Absorption costing
Variable costing
Difference
$70,000
40,000
$30,000
Why is absorption costing income higher
when units manufactured exceed units sold?
Units Manufactured Exceed Units Sold
Operating Income:
Absorption costing
Variable costing
Difference
Analysis:
Units manufactured
Units sold
Ending inventory units
Fixed cost per unit
Difference
$70,000
40,000
$30,000
15,000
12,000
3,000
x $10
$30,000
Units Manufactured Are Less Than Units Sold
Variable Costing Income Statement
Sales (15,000 x $50)
Variable cost of goods sold:
Beginning inventory (5,000 x $25)
Variable cost of goods manufactured
(10,000 x $25)
Manufacturing margin
Variable selling and admin. expenses
Contribution margin
Fixed costs:
Fixed manufacturing costs
Fixed selling and admin. expenses
Income from operations
$750,000
$125,000
250,000
$150,000
50,000
375,000
$375,000
75,000
$300,000
200,000
$100,000
Units Manufactured Are Less Than Units Sold
Variable Costing Income Statement
Sales (15,000 x $50)
Variable cost of goods sold:
Beginning inventory (5,000 x $25)
Variable cost of goods manufactured
(10,000 x $25)
Manufacturing margin
Variable selling and admin. expenses
Contribution margin
Fixed costs:
Fixed manufacturing costs
Fixed selling and admin. expenses
Income from operations
$750,000
$125,000
250,000
$150,000
50,000
375,000
$375,000
75,000
$300,000
200,000
$100,000
Units Manufactured Are Less Than Units Sold
Absorption Costing Income Statement
Sales (15,000 x $50)
Cost of goods sold:
Beginning inventory (5,000 x $35)
Cost of good manufactured
(10,000 x $45)
Cost of goods sold
Gross profit
Selling and administrative expenses
($75,000 + $50,000)
Income from operations
$750,000
$175,000
400,000
575,000
$175,000
125,000
$ 50,000
Units Manufactured Are Less Than Units Sold
Operating Income:
Variable costing
Absorption costing
Difference
$100,000
50,000
$ 50,000
Why is variable costing income
higher when units manufactured are
less than units sold?
Units Manufactured Are Less Than Units Sold
Operating Income:
Variable costing
Absorption costing
Difference
Analysis:
Units sold
Units manufactured
Ending inventory units
Fixed cost per unit
Difference
$100,000
50,000
$ 50,000
15,000
10,000
5,000
x $10
$50,000
IF
THEN
Units Sold < Units produced
Variable Costing < Absorption Costing
Income
Income
IF
THEN
Units Sold > Units produced
Variable Costing > Absorption Costing
Income
Income
Income Analysis Under Variable Costing
and Absorption Costing
Frand Manufacturing
Company has no beginning
inventory and sales are
estimated to be 20,000 units at
$75 per unit, regardless of
production levels.
Income Analysis Under Variable Costing
and Absorption Costing
Proposal 1: 20,000 Units to Be Manufactured and Sold
Total Cost
Manufacturing costs:
Variable
$ 700,000
Fixed
400,000
Total costs
$1,100,000
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed
100,000
Total expenses
$ 200,000
Unit Cost
$35
20
$55
Income Analysis Under Variable Costing
and Absorption Costing
Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold
Total Cost
Manufacturing costs:
Variable
$ 875,000
Fixed
400,000
Total costs
$1,275,000
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed
100,000
Total expenses
$ 200,000
Unit Cost
$35
16
$51
Frand Manufacturing Company
Absorption Costing Income Statements
Sales
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55)
$35 + ($400,000 ÷ 20,000)
20,000 Units 25,000 Units
Manufactured Manufactured
$1,500,000
$1,500,000
$1,100,000
Frand Manufacturing Company
Absorption Costing Income Statements
Sales
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55)
(25,000 units x $51)
$35 + ($400,000 ÷ 25,000)
20,000 Units 25,000 Units
Manufactured Manufactured
$1,500,000
$1,500,000
$1,100,000
$1,275,000
Frand Manufacturing Company
Absorption Costing Income Statements
Sales
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55)
(25,000 units x $51)
Less ending inventory:
(5,000 units x $51)
Cost of goods sold
Gross profit
Selling and administrative expenses
($100,000 + $100,000)
Income from operations
20,000 Units 25,000 Units
Manufactured Manufactured
$1,500,000
$1,500,000
$1,100,000
$1,275,000
$1,100,000
$ 400,000
255,000
$1,020,000
$ 480,000
200,000
$ 200,000
200,000
$ 280,000
Now, assume that
Frand Manufacturing
uses variable costing.
Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
$1,500,000
$1,500,000
Sales
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35)
$ 700,000
(25,000 units x $35)
Direct materials, direct labor, and
variable manufacturing overhead only.
$ 875,000
Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
$1,500,000
$1,500,000
Sales
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35)
$ 700,000
(25,000 units x $35)
Less ending inventory:
(0 units x $35)
0
(5,000 units x $35)
Variable cost of goods sold
$ 700,000
Manufacturing margin
$ 800,000
Continued
$ 875,000
175,000
$ 700,000
$ 800,000
Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Manufacturing margin
Variable selling and administrative
expenses
Contribution margin
Fixed costs:
Fixed manufacturing costs
Fixed selling and administrative
expenses
Total fixed costs
Income from operations
$ 800,000
$ 800,000
100,000
$ 700,000
100,000
$ 700,000
$ 400,000
$ 400,000
100,000
$ 500,000
$ 200,000
100,000
$ 500,000
$ 200,000
What would be the income
from operations if the firm
manufactured 30,000 units?
Frand Manufacturing Company
Variable Costing Income Statements
30,000 Units
Manufactured
Sales
Variable cost of goods sold:
Variable cost of goods manufactured:
(30,000 units x $35)
Less ending inventory:
(10,000 units x $35)
Variable cost of goods sold
Manufacturing margin
Continued
$1,500,000
$1,050,000
350,000
$ 700,000
$ 800,000
Frand Manufacturing Company
Variable Costing Income Statements
30,000 Units
Manufactured
Manufacturing margin
Variable selling and administrative
expenses
Contribution margin
Fixed costs:
Fixed manufacturing costs
Fixed selling and administrative
expenses
Total fixed costs
Income from operations
$ 800,000
100,000
$ 700,000
$ 400,000
100,000
$ 500,000
$ 200,000
Management’s Use of Costing Methods
Variable costing reports and absorption
costing reports are useful in the following
situations:
1. Controlling costs
2. Pricing products
3. Planning production
4. Analyzing market segments
5. Analyzing contribution margins
Accounting Reports and
Management Decisions
ACCOUNTING REPORTS
Absorption Costing and Variable Costing
MANAGEMENT
MANAGEMENT
DECISIONS
Controlling
Costs
Pricing
Planning
Production
Analyzing
Market
Segments
Analyzing
Contribution
Margins
ACTUAL
PLANNED
Pricing Products
In the short run, we are
committed to our existing
manufacturing facilities.
Pricing Products
That is correct. The pricing decision
should be based upon making the best use
of our existing capacity.
Pricing Products
Even in the long-run where plant capacity
can be changed, the selling prices of our
products must cover all costs and provide
a reasonable income.
Analyzing Market Segment
A market segment is a
portion of business that
can be assigned to a
manager for profit
responsibility.
Contribution Margin Reporting
for Market Segments
Camelot Fragrance Company manufactures
and sells the Gwenevere perfume for women
and the Lancelot cologne line for men. The
inventories are negligible.
Northern Southern
Territory Territory
Sales:
Gwenevere
Lancelot
Total territory sales
Variable production costs:
Gwenevere (12% of sales)
Lancelot (12% of sales)
Total variable production
cost by territory
Total
$60,000
20,000
$80,000
$30,000
50,000
$80,000
$ 90,000
70,000
$160,000
$ 7,200
2,400
$ 3,600
6,000
$ 10,800
8,400
$ 9,600
$ 9,600
$ 19,200
Continued
Northern Southern
Territory Territory
Promotion costs:
Gwenevere (30% of sales)
Lancelot(20% of sales)
Total variable production
cost by territory
Sales commissions:
Gwenevere (20% of sales)
Lancelot (12% of sales)
Total sales commission
by territory
Total
$18,000
4,000
$ 9,000
10,000
$ 27,000
14,000
$22,000
$19,000
$ 41,000
$12,000
2,000
$ 6,000
5,000
$ 18,000
7,000
$14,000
$11,000
$ 25,000
Camelot Fragrance Company
Contribution Margin by Sales Territory
For the Month Ended March 31, 2006
Sales
Variable cost of goods sold
Manufacturing margin
Variable selling expenses:
Promotion costs
Sales commissions
Total
Contribution margin
Contribution margin ratio
Northern
Territory
Southern
Territory
$80,000
9,600
$70,400
$80,000
9,600
$70,400
$22,000
14,000
$36,000
$34,400
$19,000
11,000
$30,000
$40,400
43%
50.5%
Camelot Fragrance Company
Contribution Margin by Product Line
For the Month Ended March 31, 2006
Gwenevere Lancelot
Sales
Variable cost of goods sold
Manufacturing margin
Variable selling expenses:
Promotion costs
Sales commissions
Total
Contribution margin
Contribution margin ratio
$90,000
10,800
$79,200
$70,000
8,400
$61,600
$ 27,000
18,000
$45,000
$34,200
$14,000
7,000
$21,000
$40,600
38%
58%
Camelot Fragrance Company
Contribution Margin by Salesperson—Northern Territory
For the Month Ended March 31, 2003
Inez
Rodriquez
Tom
Ginger
Beth
Williams
Total
$20,000
2,400
$17,600
$20,000
2,400
$17,600
$40,000
4,800
$35,200
$80,000
9,600
$70,400
$ 5,000
3,000
$ 8,000
$ 9,600
$ 5,000
3,000
$ 8,000
$ 9,600
$12,000
8,000
$20,000
$15,200
$22,000
14,000
$36,000
$34,400
Contribution margin ratio
48%
48%
38%
43%
Sales mix (% Lancelot sales)
50%
50%
0%
25%
Sales
Variable cost of goods sold
Manufacturing margin
Variable selling expenses:
Promotion costs
Sales commissions
Contribution margin
Contribution Margin Analysis
Planned
Contribution
Margin
Sales
–
Actual
Contribution
Margin
Variable Cost of
Goods Sold
Continued
Variable Selling
and
Administrative
Expenses
Contribution Margin Analysis
Sales
Quantity
Factor
+/–
Price
Factor
Variable Cost of
Goods Sold
Quantity
Factor
+/–
Unit Cost
Factor
Variable Selling
and
Administrative
Expenses
Quantity
Factor
+/–
Unit Cost
Factor
Changes in Contribution Margin as a
Result of Quantity and Price Factors
Quantity factor
The difference between the actual quantity
sold and the planned quantity sold,
multiplied by the planned unit sales price or
unit cost.
Unit price or unit cost factor
The difference between the actual unit price
or unit cost and the planned unit price or
unit cost, multiplied by the actual quantity
sold.
Noble Inc. for Year Ended
December 31, 2006
Actual
Sales
Less: Variable cost of
goods sold
Variable selling and
administrative exp.
Total
Contribution margin
Increase or
Planned (Decrease)
$937,500 $800,000 $137,500
$425,000 $350,000 $ 75,000
162,500 125,000
37,500
$587,500 $475,000 $112,500
$350,000 $325,000 $ 25,000
Continued
Noble Inc. for Year Ended
December 31, 2006
Actual
Number of units sold
125,000
Per unit:
Sales price
$7.50
Variable cost of
goods sold
$3.40
Variable selling and
administrative exp.
$1.30
Planned
100,000
$8.00
$3.50
$1.25
Contribution Margin Report
Blue Skies Airlines
Inc. operates a small
commercial airline.
Blue Skies Airlines Inc.
Contribution Margin and Income from Operations Report
for the Month Ended April 30, 2006
Revenue
Variable costs:
Fuel expense
Wages expense
Food and beverage service exp.
Selling expenses
Contribution margin
Fixed costs:
Depreciation expense
Rental expense
Income from operations
$19,238,000
$4,080,000
6,120,000
444,000
3,256,000
$3,600,000
800,000
13,900,000
$ 5,338,000
4,400,000
$ 938,000
Blue Skies Airlines Inc.
Contribution Margin by Route Report—Chicago/Atlanta
for the Month Ended April 30, 2006
Revenue
Variable costs:
Fuel expense
Wages expense
Food and beverage service exp.
Selling expenses
Contribution margin
$6,400,000
$1,120,000
1,680,000
240,000
1,760,000
Contribution Margin Ratio = 0.25
4,800,000
$1,600,000
Blue Skies Airlines Inc.
Contribution Margin by Route Report—Atlanta/Los Angeles
for the Month Ended April 30, 2006
Revenue
Variable costs:
Fuel expense
Wages expense
Food and beverage service exp.
Selling expenses
Contribution margin
$7,525,000
$1,760,000
2,640,000
105,000
770,000
Contribution Margin Ratio = 0.30
5,275,000
$2,250,000
Blue Skies Airlines Inc.
Contribution Margin by Route Report—Los Angeles/Chicago
for the Month Ended April 30, 2006
Revenue
Variable costs:
Fuel expense
Wages expense
Food and beverage service exp.
Selling expenses
Contribution margin
$5,313,000
$1,200,000
1,800,000
99,000
726,000
Contribution Margin Ratio = 0.28
3,825,000
$1,488,000
Blue Skies Airlines Inc.
Contribution Margin—Chicago/Atlanta
Actual—May Planned—May
Revenue
Less variable expenses:
Fuel expense
Wages expense
Food and beverage service exp.
Selling expenses and commiss.
Total
Contribution margin
$7,600,000
$6,400,000
$1,232,000
1,680,000
300,000
2,200,000
$5,412,000
$2,188,000
$1,120,000
1,680,000
240,000
1,760,000
$4,800,000
$1,600,000
0.29
0.25
Contribution Margin Ratio
Continued
Blue Skies Airlines Inc.
Contribution Margin—Chicago/Atlanta
Actual—May Planned—May
Number of miles flown
Number of passengers flown
Per unit:
Ticket price
Fuel expense
Wages expense
Food and beverage service exp.
Selling expenses
56,000
20,000
56,000
16,000
$380
22
30
15
110
$400
20
30
15
110
Contribution Margin Analysis
Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in revenue attributed to:
Quantity factor:
Increase in the number of tickets sold
in May (4,000 x $400)
$1,600,000
Price factor:
Decrease in the ticket price in May
($20 x 20,000)
(400,000)
Net increase in revenue
$1,200,000
Continued
Contribution Margin Analysis
Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in fuel costs attributed to:
Unit cost factor:
Increase in unit cost in May times
number of miles flown
($2 x 56,000)
Continued
$112,000
Contribution Margin Analysis
Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in food and beverage service
costs attributed to:
Quantity factor:
Increase in number of tickets sold
in May times planned unit cost
in May (4,000 x $15.00)
Continued
$60,000
Contribution Margin Analysis
Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Increase in selling costs and commissions
attributed to:
Quantity factor:
Increase in number of tickets sold
in May times planned unit cost
in May (4,000 x $110)
Continued
$440,000
Contribution Margin Analysis
Report—Service Company
Blue Skies Airlines Inc.
Contribution Margin Analysis
For the Month Ended May 31, 2006
Summary:
Net increase in revenue
Net increase in fuel cost
Net increase in food and beverage
service costs
Net increase in selling costs
Increase in contribution margin
$1,200,000
(112,000)
(60,000)
(440,000)
$ 588,000
Chapter 19
The End