Chapter 5 Variable Costing
Contains Fixed
Manufacturing
Overhead
Presentation Outline
I.
Absorption Costing v. Variable Costing
II. A Comparison of Income Data for
Absorption Costing and Variable Costing
III. An Illustration
I. Absorption Costing v. Variable
Costing
A.
B.
C.
D.
Cost Classifications
Fixed Manufacturing Overhead
Format of Income Statement
Report Usage
A. Cost Classifications
Absorption Costing
Variable Costing
Product costs include:
Product costs include:
> Direct materials
> Direct materials
> Direct labor
> Direct labor
> Variable mfg. overhead
> Variable mfg. overhead
> Fixed mfg. overhead
Period costs include:
> Selling & admin. expenses
Period costs include:
> Selling & admin. expenses
> Fixed mfg. overhead
B. Fixed Manufacturing Overhead
Absorption Costing
Variable Costing
Fixed manufacturing overhead
is treated as a product cost.
Fixed manufacturing overhead is
treated as a period cost and
deducted in full each year from
revenues.
Fixed mfg.
overhead is
never an
asset.
C. Format of Income Statement
Full (Absorption) Costing
Variable Costing
Sales
Sales
- Cost of goods sold
- Variable expenses
= Gross margin
= Contribution margin
- Selling & admin. expenses
-
= Net income
= Net income
Fixed expenses
See Illustration 5-2 on page 166.
D. Report Usage
Absorption costing is
required for external
reporting.
Variable costing is
permitted for
internal use only.
II. A Comparison of Income Data
for Absorption Costing and
Variable Costing
A. Production = Sales (no change in inventories)
B. Production > Sales (inventories increase)
C. Production < Sales (inventories decrease)
A. Production = Sales
(No change in inventories)
Absorption Costing
Net Income
Variable Costing Net
Income
If there is no change in inventories, then there is
generally no change in the fixed manufacturing
overhead costs in inventories under absorption costing.
B. Production > Sales
(Inventories increase)
Absorption Costing
Net Income
Variable Costing Net
Income
If inventories increase, then some of the current fixed
manufacturing overhead costs will be deferred in
inventories under absorption costing.
C. Production < Sales
(Inventories decrease)
Absorption Costing
Net Income
Variable Costing Net
Income
If inventories decrease, then some of the prior fixed
manufacturing overhead costs that had been deferred
in inventories under absorption costing, will be released
as a current charge against income.
III. An Illustration
Selling price per unit
$2,000
Variable costs per unit:
Direct materials
$ 600
Direct labor
$
225
Variable manufacturing overhead
$
75
Variable selling and administrative expenses
$
40
Fixed costs per year:
Fixed manufacturing overhead
$1,200,000
Fixed selling expenses
$ 100,000
Fixed administrative expenses
$ 500,000
Annual production in units
5,000
Compute the unit product cost under absorption costing.
Direct materials
600
Direct labor
225
Variable manufacturing overhead
75
Fixed manufacturing overhead ($1,200,000 / 5,000 units)
240
Absorption unit product cost
1,140
Compute the unit product cost under variable costing.
Direct materials
600
Direct labor
225
Variable manufacturing overhead
75
Variable unit product cost
900
Year 1 Assumption:
Production = Sales
5,000 units = 5,000 units
Variable Costing Income Statement
Sales (5,000 units x $2,000)
10,000,000
Less variable expenses
Cost of goods sold:
Beginning finished goods inventory
0
Cost of goods mfg (5,000 units x $900)
4,500,000
Goods available for sale
4,500,000
Ending fin. goods inventory
Cost of goods sold
Selling expense (5,000 units x $40)
Contribution margin
0
4,500,000
200,000
5,300,000
Less fixed expenses:
Manufacturing overhead
1,200,000
Selling expense
100,000
Administrative expense
500,000
Net income
3,500,000
Abosorption Costing Income Statement
Sales (5,000 units x $2,000)
10,000,000
Less cost of goods sold:
Beginning finished goods inventory
0
Cost of goods mfg (5,000 units x $1,140)
5,700,000
Goods available for sale
5,700,000
Ending fin. goods inventory
Cost of goods sold
Gross margin
0
5,700,000
4,300,000
Operating expenses:
Selling expenses ($100,000 + (5,000 units x $40)
300,000
Administrative expenses
500,000
Net operating income
3,500,000
Year 2 Assumption:
Production > Sales
5,000 units = 4,800 units
Variable Costing Income Statement
Sales (4,800 units x $2,000)
9,600,000
Less variable expenses
Cost of goods sold:
Beginning finished goods inventory
0
Cost of goods mfg (5,000 units x $900)
4,500,000
Goods available for sale
4,500,000
Ending fin. goods inventory (200 units x $900)
Cost of goods sold
Selling expense (4,800 units x $40)
Contribution margin
180,000
4,320,000
192,000
5,088,000
Less fixed expenses:
Manufacturing overhead
1,200,000
Selling expense
100,000
Administrative expense
500,000
Net income
3,288,000
Abosorption Costing Income Statement
Sales (4,800 units x $2,000)
9,600,000
Less cost of goods sold:
Beginning finished goods inventory
0
Cost of goods mfg (5,000 units x $1,140)
5,700,000
Goods available for sale
5,700,000
End. fin. goods inv. (200 units x $1,140)
Cost of goods sold
Gross margin
228,000
5,472,000
4,128,000
Operating expenses:
Selling expenses ($100,000 + (4,800 units x $40)
292,000
Administrative expenses
500,000
Net operating income
3,336,000
Reconciliation of the operating income between variable costing and absorption
costing
Variable costing net income
3,288,000
- Fixed manufacturing overhead released from
beginning inventory
0 units x $240
0
+ Fixed manufacturing overhead deferred in
ending inventory
200 units x $240
Absorption costing net income
48,000
3,336,000
Year 3 Assumption:
Production < Sales
5,000 units = 5,200 units
Variable Costing Income Statement
Sales (5,200 units x $2,000)
10,400,000
Less variable expenses
Cost of goods sold:
Beginning fin. goods inv. (200 units x $900)
180,000
Cost of goods mfg (5,000 units x $900)
4,500,000
Goods available for sale
4,680,000
Ending fin. goods inventory
Cost of goods sold
Selling expense (5,200 units x $40)
Contribution margin
0
4,680,000
208,000
5,512,000
Less fixed expenses:
Manufacturing overhead
1,200,000
Selling expense
100,000
Administrative expense
500,000
Net income
3,712,000
Abosorption Costing Income Statement
Sales (5,200 units x $2,000)
10,400,000
Less cost of goods sold:
Beg. Fin. goods inv. (200 units x $1,140)
228,000
Cost of goods mfg (5,000 units x $1,140)
5,700,000
Goods available for sale
5,928,000
End. fin. goods inv.
Cost of goods sold
Gross margin
0
5,928,000
4,472,000
Operating expenses:
Selling expenses ($100,000 + (5,200 units x $40)
308,000
Administrative expenses
500,000
Net operating income
3,664,000
Reconciliation of the operating income between variable costing and absorption
costing
Variable costing net income
3,712,000
- Fixed manufacturing overhead released from
beginning inventory
200 units x $240
48,000
+ Fixed manufacturing overhead deferred in
ending inventory
0 units x $240
Absorption costing net income
0
3,664,000
A Comparison of Incomes
Year 1
Absorption
Net Income
3,500,000
Variable Net
Income
3,500,000
3,336,000
3,288,000
3,664,000
3,712,000
10,500,000
10,500,000
(Production = Sales)
Year 2
(Production > Sales)
Year 3
(Production < Sales)
3 Year Totals
When total production over the 3 year period = total sales over that
period, total net income under the approaches is equal.