CHAPTER 14: MEASURING AND
ASSIGNING COSTS FOR INCOME
STATEMENTS
Cost Management, Canadian Edition
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 1
Learning Objectives
• Q1: How are absorption costing income statements
constructed?
• Q2: How are variable costing income statements
constructed?
• Q3: What factors affect the choice of production
volume measures for allocating fixed overhead?
• Q4: How are throughput costing income statements
constructed?
• Q5: What are the uses and limitations of absorption,
variable, and throughput costing income
statements?
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 2
Q1: How are absorption costing
income statements
constructed?
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide 3
Absorption Costing Income
Statements
• Under absorption costing, fixed manufacturing
overhead is an inventoriable cost.
• GAAP requires the use of absorption costing.
• Absorption costing income statements are prepared
using the traditional format.
– Expenses are grouped by function.
– Manufacturing costs deducted above the gross
margin subtotal.
– Nonmanufacturing costs deducted below the gross
margin subtotal.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 4
Absorption Costing Income
Statement Example
Russell Corporation produces a product that sells for $10. In 2009, there
were 10,000 units in beginning finished goods inventory that had a per unit
cost of $4.45. The company expected to produce, and actually did produce,
80,000 units, and 62,000 units were sold. The costs incurred in 2009 are
shown below. Given the cost information below, compute the inventoriable
costs per unit under absorption costing.
Direct materials
Direct labour
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
© John Wiley & Sons, 2009
2009
$60,000
128,000
68,000
55,800
100,000
70,000
Direct materials
Direct labour
Variable mfg overhead
Fixed mfg overhead
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
$0.75
1.60
0.85
1.25
$4.45
Slide # 5
Absorption Costing Income
Statement Example
Suppose that the Russell Corporation uses the FIFO inventory method.
Prepare an absorption costing income statement for 2009.
Sales
(#units
unitssold
sold
$10)
Sales (#
@@
$10)
Cost
ofgoods
goodssold
sold
units
@ $4.45)
Cost of
(# (#
units
soldsold
@ $4.45)
Gross
margin
Gross margin
Nonmfg
costs($70,000
($70,000+ +$55,800)
$55,800)
Nonmfg costs
Operating
income
Operating income
$620,000
$620,000
275,900
344,100
125,800
$218,300
Note that cost of goods sold is based on the 2009 per-unit
manufacturing costs because:
(1) Cost per unit was the same in 2008 and 2009. If cost
had been different in 2008, 10,000 of the 62,000 units sold
would be recorded at the per unit cost in 2008
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 6
Q2: How are variable costing
income statements
constructed?
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide 7
Variable Costing Income Statements
• Under variable costing, fixed manufacturing
overhead is a period cost.
• Variable costing income statements are used
internally only.
• Variable costing income statements are prepared
using the contribution format.
– Expenses are grouped by cost behaviour.
– Variable costs deducted above the contribution
margin subtotal.
– Fixed costs deducted below the contribution margin
subtotal.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 8
Variable Costing Income Statement
Example
Russell Corporation produces a product that sells for $10. In 2009, there
were 10,000 units in beginning finished goods inventory, with a per unit
variable cost of $3.20. The company expected to produce, and actually did
produce, 80,000 units, and 62,000 units were sold. The costs incurred in
2009 are shown below. Compute the inventoriable costs per unit under
variable costing.
Direct materials
Direct labour
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
© John Wiley & Sons, 2009
2009
$60,000
128,000
68,000
55,800
100,000
70,000
Direct materials
Direct labour
Variable mfg overhead
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
$0.75
1.60
0.85
$3.20
Slide # 9
Variable Costing Income
Statement Example
Suppose that the Russell Corporation uses the FIFO inventory method.
Prepare a variable costing income statement for 2009.
@ $8)
sold
Sales
Sales(#(#units
units
sold
@ $8)
Variable
Variablecosts:
costs:
@ $3.20)
sold sold
(# units
sold
Cost
Costofofgoods
goods
sold
(# units
@ $3.20)
costs
Nonmfg
Nonmfgvariable
variable
costs
Contribution
Contributionmargin
margin
Fixed
Fixedcosts:
costs:
Fixed
Fixedmfg
mfgoverhead
overhead
costs
Fixed
Fixednonmfg
nonmfg
costs
Operating
Operatingincome
income
$620,000
$620,000
198,400
198,400
55,800
55,800
365,800
365,800
100,000
100,000
70,000
70,000
$195,800
$195,800
Note that per unit cost was the same in 2008 and 2009 which is why
COGS did not factor in separate costs for the 10,000 2008 units and the
52,000 2005 units.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 10
Variable Costing Income
Statement Example
Suppose that the Russell Corporation uses the FIFO inventory method.
Reconcile the income under variable costing you determined on the prior
slide with the $218,300 income under absorption costing computed on slide
#4.
Variable costing income
$195,800
Add: fixed overhead attached to the increase in inventory
(18,000 units x $1.25/unit)
Absorption costing income
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
22,500
$218, 300
Slide # 11
Q3: What factors affect the
choice of production volume
measures for allocating fixed
overhead?
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide 12
Actual versus Estimated
Denominator Levels
• Normal costing (chapter 5) uses an estimated,
rather than an actual, denominator level for the
overhead cost allocation base.
• If an actual denominator level is used,
information is not timely.
• Using an estimated denominator level provides
a smoothing effect, for two reasons:
– Numerator reason
– Denominator reason
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 13
Various Measures of Production
Volume
• Supply-based measures of capacity:
– The maximum possible capacity, with no allowance
for downtime, is known as theoretical capacity.
– Theoretical capacity, reduced by an allowance for
normal downtime, is known as practical capacity.
• Demand-based measures of capacity:
– The average use of capacity of several years is
known as normal capacity.
– The anticipated use of capacity for the upcoming
year is known as budgeted capacity or expected
capacity.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 14
Effect of Denominator Volume
on the Income Statement
• When denominator volume is different than
actual volume, there is a fixed overhead volume
variance.
• The volume variance is the difference between
budgeted fixed overhead and applied fixed
overhead.
• If material, the volume variance is closed to work
in process, finished goods, and cost of goods sold
at year-end.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 15
Absorption Costing Income Statement
& Volume Variance Example
Russell Corporation produces a product that sells for $10. In 2009, there
were 10,000 units in beginning finished goods inventory. The company
expected to produce 100,000 units in 2009. However, it actually produced
80,000 units and sold 62,000 units. The costs incurred in 2009 are shown
below. Compute the inventoriable costs per unit under absorption costing.
Direct materials
Direct labour
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
2009
$60,000
128,000
68,000
55,800
100,000
70,000
Direct materials
Direct labour
Variable mfg overhead
Fixed mfg overhead
$0.75
$1.60
$0.85
$1.00
$4.20
Note that choice of denominator level affects only the fixed
overhead cost per unit.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 16
Absorption Costing Income Statement
& Volume Variance Example
Suppose that the Russell Corporation uses the FIFO inventory method and
that the volume variance is considered material. Assume that the balances
in WIP, FG, and CGS, before any adjustment for the volume variance, were at
a ratio of 1:2:7 at 12/31/09. There was no fixed overhead spending variance
in 2009. Compute the volume variance and prepare the year-end entry to
close the fixed overhead control account.
Budgeted fixed overhead
Fixed overhead applied (80,000 units x $1/unit)
Unfavourable fixed overhead volume variance
Fixed overhead control
Work in process [(1/10) x 20,000]
Finished goods [(2/10) x 20,000]
Cost of good sold [(7/10) x 20,000]
$100,000
80,000
$20,000
20,000
2,000
4,000
14,000
Note that the unfavourable volume variance equals the underapplied fixed
overhead because there was no spending variance for fixed overhead.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 17
Absorption Costing Income Statement
& Volume Variance Example
Using the cost information on slide #8 and the volume variance you
calculated on the prior slide, prepare an absorption costing income
statement for 2009.
Sales
(# units
unitssold
sold@@$10)
$10)
Sales (#
Cost
of goods
goodssold:
sold:
Cost of
(# units
units sold
sold@@$4.20)
$4.20)
(#
Adjustment for volume variance
Adjustment for volume variance
Gross margin
Gross margin
Nonmfg costs ($70,000 + $55,800)
Nonmfg costs
($70,000 + $55,800)
Operating
income
Operating income
© John Wiley & Sons, 2009
$620,000
$620,000
$260,400
$260,400
14,000 274,400
14,000 274,400
345,600
345,600
125,800
125,800
$219,800
$219,800
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 18
Q4: How are throughput costing
income statements
constructed?
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide 19
Throughput Costing Income
Statements
• Under throughput costing, all manufacturing costs
except direct materials are period costs.
• Throughput costing income statements are used
internally only; useful when most manufacturing
costs are not variable in the short run.
• Throughput costing income statements are
prepared using a new format.
– Sales – cost of goods sold (direct materials only) =
throughput margin
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 20
Throughput Costing Income
Statement Example
Russell Corporation produces a product that sells for $10. In 2009, there were 10,000
units in beginning finished goods inventory with per unit costs that were the same as
those experienced in 2009. The company expected to produce, and actually did
produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2009 are
shown below. Suppose that the Russell Corporation uses the FIFO inventory method.
Prepare a throughput costing income statement for 2009.
Direct materials
Direct labour
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
2009
$60,000
128,000
68,000
55,800
100,000
70,000
Note that DL and VO
costs expensed based
on units produced, not
units sold
© John Wiley & Sons, 2009
Sales
(# units
soldsold
@ $8)
Sales
(# units
@ $8)
CostCost
of goods
sold sold
(# units
sold @
$0.75)
of goods
(# units
sold
@ $0.75)
Throughput
margin
Throughput
margin
All other
costs:
All other
costs:
Direct
labour
Direct
labour
Variable
mfgmfg
overhead
Variable
overhead
Fixed
mfgmfg
overhead
Fixed
overhead
Variable
nonmfg
overhead
costscosts
Variable
nonmfg
overhead
Fixed
nonmfg
costscosts
Fixed
nonmfg
Operating
income
Operating
income
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
$620,000
$620,000
46,500
46,500
573,500
573,500
128,000
128,000
68,000
68,000
100,000
100,000
55,800
55,800
70,000
70,000
$151,700
$151,700
Slide # 21
Throughput Costing Income
Statement Example continued
Reconcile the income under throughput costing you computed on the prior
slide to the income under variable costing computed on slide #8 and to the
income under absorption costing computed on slide #5.
Throughput costing income
$151,700
Add: Costs attached to the increase in inventory:
labor (18,000
Direct labour
(18,000units
unitsx x$1.60/unit)
$1.60/unit)
28,800
Variable overhead (18,000 units x $0.85/unit)
15,300
Variable costing income
$195,800
Add: fixed overhead attached to the increase in inventory
(18,000 units x $1.25/unit)
Absorption costing income
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
22,500
$218, 300
Slide # 22
Q5: What are the uses and
limitations of absorption,
variable, and throughput
costing income statements?
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide 23
Uses and Limitations of the Three
Income Statement Methods
• Absorption costing is used for external reporting but
may not be best for performance evaluation purposes.
• Variable and throughput costing avoid incentives to
build up inventory levels.
• Throughput costing may be useful for some shortterm decision making.
• Under absorption costing, if practical capacity is used
as the denominator level,
– the fixed overhead rate is a useful measure of the cost
of capacity, and
– the volume variance helps measure the use of capacity.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide # 24
Copyright
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use of the information contained herein.
© John Wiley & Sons, 2009
Chapter 14: Measuring and Assigning Costs for Income Statements
Cost Management, Cdn Ed, by Eldenburg et al
Slide 25