Transcript Strategic Transfer Pricing, Absorption Costing and

Chapter 9
Inventory Costing and Capacity Analysis
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Introduction
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The reported income number captures the attention
of managers in a way few other numbers do.
This chapter examines two types of cost accounting
choices in which the reported income number of
manufacturing companies is affected by inventories.
Variable costing and absorption costing
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methods treat fixed manufacturing overhead differently:
Under variable costing, fixed manufacturing overhead costs
are excluded from inventoriable costs and are a cost of the
period in which they are incurred.
Under absorption costing, these costs are inventoriable and
become expenses only when a sale occurs.
Under both methods all nonmanufacturing costs in
the value chain (such as research and development
and marketing), whether variable or fixed, are
recorded as expenses when incurred.
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Variable Costing
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All variable manufacturing costs are assigned to
production and they become part of the unit cost.
Fixed costs are charged to the Income Summary
Direct Material Inventory
Payroll
Work-in-Process Inventory
Variable
factory
labor
Variable Overhead
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Variable Costing
Payroll
Work-in-Process Inventory
Fixed Absorption costing
factory
labor
Income Summary
Finished Goods
Cost of Goods Sold
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Comparison of Variable and Absorption Costing
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Inventory values are smaller with variable costing
because it capitalizes only variable cost as asset.
 Inventory values using absorption costing have an
additional fixed factory overhead per unit
 Income in periods of increasing (decreasing)
inventory are higher (lower) with absorption costing
than with variable costing
 Absorption costing operating income
– Variable costing operating income
= Fixed manufacturing costs in ending inventory under
absorption costing
– Fixed manufacturing costs in beginning inventory
under absorption costing
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Inventory Buildup
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Absorption costing enables a manager to increase
operating income in a specific period by increasing
the production schedule, even if there is no customer
demand for the additional production.
While the utilized part of fixed costs is inventoried,
production volume variance is not. Reducing volume
variance by producing to inventory reduces a loss
due to low demand
loss is shifted to the future unless demand rises
Cost in inventory
fixed cost in inventory
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Undesirable effects of producing for inventory
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Production of items that absorb minimal fixed
manufacturing costs may be delayed.
A plant manager may accept a particular order to
increase production even though another plant in
the same company is better suited to handle that
order.
A plant manager may defer maintenance.
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Revising Performance Evaluation
Budget carefully and use inventory planning.
2 Discontinue the use of absorption costing for
internal reporting and instead use variable costing.
3 Incorporate a carrying charge for inventory.
4 Lengthen the time period used to evaluate
performance
5 Include nonfinancial as well as financial variables in
the measures used to evaluate performance.
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Sales in units this period
÷ Ending inventory in units this period
Ending inventory in units this period
÷ Ending inventory in units last period
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Throughput Costing...
treats all costs except those related to variable direct
materials as period costs.
Only direct materials costs are inventoriable costs.
Inventoriable costs
absorption costing
loss
variable costing
Reported loss
absorption costing
variable costing
Throughput costing
Revenue,
both periods
Throughput costing
sales volume
production volume
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Comparison of Inventory Costing Methods
Actual
or Normal
or Standard
Costing
Variable
Costing
Absorption
Costing
Throughput
Costing
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Alternative Denominator-Level Concepts
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The choice of the denominator used to allocate budgeted fixed
manufacturing costs to products can greatly affect the
numbers a normal or standard (absorption) costing system will
report prior to the end of an accounting period.
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Alternative Denominator-Level Concepts
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Theoretical capacity xt (maximum or ideal capacity)
 based on producing at full (peak) efficiency all the time.
 Practical capacity xp
 reduces theoretical capacity by unavoidable operating interruptions
 The use of practical capacity is required by the IRS.
 Normal capacityxn
 based on the level of capacity utilization that satisfies average
customer demand over several periods
 includes seasonal, cyclical, and trend factors.
 Master-budget capacity xm
 based on the expected level of capacity utilization for the next
budget period (typically one year).
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Budgeted Fixed Manufacturing Overhead Rate
for xt
negative volume variance
Budgeted Fixed cost
volume variance for
normal capacity
volume variance for xp
Slope = fixed overhead rate
xm
xn xp xt
xa
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Decision Making
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Cost data from a normal or standard costing
system are often used in pricing or productemphasis decisions.
Downward Demand Spiral
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f ( x)
f2
The use of normal capacity utilization or master-budget
capacity utilization can result in capacity costs being
spread over a small number of output units.
Downward demand spiral: continuing reduction in
demand that occurs when the prices of competitors are
not met and demand drops.
f1
D2
D1
x
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CCs for chapter 9
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9-21 (3%)
9-23 (5%)
9-33 (3%)
9-17 (5%)
9-19 (5%)
9-25 (=11.9-24)(3%)
9-37 (10%)
9-41 (10%) (new in 12)
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If not otherwise indicated problems identical to 11th ed.
Please explain the problem statement, give the data,
and explain your solution. Mere results will not yield
satisfactory grade.
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Data 9-37
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Denominator level choice
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Standard for Actual units of output: 70 000
Budgeted fixed overhead: $120 000
at practical capacity:
 fixed manuf. overhead spending variance: 10 000 (U)
 production volume variance: $36 000 (U)
at normal capacity:
 production volume variance: $20 000 (F)
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