Transcript No Slide Title

Chapter 9
Income Effects of Alternative
Inventory Costing Models
Copyright © 2003 Pearson Education Canada Inc.
Slide 7-97
Absorption Costing
Absorption costing income statement
• also called full costing
• classify costs based on functions
• inventory composed of variable and fixed production
costs
• net income is function of sales and production
Revenue
Manufacturing costs
Contribution margin
Marketing costs
Operating income
Copyright © 2003 Pearson Education Canada Inc.
Pages 313 - 316
Slide 7-98
Variable Costing
Variable costing income statement
• also called direct costing
• classify costs based on behaviour
• inventory composed of variable production costs only
• net income is a function of sales
Revenue
Variable costs
Contribution margin
Fixed costs
Operating income
Copyright © 2003 Pearson Education Canada Inc.
Pages 313 - 316
Slide 7-99
Comparing the Two Income Statements
• Difference in net income between a variable
costing income statement and an absorption
costing income statement is due to the treatment
of fixed manufacturing costs
• Fixed manufacturing costs are treated as a period
cost under variable costing
• Fixed manufacturing costs are treated as an
inventoriable (product) cost under absorption
costing
Copyright © 2003 Pearson Education Canada Inc.
Pages 316 - 318
Slide 7-100
How the Two Income Statements Differ
Variable
Absorption
Revenue
Revenue
Manufacturing
costs
Variable costs
Contribution
margin
Fixed costs
Operating
income
Copyright © 2003 Pearson Education Canada Inc.
Fixed
Manufacturing
Overhead
Costs
Gross margin
Marketing costs
Operating
income
Pages 316 - 318
Slide 7-101
Converting Between the Two Statements
Direct operating income - absorption operating income
= Fixed manufacturing costs in ending inventory - fixed
manufacturing costs in beginning inventory
= (200 x $16) - (0 x $16) = $3,200
or
= (Units produced - units sold) x fixed manufacturing
cost rate
= (600 - 400) x $16 = $3,200
or
= (Ending inventory units - Beginning inventory units) x
fixed manufacturing cost rate
= (200 units - 0 units) x $16 = $3,200
Copyright © 2003 Pearson Education Canada Inc.
Pages 319 - 321
Slide 7-102
Performance Evaluation – Absorption
• One of the problems with absorption costing that
managers can increase operating income in the short
run by increasing production independent of sales
• The additional units produced absorb some of the
fixed costs which are carried forward on the balance
sheet rather than being expensed on the income
statement
• Therefore
• carefully monitor inventory levels
• consider a charge for the amount of inventory
carried (1% x value of inventory on hand)
• evaluate performance over longer periods
Copyright © 2003 Pearson Education Canada Inc.
Pages 321 - 324
Slide 7-103
Throughput Costing
• Throughput costing (or super-variable costing)
treats all costs except those related to variable direct
materials as costs of the period in which they were
incurred
• only variable direct material costs are inventoriable
• since all other production-related costs are
expensed on the income statement, management is
less motivated to increase inventories (shifting costs
from the income statement to the balance sheet)
• reducing inventory levels means less funds are tied
up in inventory
Copyright © 2003 Pearson Education Canada Inc.
Pages 325 - 326
Slide 7-104
Capacity Concepts
• Many different numbers can be used as “capacity”
under absorption costing
Theoretical capacity – ideal
situation with 100% efficiency
Practical capacity – recognize
that some downtime is
unavoidable
Normal capacity – the average
output level over a 2-3 year
period
Budgeted capacity – expected
output for the next year
Copyright © 2003 Pearson Education Canada Inc.
1,152,000 bottles
800,000 bottles
500,000 bottles
400,000 bottles
Pages 328 - 333
Slide 7-105
Capacity and Absorption Costing
• Using theoretical capacity or practical capacity as
the denominator reduces the amount of fixed
manufacturing overhead assigned to inventory and
increases the production volume variance
• Canada Customs and Revenue Agency (CCRA) does
not allow the use of theoretical or practical capacity
in determining taxable income
• When considering which denominator to use keep
in mind that the resultant cost information will be
used for product costing and capacity management,
pricing, performance evaluation, and forecasting
Copyright © 2003 Pearson Education Canada Inc.
Pages 328 - 333
Slide 7-106