Variable Costing for Management Analysis

20 1

Absorption Costing

Under

absorption costing

, all manufacturing costs are included in finished goods and remain there as an asset until the goods are sold.

20-1 2

20-1

20-1 Absorption costing is necessary in determining historical costs for financial reporting to external users and for tax reporting.

4

Variable Costing

Variable costing

(also called

direct costing

) may be more useful to management in making decisions. In variable costing, the cost of goods manufactured is composed only of variable manufacturing costs.

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20-1

Costs of Goods Manufactured Comparison Absorption Costing Cost of Goods Manufactured Direct Materials Direct Labor Variable Factory OH Fixed Factory OH

20-1

Cost of Goods Manufactured Variable Costing Period Expense

Variable Costing Income Statement Compared to Absorption Costing Income Statement

Assume that Belling Co. manufactured 15,000 units at the following costs: 20-1

Variable Costing Income Statement

20-1

Absorption Costing Income Statement

20-1

The absorption costing income statement does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of good sold. Deducting cost of goods sold from sales yields

gross profit

. Deducting selling and administrative expenses then yields

income from operations

.

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Example Exercise 20-1 Leone Company has the following information for March: Sales $450,000 Variable cost of goods sold Fixed manufacturing costs 220,000 80,000 Variable selling and administrative expenses 50,000 Fixed selling and administrative expenses 35,000 Determine the March (a) manufacturing margin, (b) contribution margin, and (c) income from operations for Leone Company.

20-1

Follow My Example 20-1 (a) $230,000 ($450,000 – $220,000) (b) $180,000 ($230,000 – $50,000) (c) $65,000 ($180,000 – $80,000 – $35,000) 20-1 For Practice: PE 20-1A, PE 20-1B

20-2 Frand Manufacturing Company has no beginning inventory and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels.

14

Proposal 1: 20,000 Units to be Manufactured and Sold

20-2

Proposal 2: 25,000 Units to be Manufactured; 20,000 Units to be Sold

20-2

Absorption Costing Income Statements for Two Production Levels

$35V 20F $55 20-2

Absorption Costing Income Statements for Two Production Levels

$35V 16F $51

The $80,000 increase in income from operations would be caused by allocating the fixed manufacturing costs of $400,000 over a greater number of units of production.

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Now, assume that Frand Manufacturing uses variable costing and has sales of 20,000 units. Exhibit 6 illustrates that net income remains a constant $200,000 at the three levels of production.

20-2 20

Variable Costing Income Statements for Two Production Levels

20-2

Example Exercise 20-4 Variable costs are $100 per unit, and fixed costs are $50,000. Sales are estimated to be 4,000 units. (a) How much would absorption costing income from operations differ between a plan to produce 4,000 units and a plan to produce 5,000 units? (b) How much would variable costing income from operations differ between the two production plans?

20-2

Follow My Example 20-4 (a) $10,000 greater in producing 5,000 units 4,000 units x ($12.50 – $10.00), or [1,000 units x ($50,000/5,000 units)].

(b) There would be no difference in variable costing income from operations between the two plans.

20-2 For Practice: PE 20-4A, PE 20-4B

20-3

Objective 3

Describe and illustrate management’s use of variable costing and absorption costing for controlling costs, pricing products, planning production, analyzing contribution margins, and analyzing market segments.

24

Controllable and Noncontrollable Costs

For a specific level of management,

controllable costs

are costs that can be influenced by management at that level, and

noncontrollable costs

are costs that another level of management controls.

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Pricing Products

Many factors enter into determining the selling price of a product. The cost of making the product is clearly significant. In the short run, pricing decisions should be based upon making the best use of existing manufacturing facilities.

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In the long run, plant capacity can be increased or decreased. If a business is to continue operating, the selling prices of its products must cover all costs and provide a reasonable income.

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Analyzing Contribution Margins

Managers can plan and control operations by evaluating the differences between planned and actual contribution margin.

20-3 28

Analyzing Market Segments

A

market segment

is a portion of a business that can be analyzed using sales, costs, and expenses to determine its profitability. 20-3 29

20-4

Objective 4

Use variable costing for analyzing market segments including product, territories, and salespersons segments.

30

Analyzing Market Segments

Camelot Fragrance Company manufactures and sells the Gwenevere perfume for women and the Lancelot cologne line for men. The inventories are negligible.

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Camelot Fragrance Company

20-4

Contribution Margin by Sales Territory Report

20-4

Sales Mix

Sales mix

, sometimes referred to as

product mix

, is defined as the relative distribution of sales among the various products sold. 20-4 34

Product Profitability Analysis

Some products are more profitable than others due to differences with respect to pricing, manufacturing costs, advertising support, or salesperson support. Exhibit 9 shows the contribution margin by product for Camelot Fragrance Company.

20-4 35

Contribution Margin by Product Line Report

20-4

Salesperson Profitability Analysis

Sales managers may wish to evaluate the performance of salespersons. This may be done with a report that shows contribution margin by salesperson. Such a report is shown in Exhibit 10 for the Northern Territory salespersons.

20-4 37

Contribution Margin by Salesperson Report

20-4

20-4 Example Exercise 20-5 The following data are for Moss Creek Apparel: East West Sales volume (units): Shirts Shorts 6,000 4,000 5,000 8,000 Sales price: Shirts Shorts Variable cost per unit: Shirts $ 12 $ 16 $ 13 $ 18 $ 7 $ 7 Shorts $ 10 $ 10 Determine the contribution margin for (a) Shorts and (b) the West Region.

66 67

Follow My Example 20-5 (a) $88,000 [4,000 units x ($16 – $10)] + [8,000 units x ($18 – $10)] (b) $94,000 [5,000 units x ($13 – $7)] + [8,000 units x ($18 – $10)] 20-4 For Practice: PE 20-5A, PE 20-5B