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# CHAPTER 5

Variable Costing

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## Full (Absorption) Costing

Inventory costs include:
-direct materials used -direct labor incurred -both fixed & variable manufacturing overhead

## Required by GAAP for external reporting purposes

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Learning objective 1: Explain the difference between full (absorption) and variable costing

Which of the following complies with GAAP for external reporting purposes? a. Absolute costing b. Variable costing c. Fixed costing d. Full costing

## Answer: d. Full costing

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Learning objective 1: Explain the difference between full (absorption) and variable costing

## Full (Absorption) Costing

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Learning objective 1: Explain the difference between full (absorption) and variable costing

Variable Costing
Inventory costs includes: -Direct materials used -Direct labor incurred -Variable manufacturing overhead Fixed manufacturing overhead treated as a period cost Helpful for internal decision making Not allowed for GAAP reporting

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Learning objective 1: Explain the difference between full (absorption) and variable costing

Variable Costing

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Learning objective 1: Explain the difference between full (absorption) and variable costing

## Difference Between Full and Variable Costing

Treatment of fixed manufacturing overhead
Under full costing, it is included in inventory and expensed when the product is sold Under variable costing, it is considered a period cost and expensed in the period incurred.

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Learning objective 1: Explain the difference between full (absorption) and variable costing

## Variable Costing Income Statement

Utilizes the contribution margin approach
- Contribution margin ratio = contribution margin/sales

## Can help in decision making - Contribution margin ratio x change in sales =

change in contribution margin - Fixed costs stay the same when sales change

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## Learning objective 2: Prepare an income statement using variable costing.

Which of the following provides information helpful to internal decision making? a. Absolute costing b. Variable costing c. Fixed costing d. Full costing

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## Learning objective 2: Prepare an income statement using variable costing.

Sales are \$100,000 and contribution margin is \$65,000 Calculate the contribution margin ratio: \$65,000 / \$100,000 = 0.65 or 65% Calculate the change in contribution margin if sales change by \$10,000 \$10,000 X 0.65 = \$6,500

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## Example - Clausen Tube

Selling price \$2,000

Variable costs (per unit): -Materials = \$600/unit -Labor = \$225/unit -Variable mfg. overhead = \$75/unit -Variable selling expense = \$40/unit
Fixed mfg. overhead = \$1,200,000 Production = 5,000 units

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Clausen Tube - Full Cost/Unit

Full cost/unit (5,000 units) is calculated as follows: \$600/unit Total Material Costs Total labor costs Total variable OH
\$225/unit \$75/unit

Full Cost/Unit

## \$1,200,000/ 5000 units

\$240/unit
= \$1,140/unit

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Clausen Tube Variable Cost/Unit

Variable unit cost is calculated as follows:
Unit materials cost = \$600 Unit labor cost = \$225 Unit variable overhead = \$75 Variable cost per unit =
\$600 + \$225 + \$75 = \$900 per unit

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Clausen Tube Income Statement

Selling price = \$2,000/unit Full cost = \$1,140/unit Variable cost = \$900/unit Variable selling expense = \$40/unit Fixed overhead = \$1,200,000 Fixed selling expense = \$100,000 Fixed administrative expense= \$500,000

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Clausen Tube Income Statements

Production equals sales (5,000 units)
Full Cost Sales 5,000 x \$2,000 = 10,000,000 Cost of goods sold 5,000 x \$1,140 = 5,700,000 Gross margin 4,300,000 Selling & Admin Expenses* 800,000 Net Income 3,500,000 *100,000 + 500,000 + (5,000 x \$40) Variable Cost Sales 5,000 x \$2,000 = 10,000,000 5,000 x \$900 Variable costs +(5,000 x \$40)= 4,700,000 Contribution margin 5,300,000 Fixed costs** 1,800,000 Net Income 3,500,000 **1,200,000 + 100,000 + 500,000

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Clausen Tube Income Statements

Production (5,000) is greater than sales (4,000)
Full Cost Sales 4,000 x \$2,000 = 8,000,000 Cost of goods sold 4,000 x \$1,140 = 4,560,000 Gross margin 3,440,000 Selling & Admin Expenses* 760,000 Net Income 2,680,000 *100,000 + 500,000 + (4,000 x \$40) Variable Cost Sales 4,000 x \$2,000 = 8,000,000 4,000 x \$900 + Variable Costs (4,000 x \$40) = 3,760,000 Contribution margin 4,240,000 Fixed Costs** 1,800,000 Net Income 2,440,000 **1,200,000 + 100,000 + 500,000

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Clausen Tube Income Statements

Production (5,000) less than sales (6,000)
Full Cost Sales 6,000 x \$2,000 = 12,000,000 Cost of goods sold 6,000 x \$1,140 = 6,840,000 Gross margin 5,160,000 Selling & Admin Expenses* 840,000 Net Income 4,320,000 *100,000 + 500,000 + (6,000 x 40) Variable Cost Sales 6,000 X 2,000 = 12,000,000 6,000 X 900 Variable costs +(6,000 x\$40) = 5,640,000 Contribution margin 6,360,000 Fixed costs** 1,800,000 Net Income 4,560,000 **1,200,000 + 100,000 + 500,000
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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Variable Costing for External Reporting

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Learning objective 3: Discuss the effect of production on full and variable costing income.

Summit Manufacturing, Inc. produces snow shovels. The selling price is \$25. Costs are:
Materials Labor Variable Overhead Fixed Overhead Variable Selling & Admin Fixed Selling & Admin 4 3 2 168,000 1 152,000

## Production is 42,000 snow shovels. Calculate full cost/unit.

(4 x 42,000) + (3 x 42,000) + (2 x 42,000)+ 168,000) = 546,000 / 42,000 = \$13/unit
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Learning objective 3: Discuss the effect of production on full and variable costing income.

Summit Manufacturing, Inc. produces snow shovels. The selling price is \$25. Costs are:
Materials Labor Variable Overhead Fixed Overhead Variable Selling & Admin Fixed Selling & Admin 4 3 2 168,000 1 152,000

## Production is 42,000 snow shovels. Calculate variable cost/unit.

(4 + 3 + 2) = 9 per unit

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Learning objective 3: Discuss the effect of production on full and variable costing income.

Summit Manufacturing, Inc. produces snow shovels. The selling price is \$25. Costs are:
Full Cost Unit Cost Variable Unit Cost Fixed Overhead Variable Selling & Admin Fixed Selling & Admin 13 9 168,000 1 152,000

Sales are 38,500 snow shovels. Calculate net income using full cost.
Sales Cost of Goods Sold Selling & Admin Net Income 38,500 x \$25 38,500 x \$13 152,000 + 38,500 x \$1 962,500 500,500 190,500 271,500

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Learning objective 3: Discuss the effect of production on full and variable costing income.

Summit Manufacturing, Inc. produces snow shovels. The selling price is \$25. Costs are:
Full Cost Unit Cost Variable Unit Cost Fixed Overhead Variable Selling & Admin Fixed Selling & Admin 13 9 168,000 1 152,000

Sales are 38,500 snow shovels. Calculate net income using variable cost.
Sales Variable Cost of Sales Variable Selling & Admin Fixed Overhead Fixed Selling and Admin Net Income 38,500 X 25 38,500 X 9 152,000 + 38,500 X 1 962,500 346,500 38,500 168,000 152,000 257,500

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Impact of Method Selection on Income Statement

Units produced = units sold
No difference in net income

## Units produced greater than units sold

Full costing yields higher net income

## Units Produced less than units sold

Variable costing yields higher net income

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## If units produced exceed units sold:

a. Full costing yields a higher income than variable costing b. Full costing yields a lower income than variable costing c. Full costing and variable costing yield the same income d. Variable costing yields a higher income than full costing

a. Full costing yields a higher income than variable costing
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Learning objective 3: Discuss the effect of production on full and variable costing income.

## If units produced are less than units sold:

a. Full costing yields a higher income than variable costing b. Full costing yields a lower income than variable costing c. Full costing and variable costing yield the same income d. Variable costing yields a lower income than full costing

b. Full costing yields a lower income than variable costing
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Learning objective 3: Discuss the effect of production on full and variable costing income.

Reducing Production

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Learning objective 3: Discuss the effect of production on full and variable costing income.

## Impact of JIT on Income

Companies using JIT typically have low levels of inventory Units produced are approximately equal to units sold Difference between full and variable costing is likely to be very small.

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Learning objective 4: Explain the impact of JIT on the difference between full and variable costing income

## Benefits of Variable Costing for Internal Reporting

Variable costing facilitates cost-volumeprofit (CVP) analysis -separates fixed and variable costs -easily calculate the change in income when sales change

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Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes

## Benefits of Variable Costing for Internal Reporting

Variable costing limits management of earnings via production volume -Managers are often compensated based on income in their division -Full costing produces higher income when production is greater than sales -Managers have an incentive to manage earnings under full costing

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Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes

## Impact of Changes in Sales

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Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes