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ACCT1022 Study Guide - Quiz Guide: Cost Driver, Total Absorption Costing, Budget

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limespider939
22 Jan 2014
School
Boston College
Department
Accounting
Course
ACCT1022
Professor
Ken Porter

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Document Summary

Under absorption costing, fixed manufacturing-overhead costs are assigned to units of product as product costs. Under variable costing, fixed manufacturing-overhead costs are not assigned to units of product as product costs; rather they are treated as period costs and expensed during the period in which they are incurred. When inventory increases, the income reported under absorption costing will be greater than the income reported under variable costing. This difference results from the fact that under absorption costing, some of the fixed manufacturing costs incurred during the period will not be expensed. In contrast, under variable costing all of the fixed manufacturing costs incurred during the period will be expensed during that period. Many managers prefer variable costing over absorption costing because income statements prepared under variable costing more closely reflect operations. For example, when sales increase, other things being equal, income will also increase under variable costing. Under absorption costing, however, income will not necessarily increase when sales increase.

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Related Questions

Crossbow Corp. produces a single product. Data concerning June's operations follow: Units in beginning inventory 0 Units produced 6,000 Units sold 5,000 Variable costs per unit: Manufacturing $ 7 Selling and administrative $ 3 Fixed costs in total: Manufacturing $12,000 Selling and administrative $ 3,000 For the year in question, net operating income under variable costing will be: higher than net operating income under absorption costing. lower than net operating income under absorption costing. the same as net operating income under absorption costing. The relation between absorption costing and variable costing net operating income cannot be determined.

Mario's Foods produces frozen meals, which it sells for $9 each.The company uses the FIFO invenotry costing method, and it computesa new monthy fixed manufactoring overhead rate based on the actualnumber of meals produced that month. All cost and production levelsare exactly as planned. The following data are from the company'sfirst two months in business:

JAN FEB
Sales........................ 1,600 meals 1,900 meals
Production............... 2,000 meals 1,600 meals
Variable manufactoring expense per meal $5 $5
Sales commision expense per meal $2 $2
Total fixed manfucuring overhead $800 $800
Total fixed makerting and administrative expenses $700 $700

Requirements:

1. Compute the product cost per meal produced underabsorptioncosting and under variable costing. Do this first for January, andthen for Febuary.

2. Prepare seperate monthly income statements for January andfor February, using the following:

a. Absorrption costing

b. Variable Costing

3. Is operating income higher under absorption costing orvariable costing in January? In February? Explain the pattern ofdifferences in operating income based on absorption costing versusvariable costing.

Requirement 1. Compute the product cost permeal under absortion costing and under variable costing. Do thisfirst for January and the Febuary

JAN FEB
Absorbtion Costing Variable Costing Absorption Costing Variable Costing
Total Product cost

Requirement 2a. Prepare seperate monthly incomestatements for January and for Feb, using absorption costing

Mario's Foods o

Contribution Margin Income Statement (variablecosting)

Month Ended

Jan 31 Feb 31
Less

Requirement 2b. Prepare Marios Foods Jan and Feb incomeStatement using variable costing

Requirement 3. Is operating income higher under absorptioncosting or variable costing in Jan? In Feb? Explain the pattern ofdifferences in operating income based on absorption costing versusvariable costing.

In Jan, absorption costing operating income_____(equals,exceedsor less than) variable costing income. This is because unitsproduced ______(equal to, greater than, less than) units weresold.

Absorption costing some of _____(Jan or Feb) __________(fixedmanufacturing overhead, nonmaufactoring, variable maufactoringoverhead) costs in the units of ending inventory. These cost willnot be_____(capitalized, expensed, paid in for cash) until thoseare sold. Deferring these _________ ( fixed manufactoring overhead,nonmanufactoring, variable manufactoring overhead)cost to thefuture _______ (Increases, Decreases)January's absoprtion costingincome.

In Feb, absorption costing operating income ________ (equals,exceeds, less than) variable costing operating income. This isbecause units produced were _____ (equal to, greather than, lessthan)units sold for the month.

As inventory______(increases, declines) as was the case in thisFebruary, January's ________(fixed manufactoring overhead,nonmanufactoring, variable manufactoring overhead) costs thatabsorption costing assigned to that inventory are expensed in_______(Jan, Feb). This _______ ( increases, decreases)Febuary'sabsorption costing income.

Variable Costing

An approach to measuring profitability that avoids the problemsinherent in making fixed overhead look like a variable cost isvariable costing. Variable costing (sometimes called directcosting) assigns only unit-level variable manufacturing costs tothe product; these costs include direct materials, direct labor,and variable overhead. Fixed overhead is treated as a period costand is not inventoried with the other product costs. Instead, it isexpensed in the period incurred.

The result of treating fixed manufacturing overhead as a periodexpense is to reduce the factory costs that are inventoriable.Under variable costing, only direct materials, direct labor, andvariable overhead are inventoried. (Remember that marketing andadministrative expenses are never inventoried-whether variable orfixed.)

Example: Fender Company showed the followingunit costs for its product:

Direct materials $1.15
Direct labor 0.60
Variable overhead 0.22
Fixed overhead* 2.44
*Based on capacity of 29,800units.

Last year, Fender made 29,800 units and sold 27,700 units at aprice of $9.01. Selling and administrative expense equaled $49,170(all fixed). Beginning Finished Goods Inventory contained 410 unitswith cost of $1,808.10.

Cost of one unit under variablecosting = Direct materials + Direct labor +Variable overhead
= $1.15 + $0.60 + $0.22 =$1.97
Units in ending Finished GoodsInventory = 410 + 29,800 - 27,700 = 2,510units
Ending Finished GoodsInventory = 2,510 × $1.97 = $4,944.70

The income statement for Fender Company is as follows:

Sales $249,577
Variable cost of Goods Sold ($1.97× 27,700) 54,569
Contribution margin $195,008
Less:
Fixed overhead 72,712
Selling andadministrative expense 49,170 121,882
Variable-costing operatingincome $73,126

Notice that all of the fixed factory overhead of $72,712 ($2.44× 29,800) and the variable cost of manufacturing for the units sold($1.97 × 27,700 units sold) appear on the variable-costing incomestatement. None of the fixed factory overhead is attached to unsoldunits added to Finished Goods inventory because the fixed overheadis treated as a period expense. Only the variable cost ofmanufacturing ($1.97 × 2,100) is added to Finished Goods inventory- attached to the 2,100 units that were produced but not sold.

1. Under variable costing, ifbeginning Finished Goods Inventory equaled zero, the value ofending Finished Goods Inventory would be $?? .
2. Ignoring question 1 above,if Fender Company sold 30,020 units, there wouldbe units in ending Finished Goods Inventory with a valueof $?? (round to the nearest cent).

Reconciling the Difference Between Absorption andVariable Costing

When inventories change from the beginning to the end of theperiod, the two costing approaches will give different operatingincomes. The reason for this is that absorption costing assignsfixed manufacturing overhead to units produced. If those units aresold, the fixed overhead appears on the income statement under costof goods sold. If the units are not sold, the fixed overhead goesinto inventory. Under variable costing, however, all fixed overheadfor the period is expensed. As a result, absorption costing allowsmanagers to manipulate operating income by producing for inventory.Let's compare the income statements under the two methods forFender Company.

Example: Fender Company showed the followingunit costs for its product:

Direct materials $1.15
Direct labor 0.60
Variable overhead 0.22
Fixed overhead* 2.44
*Based on capacity of 29,800units.

Last year, Fender made 29,800 units and sold 27,700 units at aprice of $9.01. Selling and administrative expense equaled $49,170(all fixed). Beginning Finished Goods Inventory contained 410 unitswith cost of $1,808.1.

Absorption-CostingIncome Variable CostingIncome
Sales $249,577.00 Sales $249,577.00
COGS ($4.41 × 27,700) 122,157.00 Variable COGS ($1.97 × 27,700) 54,569.00
Gross margin $127,420.00 Contribution margin $195,008.00
Less: Fixed overhead 72,712
Selling & admin.exp 49,170 Selling & admin. exp. 49,170
Operating income $78,250.00 Operating income $73,126.00

There is a difference of $5,124 between the absorption-costingoperating income and the variable-costing operating income. This$5,124 is caused by the different treatment of fixed factoryoverhead. Under absorption costing, the 2,100 units added to endinginventory took not only the $1.97 of variable manufacturing cost,but also $2.44 per unit in fixed overhead. Under variable costing,however, all the fixed factory overhead of $72,712 was expensed.None of it was added to units going into ending inventory.

Absorption-costing income -Variable-costing income = Change in inventory × fixedoverhead rate
= 2,100 units × $2.44 = $5,124

What if more units are sold than are produced? That is, what ifending inventory is less than beginning inventory? Let's look atthe comparative income statement assuming Fender sells 29,890units.

Absorption-CostingIncome Variable CostingIncome
Sales $269,308.9 Sales $269,308.9
COGS ($4.41 × 29,890) 131,814.9 Variable COGS ($1.97 × 29,890) 58,883.3
Gross margin $137,494 Contribution margin $210,425.6
Less: Fixed overhead 72,712
Selling & admin.exp 49,170 Selling & admin. exp. 49,170
Operating income $88,324 Operating income $88,543.6

Now we see that variable-costing income is higher thanabsorption costing income. This is because each of the 90 unitsthat came out of inventory had $2.44 of fixed overhead attached.However, this did not occur under variable costing.

Absorption-costing income -Variable-costing income = Change in inventory × fixedoverhead rate
= 90 units × $2.44 = $219.60

The following table summarizes the impact of changes ininventory on the difference between absorption-costing income andvariable-costing income.

Changes in Inventoryunder Absorption and Variable Costing
If Then
Production > Sales Absorption-costing income >Variable-costing income
Production < Sales Variable-costing income >Absorption-costing income
Production = Sales Absorption-costing income =Variable-costing income

The variable-costing income statement has an advantage inaddition to providing better signals regarding performance. It alsoprovides more useful information for management decision making.For example, how much more will Fender Company earn if it sells onemore unit? Under absorption costing, the per-unit gross profit is$4.60 ($9.01 - $4.41). However, that figure includes some fixedoverhead, and fixed overhead will not change if another unit isproduced and sold. The variable-costing gives more usefulinformation. Additional contribution margin of the extra unit is$7.04 ($9.01 - $1.97). The key insight of variable costing is thatfixed expenses do not change as units produced and sold change.Therefore, while the variable-costing income statement cannot beused for external reporting, it is a valuable tool for somemanagement decisions.