AFM102 Lecture Notes - Lecture 15: Disturbance Storm Time Index, Fixed Cost, Finished Good
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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 Ã $1.97 = $4,944.70 |
The income statement for Fender Company is as follows:
| Sales | $249,577 | |
| Variable cost of Goods Sold ($1.97Ã 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 ($2.44Ã 29,800) and the variable cost of manufacturing for the units sold($1.97 Ã 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 Ã 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 Ã 27,700) | 122,157.00 | Variable COGS ($1.97 Ã 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 à fixedoverhead rate |
| = 2,100 units à $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 Ã 29,890) | 131,814.9 | Variable COGS ($1.97 Ã 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 à fixedoverhead rate |
| = 90 units à $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.
Comprehensive budgeting problem; activity-based costing,operating and financial budgets. Tyva makes a very popular undyedcloth sandal in one style, but in Regular and Deluxe. The Regularsandals have cloth soles and the Deluxe sandals have cloth-coveredwooden soles. Tyva is preparing its budget for June 2015 and hasestimated sales based on past experience.
Other information for the month of June follows:
Input Prices
Direct materials
Cloth $5.25 per yard
Wood $7.50 per board foot
Direct manufacturing labor $15 per direct manufacturinglabor-hour
Input Quantities per Unit of Output (per pair ofsandals)
Regular | Deluxe | |
Direct materials | ||
Cloth | 1.3 yards | 1.5 yards |
Wood | 0 | 2 b.f. |
Direct manufacturing labor-hours | 5 hours | 7 hours |
Setup hours per batch | 2 hours | 3 hours |
Inventory Information, Direct Materials
| Cloth | Wood |
Beginning inventory | 610 yards | 800 b.f. |
Target ending inventory | 386 yards | 295 b.f. |
Cost of beginning inventory | $3,219 | $6,060 |
Tyva accounts for direct materials using a FIFO cost flowassumption.
Sales and Inventory Information, FinishedGoods
Regular | Deluxe | |
Expected sales in units (pairs of sandals) | 2,000 | 3.000 |
Selling price | $120 | $195 |
Target ending inventory in units | 400 | 600 |
Beginning inventory in units | 250 | 650 |
Beginning inventory in dollars | $23,250 | $92,625 |
Tyva uses a FIFO cost flow assumption for finished goodsinventory.
All the sandals are made in batches of 50 pairs of sandals. Tyvaincurs manufacturing overhead costs, marketing and generaladministration, and shipping costs. Besides materials and labor,manufacturing costs include setup, processing, and inspectioncosts. Tyva ships 40 pairs of sandals per shipment. Tyva usesactivity-based costing and has classified all overhead costs forthe month of June as shown in the following chart:
Cost Type | Denominator Activity | Rate |
Manufacturing | ||
Setup | Setup hours | $18 per setup hour |
Processing | Direct man. Labor-hours | $1.80 per DMLH |
Inspection | Number of pairs of sandals | $1.35 per pair |
Nonmanufacturing | ||
Marketing & general admin | Sales revenue | 8% |
Shipping | Number of shipments | $15 per shipment |
Questions
1.Prepareeach of the following for June:
a.Revenuesbudget
b.Productionbudget in units
c.Directmaterial usage budget and direct material purchases budget in bothunits and dollars, round to dollars
d.Directmanufacturing labor cost budget
e.Manufacturing overhead cost budgets forsetup, processing, and inspection activities
f.Budgetedunit cost of ending finished goods inventory and ending inventoriesbudget
g.Cost ofgoods sold budget
h.Marketingand general administration and shipping costs budget
Tyvaâs balance sheet for May 31 follows.
TYVA BALANCE SHEET AS OF MAY 31
Assets | ||
Cash | 9,435 | |
Accounts Receivable | 324,000 | |
Less: allowance for bad debts | 16,200 | 307,800 |
Inventories | ||
Direct materials | 9,279 | |
Finished goods | 115,875 | |
Fixed assets | 870,000 | |
Less: accumulated depreciation | 136,335 | 733,665 |
Total assets | 1,176,054 |
Liabilities and Equity
Liabilities and Equity | |
Accounts payable | 15,600 |
Taxes payable | 10,800 |
Interest payable | 750 |
Long-term debt | 150,000 |
Common stock | 300,000 |
Retained earnings | 698,904 |
Total liabilities & equity | 1,176,054 |
Use the balance sheet and the following information to prepare acash budget for Tyva for June. Round to dollars.
All sales are on account; 60% are collected in the month of thesale, 38% are collected the following month, and 2% are nevercollected and written off as bad debts.
All purchases of materials are on account. Tyva pays for 80% ofpurchases in the month of purchase and 20% in the followingmonth.
All other costs are paid in the month incurred, including thedeclaration and payment of a $15,000 cash dividend in June.
Tyva is making monthly interest payments of 0.5% (6%per year) ona $150,000 long-term loan.
Tyva plans to pay the $10,800 of taxes owed as of May 31 in themonth of June. Income tax expense for June is zero.
30% of processing, setup, and inspection costs and 10% ofmarketing and general administration and shipping costs aredepreciation.
Prepare a budgeted income statement for June and a budgetedbalance sheet for Tyva as of June 30, 2015.
Listed below are the answers to the first question. Ijust need help with preparing a cash budget for June, and abudgeted income statement and budgeted balance sheet as of June30.
| 1 | |||||||||
| a. | Revenue Budget | ||||||||
| For the Month of June 2015 | |||||||||
| Regular | Deluxe | ||||||||
| Expected sales in units | 2,000 | 3,000 | |||||||
| Selling price | 120 | 195 | |||||||
| Total sales | $240,000 | $585,000 | |||||||
| b. | Production Budget in Units | ||||||||
| For the Month of June 2015 | |||||||||
| Regular | Deluxe | ||||||||
| Budgeted unit sales | 2,000 | 3,000 | |||||||
| Add: target ending finished goods inventory | 400 | 600 | |||||||
| Total required units | 2,400 | 3,600 | |||||||
| Deduct: beginning finished goods inventory | 250 | 650 | |||||||
| Units of finished goods to be produced | 2,150 | 2,950 | |||||||
| c. | Direct Material Usage Budget in Units andDollars | ||||||||
| For the Month of June 2015 | |||||||||
| Direct materials required for | |||||||||
| Cloth | Wood | Cloth | Wood | ||||||
| Units | Yards | B.F. | Total | Total | |||||
| Regular | 2,150 | 1.3 | 0 | 2,795 | 0 | ||||
| Deluxe | 2,950 | 1.5 | 2 | 4,425 | 5,900 | ||||
| 7,220 | 5,900 | ||||||||
| Cost Budget - to be purchased | |||||||||
| Beg. | Need to | Cost to | |||||||
| Inv. | purchase | purchase | |||||||
| Cloth | 7,220 | 610 | 6,610 | 5.25 | 34,703 | ||||
| Wood | 5,900 | 800 | 5,100 | 7.5 | 38,250 | ||||
| 72,953 | |||||||||
| Cost of direct materials to be used thisperiod | |||||||||
| available from beginning inventory | Total | ||||||||
| Cloth | 34,703 | 3,219 | 37,922 | ||||||
| Wood | 38,250 | 6,060 | 44,310 | ||||||
| 82,232 | |||||||||
| Direct Materials Purchases Budget | |||||||||
| For the Month of June 2015 | |||||||||
| Cloth | Wood | Total | |||||||
| Physical units budget | |||||||||
| To be used in production | 7,220 | 5,900 | |||||||
| Add: target ending direct material inventory | 386 | 295 | |||||||
| Total requirements | 7,606 | 6,195 | |||||||
| Deduct: beginning direct material inventory | 610 | 800 | |||||||
| Purchases to be made | 6,996 | 5,395 | |||||||
| Cost of product | 5.25 | 7.5 | |||||||
| Totals | 36,729 | 40,463 | 77,192 | ||||||
| d. | Direct Manufacturing Labor Cost Budget | ||||||||
| For the Month of June 2015 | |||||||||
| Output | Labor hrs | Total | Wage | Total | |||||
| units | per unit | hours | rate | ||||||
| Regular | 2,150 | 5 | 10,750 | 15 | 161,250 | ||||
| Deluxe | 2,950 | 7 | 20,650 | 15 | 309,750 | ||||
| 31,400 | 471,000 | ||||||||
| e. | Manufacturing Overhead Cost Budget for Setup,Processing, and Inspection Activities | ||||||||
| For the Month of June 2015 | |||||||||
| Total production | 2,150 | 2,950 | 5,100 | ||||||
| Total sales | 2,000 | 3,000 | 5,000 | ||||||
| No. of setup hours | 86 | 118 | 204 | ||||||
| No. of shipments | 50 | 75 | 125 | ||||||
| Labor hours | 10,750 | 20,650 | 31,400 | ||||||
| Setup | Processing | Inspection | Total | ||||||
| Allocation | Setup hrs | Labor hrs | No. pairs | ||||||
| Rate | 18 | 1.8 | 1.35 | ||||||
| No. of Activity | 204 | 31,400 | 5,100 | ||||||
| Total | 3,672 | 56,520 | 6,885 | 67,077 | |||||
| f. | Budgeted Unit Cost of Ending Finished GoodsInventory | ||||||||
| For the Month of June 2015 | |||||||||
| Cost per | Regular | Total | Deluxe | Total | |||||
| Unit of | Input per | Input per | |||||||
| Input | Unit | Unit | |||||||
| Output | Output | ||||||||
| Cloth | 5.25 | 1.3 | 6.825 | 1.5 | 7.875 | ||||
| Wood | 7.5 | 0 | 0 | 2 | 15 | ||||
| Direct Manufacturing hours | 15 | 5 | 75 | 7 | 105 | ||||
| Machine setup | 18 | 0.04 | 0.72 | 0.06 | 1.08 | ||||
| Processing | 1.8 | 5 | 9 | 7 | 12.6 | ||||
| Inspection | 1.35 | 1 | 1.35 | 1 | 1.35 | ||||
| Total | 92.895 | 142.905 | |||||||
| Ending Inventories Budget | |||||||||
| For the Month of June 2015 | |||||||||
| Quantity | Cost per | Total | |||||||
| Unit | |||||||||
| Direct materials | |||||||||
| Cloth | 386 | 5.25 | 2026.5 | ||||||
| Wood | 295 | 7.5 | 2212.5 | 4239 | |||||
| Finished goods | |||||||||
| Regular | 400 | 92.895 | 37158 | ||||||
| Deluxe | 600 | 142.905 | 85743 | 122901 | |||||
| Total ending inv. | 127140 | ||||||||
| g. | Cost of Goods Sold Budget | ||||||||
| For the Month of June 2015 | |||||||||
| Regular | Deluxe | ||||||||
| Beginning finished goods inventory, Jun 1 | 23250 | 92625 | 115875 | ||||||
| Direct materials used (c) | 82232 | ||||||||
| Direct manufacturing labor (d) | 471000 | ||||||||
| Manufacturing overhead (e) | 67077 | ||||||||
| Cost of goods manufactured | 620309 | ||||||||
| Cost of goods available for sale | 736184 | ||||||||
| Deduct ending finished goods inventory, June 30(f) | 122901 | ||||||||
| Cost of goods sold | 613283 | ||||||||
| h. | Nonmanufacturing Costs Budget | ||||||||
| For the Month of June 2015 | |||||||||
| Marketing and general administration | 825000 | 0.08 | 66000 | ||||||
| Shipping | |||||||||
| (5,000 pairs / 40 pairs per shipment) | 125 | 15 | 1875 | ||||||
| Total | 67875 | ||||||||
Again, I just need help with the cash budget question, and thebudgeted income statement and budgeted balance sheet as ofJune.
Thank you!
