ACC 406 Chapter Notes - Chapter 5: Cost Driver, Cost Accounting, Financial Statement
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Outback, Ltd., manufactures tactical LED flashlights in Melbourne, Australia. The firm uses an absorption-costing system for internal reporting purposes; however, the company is considering using variable costing. Data regarding planned and actual operations for 20x4 follow: |
| Budgeted Costs | ||||||||
| |||||||||
Per Unit | Total | Actual Costs | |||||||
Direct material | $ | 12.20 | $ | 1,634,800 | $ | 1,512,800 | |||
Direct labor | 9.30 | 1,246,200 | 1,153,200 | ||||||
Variable manufacturing overhead | 4.30 | 576,200 | 533,200 | ||||||
Fixed manufacturing overhead | 4.50 | 603,000 | 613,000 | ||||||
Variable selling expenses | 7.50 | 1,005,000 | 877,500 | ||||||
Fixed selling expenses | 7.80 | 1,045,200 | 1,045,200 | ||||||
Variable administrative expenses | 2.80 | 375,200 | 327,600 | ||||||
Fixed administrative expenses | 2.80 | 375,200 | 384,200 | ||||||
| |||||||||
Total | $ | 51.20 | $ | 6,860,800 | $ | 6,446,700 | |||
| |||||||||
Planned Activity | Actual Activity | |||
Sales in units | 134,000 | 117,000 | ||
Production in units | 134,000 | 124,000 | ||
Beginning finished-goods inventory in units | 43,000 | 43,000 | ||
The budgeted per-unit cost figures were based on the company producing and selling 134,000 units in 20x4. Outback uses a predetermined overhead rate for applying manufacturing overhead to its product. A total manufacturing overhead rate of $8.80 per unit was employed for absorption costing purposes in 20x4. Any overapplied or underapplied manufacturing overhead is closed to the Cost of Goods Sold account at the end of the year. The 20x4 beginning finished-goods inventory for absorption costing purposes was valued at the 20x3 budgeted unit manufacturing cost, which was the same as the 20x4 budgeted unit manufacturing cost. There are no work-in-process inventories at either the beginning or the end of the year. The planned and actual unit selling price for 20x4 was $72.00 per unit. |
Required: |
1. | Compute the value of Outbackâs 20x4 ending finished-goods inventory under absorption costing. (Do not round intermediate calculations.) |
2. | Compute the value of Outbackâs 20x4 ending finished-goods inventory under variable costing. (Do not round intermediate calculations.) |
3. | Compute the difference between Outbackâs 20x4 reported operating income calculated under absorption costing and calculated under variable costing. (Do not round intermediate calculations.) |
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.
The questions are to be answered based on the information ofdata below an dplease help to answer the question in detail.
The questions to concentrate on are as follows:
There are various costing methods available for companies toimplement. As a company grows, it may become beneficial to consideran alternate costing method.
A. Identify an alternative costing method that could benefitthis company, and describe the main characteristics of thatmethod.
B. What should a company look for when trying to determinewhether they should adopt such a system?
C. Should the company adopt this alternative costing method?Defend your response.
This is scenario :
The Hampshire Company manufactures umbrellas that sell for$12.50 each. In 2014, the company made and sold 60,000 umbrellas.The company had fixed manufacturing costs of $216,000. It also hadfixed costs for administration of $79,525. The per-unit costs ofeach umbrella are as follows:
Direct Materials:$3.00
Direct Labor: $1.50
Variable Manufacturing Overhead:$0.40
Variable Selling Expenses: $1.10
The data that is supposed to be usedto answer the questions mentioned on top is right below. Pleasehave a look at the calculations.
Cost InformationFrom Instructions | ||||
Stick | Collapsible | |||
Units Sold | 60,000 | 3,000 | ||
Selling Price | $12.50 | $14.00 | ||
Direct Material Cost Per Unit | $3.00 | $3.10 | ||
Direct Labor Cost Per Hour | $7.50 | $8.00 | ||
Variable MO | $0.40 | $0.40 | ||
Variable Selling Costs | $1.10 | $1.10 | ||
Labor Hours Per Unit | 0.2 | 0.2 | ||
Sales Orders | 120 | 1 | ||
Purchase Orders | 50 | 3 | ||
Production Runs | 45 | 6 | ||
Material Moves | 86 | 10 | ||
Machine Setups | 130 | 6 | ||
Machine Hours | 525 | 32 | ||
Inspections | 200 | 10 | ||
Shipments | 60 | 3 | ||
Activity Information fromInstructions | ||||
Activity | Activity Cost | Activity Cost Driver | ||
Order Processing | $35,000 | Number of Sales Orders | ||
Purchasing | $36,000 | Number of Purchase Orders | ||
Material Handing | $28,000 | Material Moves | ||
Machine Setup | $14,000 | Machine Setups | ||
Production | $99,000 | Production Runs | ||
Assembly | $80,000 | Machine Hours | ||
Inspecting | $11,000 | Number of Inspections | ||
Shipping | $7,500 | Number of Shipments | ||
Requirement 1 | ||||
Activity | Total Costs | Quantity of Cost Allocation Base | Overhead Allocation Rate | |
Order Processing | $35,000 | 121 | $289 | |
Purchasing | $36,000 | 53 | $679 | |
Material Handing | $28,000 | 96 | $292 | |
Machine Setup | $14,000 | 136 | $103 | |
Production | $99,000 | 51 | $1,941 | |
Assembly | $80,000 | 557 | $144 | |
Inspecting | $11,000 | 210 | $52 | |
Shipping | $7,500 | 63 | $119 | |
Requirement 2 | ||||
Traditional Costing | ||||
Stick Umbrella | Collapsible Umbrella | Total | ||
Revenues | $750,000 | $42,000 | $792,000 | |
Direct Materials | $180,000 | $9,300 | $189,300 | |
Direct Labor | $90,000 | $4,800 | $94,800 | |
Variable Overhead | $24,000 | $1,200 | $25,200 | |
Variable Selling Costs | $66,000 | $3,300 | $69,300 | |
Allocated Fixed Overhead | $295,714 | $14,786 | $310,500 | |
Total Costs | $655,714 | $3,386 | $689,100 | |
Operating Income | $94,286 | $8,614 | $102,900 | |
Operating Income % | 13% | 21% | $13 | |
Per Unit Operating Income | $1.57 | $2.87 | ||
Requirement 3 | ||||
Activity-Based Costing | ||||
Stick Umbrella | Collapsible Umbrella | Total | ||
Revenues | $750,000 | $42,000 | $792,000 | |
Direct Materials | $180,000 | $9,300 | $189,300 | |
Direct Labor | $90,000 | $4,800 | $94,800 | |
Variable Overhead | $24,000 | $1,200 | $25,200 | |
Variable Selling Costs | $66,000 | $3,300 | $69,300 | |
Order Processing Costs | $34,711 | $289 | $35,000 | |
Purchasing Costs | $33,963 | $2,038 | $36,000 | |
Material Handing Costs | $25,084 | $2,917 | $28,000 | |
Machine Setup Costs | $13,382 | $618 | $14,000 | |
Production Costs | $87,353 | $11,647 | $99,000 | |
Assembly Costs | $75,405 | $4,595 | $80,000 | |
Inspecting Costs | $10,476 | $524 | $11,000 | |
Shipping Costs | $7,143 | $357 | $7,500 | |
Total Costs | $647,516 | $41,584 | $689,100 | |
Operating Income | $102,484 | $416 | $102,900 | |
Operating Income % | 14% | 1% | 12.99 | |
Per Unit Operating Income | $1.71 | $0.14 | ||
Requirement 4 | ||||
Costs per Unit | Stick Umbrella | Collapsible Umbrella | ||
Traditional | $10.93 | $11.13 | ||
ABC | $10.79 | $13.86 | ||
Difference | $0.14 | $($2.73) | ||
Requirement 5 | ||||
Calculation ofLabour Hours (note): 1) Labor hour per unit of stick umbrella is0.2 and it is the same for the collapsible umbrella. While theunits sold for the stick umbrella are 60,000 and for thecollapsible umbrella are 3,000. Then multiply the labor hour perunit with the units sold, then the total amount for the stickumbrella is $12,000 and for the collapsible umbrella is $600.Adding these both amounts will total $12,600 | ||||