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Chapter 17

ACCY 307 Chapter Notes - Chapter 17: Expense, Income Statement

Course Code
ACCY 307
Tamara Phelan

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Chapter 17: Measuring and Assigning Costs for Income Statements
I. Absorption Costing and Variable Costing
a. Absorption costing= all production costs are recorded on the balance sheet as part of the cost of inventory
and are then expensed as part of the cost of goods sold when units are sold
b. Both fixed and variable production costs are assumed to have future value to the organization and are
accordingly treated as product costs= the fixed and variable costs assigned to products; these costs remain
in inventory until products sell; include direct materials, direct labor, and fixed and variable overhead
i. Product costs: direct materials, director labor, variable overhead, fixed overhead
ii. Period costs: non-production costs: variable and fixed
iii. Actual fixed overhead allocation rate= Actual fixed overhead cost/Actual production volume
iv. Estimated fixed overhead allocation rate= Estimated fixed overhead cost/Estimated production
v. Cost= the value of resources given up to obtain an economic benefit
vi. Expense= an income statement category that reduces net income
c. Variable costing= all variable costs are matched against revenues, and fixed costs are treated as period
i. Product costs: direct materials, direct labor, variable overhead
ii. Period costs: production costs fixed overhead, non-production costs variable and fixed
iii. Then, inventory on the balance sheet includes only variable production costs under variable
d. Absorption Costing Compared to Variable Costing
II. Absorption Costing Using Normal Costing
a. Motivation for Normal Costing:
i. Actual Production Volumes Fluctuate (Denominator Reason)
ii. Fixed Production Overhead Costs Fluctuate (Numerator Reason)
iii. Actual Volume and Fixed Overhead Costs Are Not Known Until After Accounting for the Period
Is Completed (Information Timeliness Reason)
b. Allocation Rate Denominator Considerations
i. Supply-based capacity levels:
ii. Theoretical capacity= the upper capacity limit; it assumes continuousthat is, uninterrupted
production, 365 days per year; the maximum volume of goods or services that an organization
could hypothetically produce
iii. Practical capacity= the upper capacity limit that takes into account the organization's regularly
scheduled times for production; excludes potential production that could take place during
anticipated and scheduled maintenance downtimes, holidays, or other times in which production
would normally be interrupted.
1. In other words, practical capacity is theoretical capacity reduced for expected downtimes.
2. Practical capacity is estimated using engineering studies and labor use patterns.
iv. Demand-based capacity levels:
v. Normal capacity= an average use of capacity over time; the typical volume of goods or services
an organization produces to meet customer demand.
1. IAS 2 requires the use of normal capacity for the allocation of fixed overhead to units of
production for purposes of valuing inventory.
vi. Budgeted or expected capacity= the anticipated use of capacity over the next period; based on
management's planned operations in which customer demand is forecast
c. Volume Variance with Normal Costing
i. Volume variance= the difference between the amount of estimated fixed overhead costs used to
calculate the allocation rate and the amount of fixed overhead costs actually allocated to
inventory during the period
1. Volume variance= Expected fixed overhead cost Allocated fixed overhead cost
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