Management Advisory Services Kings College of the Philippines 2019

ABSORPTION COSTING AND VARIABLE COSTING

ACCOUNTING FOR DIFFERENCE IN INCOME
Absorption Costing Change in inventory xx
- Also referred to as Full Cost, traditional costing, Multiply by: Fixed cost per unit xx
Conventional costing or normal costing Difference in income xx

ABSORPTION VARIABLE EXTREMES:

Cost Seldom Costs are 1. SUPERVARIABLE COSTING/THROUGHPUT
Segregation segregates costs segregated into COSTING
into variable variable and
-treats direct materials as the only variable cost.
and fixed cost fixed
The objective of this is to minimize the cost of
Cost of All costs: Only material,
Inventory material, labor, labor, variable ending inventory.
variable, fixed FOH 2. SUPERABSORPTION COSTING- treats costs from
FOH all links in the value chain as inventoriable cost
Treatment of Product Cost Period Cost
Fixed FOH Variable Costing and the Theory of Constraints
Income The one which Contribution
Statement conforms with Margin Theory of Constraints focuses on managing the
GAAP Statement constraints in a company to maximize products
Net Income Net Income bet. the two may differ
from each other because of the  Companies that are involved in TOC make use of a
difference in the amount of fixed form of variable costing where direct labor is not a
overhead costs recognized as
variable cost but a fixed cost
expense during an accounting
period. This is due to the variations Reasons:
between sales and production.
1. In many companies, even though workers are
paid on an hourly basis, management has a
DISTINCTIONS BET. PERIOD AND PRODUCT COST
commitment, sometimes in a labor contract or
PERIOD COST PRODUCT COST by law, to guarantee a minimum hourly rate
Cost that is charged Cost that is included in and a minimum number of paid hours.
against current revenue the computation of 2. Direct Labor is usually not the constraint. In
during a time period product cost that is some cases, the constraint is a machine or a
regardless of the apportioned between the company policy that prevents a company from
difference between sold and unsold units
using its resources. Thus, if direct labor is not
production and sales
volume the constraint, there is no reason to increase it.
Does not form part of Inventoriable Cost Hiring additional labor would increase cost
inventory without increasing output.
Reduces income for the Reduces current income 3. TOC emphasizes continuous improvement to
current period by its full by the portion allocated maintain competitiveness. Without committed
amount to the sold units, the and motivated employees, continuous
portion allocated to
improvement cannot be sustained, thus TOC
unsold units is treated as
an asset. companies are reluctant to lay off employees
because it has an adverse effect on employee
morale.
Relationship Between Production Net Income
and Sales ACTIVITY BASED COSTING
a. Production= Sales AC=VC
b. Production>Sales AC>VC - provides a more accurate method of product/service
c. Production<Sales AC<VC costing, leading to more accurate pricing decisions
RECONCILIATION OF ABSORPTION AND VARIABLE
COSTING *the traditional approach overstated costs of high
volume products and understated costs of low volume
Absorption Costing Income xx products because drivers were always volume related
Add: FOH, beginning inventory xx
Total: xx
Less: FOH, ending inventory xx
Variable Costing Income xx

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Management Advisory Services Kings College of the Philippines 2019

BASIC METHOD OF ALLOCATING OVERHEAD COSTS 5. Line managers do not believe the product
costs reports
1. Plantwide Allocation 6. Some product that have reported high
𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝐻 𝑅𝑎𝑡𝑒 profit margins are not sold by competitor
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝐶𝑜𝑠𝑡
=
𝑇𝑜𝑡𝑎 𝐷𝐿𝐻 𝑜𝑟 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑟𝑠
Setbacks of ABC
2. Department Allocation 1. It necessitates a considerable amount of time and
3. Activity Based Costing cost
Steps: 2. It does not comply with GAAP
a. Identify costly activities (Activity Cost Pools) 3. It does not, in itself, promote total quality
required to complete products management and continuous improvement.
Activity- any process of procedure that
consumes overhead resources
FINANCIAL PLANNING AND BUDGETS
Examples:
Budget- A realistic plan, expressed in quantitative terms
Purchasing materials, setting up machinery,
for a certain period of time
assembling products and inspecting
-Its purpose is to promote a deliberate, well conceived
products
business judgment instead of accidental success in
b. Assign OH costs to activities identified in (a)
business management
c. Identify the cost driver for each activity
d. Calculate a predetermined OH rate for each
ADVANTAGES:
activity
𝑠𝑡𝑒𝑝 𝑏 1. Means of the top management to communicate
𝑃𝑟𝑒𝑑. 𝑂𝐻𝑅 = 𝑠𝑡𝑒𝑝 𝑐 its plans and goals throughout the organization.
e. Allocate OH cost to products by multiplying 2. Forces management to think about and plan for
the predetermined OH rate for each activity the future
times the level of cost driver activity used 3. Resources are more appropriately allocated
by the product 4. Potential bottlenecks can be discovered before
they occur
BENEFITS:
5. Promotes coordination of the activities of the
1. ABC leads to more cost pools
entire organization
2. ABC leads to enhanced control over OH costs
6. Goals and objectives identified in the budgeting
3. ABC leads to better management decisions
process can serve as benchmarks or standards
for evaluating performance
TYPE OF ACTIVITY LEVELS
1. UNIT-LEVEL
TYPES OF BUDGETS AND OTHER BUDGETING
-Costs of unit-level activities should be
CONCEPTS:
proportional to the number of units produced.
1. Master Budget –encompasses the
2. BATCH-LEVEL ACTIVITIES
organization’s operating and financial plans
- performed for each batch of products
for a certain future period of time.
produced, rather than each unit
a. Sales Budget- It provides the basis for
3. PRODUCT LEVEL (Product Sustaining Level)
projected cash receipts as well as for
- activities that are needed to support the entire
constructing the other budgets
product line regardless of the number of units
b. Production Budget
and batches produced
c. Direct materials Budget
4. FACILITY LEVEL (General Operation Level)
d. Direct Labor Budget
- performed in order for the entire production
e. Manufacturing Overhead Budget
process to occur
f. Ending Finished Goods Inventory
Budget
FACTORS COMMONLY ASSOCIATED WITH THE
g. Purchases Budget
NEED TO CONSIDER ABC
h. Budgeted Cost of Sales
1. Product variety and product complexity
i. Selling and Administrative Expense
2. Direct labor is a small percentage of total
Budget
costs
j. Budgeted Income Statement
3. Sales are increasing but profits are declining
k. Cash Budget
4. Product-line profit margins are hard to
l. Budgeted Balance Sheet
explain

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Management Advisory Services Kings College of the Philippines 2019

7. Life Cycle-product’s revenue and expenses

are estimated over its entire life cycle (R&D
to withdrawal of customer support). Useful
in target costing and target pricing

8. Activity Based Budgeting-applies ABC

principles and procedures to budgeting. It
requires three steps: identification of
activities, estimation of activity output
demands, and estimating the cost of
resources needed to provide the activity
output demanded.

9. Kaizen Budgeting
-based on changes that are to be made
-assumes the continuous improvement of
products and processes; the effects of
improvement and the costs of their
implementation are estimated

2. Continuous (Rolling) Budget-revised on a 10. Governmental Budget- not only a financial

regular (continuous) basis. It’s a 12 month plan and a basis for performance evaluation
budget that rolls forward one month or but also an expression of public policy and a
quarter as the current month or quarter is form of control having the force of law.
completed
- Irrespective of whether the budget is COMPUTATIONAL FORMATS
prepared on an annual or a continuous 1. BUDGETED PRODUCTION:
Budgeted Sales Xx
basis, it is important that monthly of four- Add: Desired Ending Finished Goods Inventory
weekly budgets be used for control Total Xx
purposes. Less: Expected Beginning Finished Goods Xx
Inventory
Budgeted Production xx
3. Fixed Budget- based on only one level of xx
activity. It does not segregate costs into
2. BUDGETED MATERIALS PURCHASES:
fixed and variable components. Actual Budgeted Production Xx
results are compared to budgeted costs at Multiply by: Qty. of Materials required per unit of
product Xx
the original budgeted activity level
Total Materials to be used Xx
Add: Desired Ending Materials Inventory Xx
4. Flexible Budget- series of budgets prepared Total Xx
Less: Expected Beginning Materials Inventory
for many levels of activity. This budget Budgeted Materials Purchases Xx
adjusts revenues, costs and expenses to the xx
actual level of activity in which the firm
3. BUDGETED MERCHANDISE PURCHASES
operated in order to provide a valid basis of
Budgeted Sales Xx
comparison to actual cost. Add: Desired Ending merchandise Inventory
Total Xx
Less: Expected Beginning Merchandise Inventory Xx
5. Incremental Budgeting-prepared based on Budgeted Merchandise Inventory
previous period’s budget, adjusted based Xx
Xx
on changes expected to happen in the
coming period. Managers are required to 4. CASH BUDGET
justify only the changes. Cash balance, beg. Xx
Add: Receipts Xx
Total Cash available before current financing
6. Zero-Based Budgeting-managers are Less: Disbursements Xx
required to justify all expenditures as if Excess(deficiency) of cash available over Xx
disbursements
programs involved are being proposed for Financing Xx
the first time. Cash Balance, end Xx
xx

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