Variable Costing: A Tool For Management: © 2010 The Mcgraw-Hill Companies, Inc
Variable Costing: A Tool For Management: © 2010 The Mcgraw-Hill Companies, Inc
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Overview of Absorption (full) and Variable
Costing
Absorption Variable
Costing Costing
Direct Materials
Product
Product Direct Labor
Costs
Costs Variable Manufacturing Overhead
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Quick Check
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Quick Check
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GROSS MARGIN (FAC) FORMAT
SALES
LESS COGS (DM; DL; VMOH; FMOH)
__________________________________________
GROSS MARGIN
LESS VMKT; FMKT; VADM; FADM
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OPERATING INCOMEFAC
McGraw-Hill/Irwin Slide 6
CONTRIBUTION MARGIN FORMAT
SALES
LESS DM; DL; VMOH; VMKT; VADM
__________________________________________
CONTRIBUTION MARGIN
LESS FMOH; FMKT; FADM
__________________________________________
OPERATING INCOMEVC
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Unit Cost Computations
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Unit Cost Computations
Unit product cost is determined as follows:
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Learning Objective 2
Prepare income
statements using both
variable and absorption
costing.
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Income Comparison of
Absorption and Variable Costing
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Absorption Costing
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Example: Absorption costing
What is the absorption costing net operating income for the last year?
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Solution:
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Example: Variable Costing
What is net operating income for the month under variable costing?
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Solution:
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Learning Objective 3
Understand the
advantages and
disadvantages of both
variable and absorption
costing.
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Impact on the Manager
Opponents of absorption costing argue that
shifting fixed manufacturing overhead costs
between periods can lead to faulty decisions.
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CVP Analysis, Decision Making
and Absorption costing
Absorption costing does not dovetail with CVP analysis,
nor does it support decision making. It treats fixed
manufacturing overhead as a variable cost. It assigns per
unit fixed manufacturing overhead costs to production.
Treating fixed manufacturing overhead as a
variable cost can:
• Lead to faulty pricing decisions and faulty
keep-or-drop decisions.
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External Reporting and Income Taxes
To conform to
GAAP requirements,
absorption costing must be used for
external financial reports in the Under the Tax
United States. Reform Act of 1986,
absorption costing must be
used when filling out
Since top executives income tax returns.
are typically evaluated based on
earnings reported to shareholders
in external reports, they may feel that
decisions should be based on
absorption costing data.
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Advantages of Variable Costing
and the Contribution Approach
Consistent with
CVP analysis.
Management finds Net operating income
it more useful. is closer to
net cash flow.
Consistent with standard
costs and flexible budgeting.
Advantages
Easier to estimate profitability
of products and segments.
Impact of fixed
costs on profits Profit is not affected by
emphasized. changes in inventories.
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Variable versus Absorption Costing
Fixed manufacturing
costs must be assigned Fixed manufacturing
to products to properly costs are capacity costs
match revenues and and will be incurred
costs. even if nothing is
produced.
Absorption Variable
Costing Costing
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Variable Costing and the Theory of
Constraints (TOC)
Companies involved in TOC use a form of variable
costing. However, one difference of the TOC approach
is that it treats direct labor as a fixed cost for three
reasons:
Many companies have a commitment to guarantee
workers a minimum number of paid hours.
Direct labor is usually not the constraint.
TOC emphasizes the role direct laborers play in driving
continuous improvement. Since layoffs often devastate
morale, managers involved in TOC are extremely
reluctant to lay off employees.
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Impact of Lean Production
Production
tends to equal
sales . . .
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PRACTICE PROBLEM 1
PREPARE I/S USING BOTH FORMATS
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PRACTICE PROBLEM 2
PREPARE I/S USING BOTH FORMATS
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PRACTICE PROBLEM 3
PREPARE I/S USING BOTH FORMATS
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End of Chapter 7
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