Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fourth Edition McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc All Chapter 19 Variable Costing and Performance Reporting Conceptual Learning Objectives C1: Describe how absorption costing can result in over-production C2: Explain the role of variable costing in pricing special orders 19-3 Analytical Learning Objectives A1: Compute and interpret breakeven volume in units 19-4 Procedural Learning Objectives P1: Compute unit cost under both absorption and variable costing P2: Prepare and analyze an income statement using absorption costing and using variable costing P3: Prepare a contribution margin report P4: Convert income under variable costing to the absorption cost basis 19-5 C1 Absorption Costing & Variable Costing Absorption Absorption costing costing (also (also called called full full costing), costing), assumes assumes that that products products absorb absorb all all costs costs incurred incurred to to produce produce them them While Whilewidely widelyused usedfor for financial financialreporting reporting(GAAP), (GAAP), this this costing costing method methodcan canresult resultin inmisleading misleading product productcost cost information informationfor forbusiness businessdecisions decisions 19-6 C2 Absorption Costing & Variable Costing Under variable costing, only costs that change in total with changes in production level are included in product costs 19-7 P1 Distinguishing Between Absorption Costing and Variable Costing: Absorption Costing Absorption Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product Cost 19-8 P1 Distinguishing Between Absorption Costing and Variable Costing: Variable Costing Variable Costing Direct Materials Direct Labor Product Cost Variable Overhead Fixed Overhead Period Cost 19-9 P1 Difference Between Absorption Costing and Variable Costing: Computing Unit Cost 19-10 P1 Difference Between Absorption Costing and Variable Costing: Computing Unit Cost 19-11 P1 Analysis of Income Reporting for Both Absorption and Variable Costing 19-12 A1 Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Equal Units Sold 19-13 P2 Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Exceed Units Sold 19-14 P2 Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Are Less Than Units Sold 19-15 P2 Income Reporting Summarized 19-16 C1 Planning Production Producing too much inventory Producing too little inventory Excess inventory Lost sales Higher storage and financing costs Customer dissatisfaction Greater risk of obsolescence 19-17 C2 Setting Prices Over the Long Run: Price must be high enough to cover all costs, including variable costs and fixed costs, and still provide an acceptable return to owners 19-18 C2 Setting Prices Over the Short Run: Fixed production costs such as the cost to maintain plant capacity not change with changes in production levels With excess capacity, increases in production level would increase variable production costs, but not fixed costs While managers try to maintain the long-run price on existing orders, which covers all production costs, managers should accept special orders provided the special order price exceeds variable cost 19-19 P3 Limitations of Reports Using Variable Costing •Absorption costing is almost exclusively used for external reporting (GAAP) •For income tax purposes, absorption costing is the only acceptable basis for filings with the Internal Revenue Service (IRS) under the Tax Reform Act of 1986 •Absorption costing is the only acceptable basis for both external reporting and tax reporting 19-20 End of Chapter 19 19-21 ... (IRS) under the Tax Reform Act of 198 6 •Absorption costing is the only acceptable basis for both external reporting and tax reporting 19- 20 End of Chapter 19 19-21 ... Period Cost 19- 9 P1 Difference Between Absorption Costing and Variable Costing: Computing Unit Cost 19- 10 P1 Difference Between Absorption Costing and Variable Costing: Computing Unit Cost 19- 11 P1... Reporting for Both Absorption and Variable Costing 19- 12 A1 Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Equal Units Sold 19- 13 P2 Analysis of Income Reporting