Prepared by Debby Bloom-Hill CMA, CFM CHAPTER Variable Costing Slide 5-2 Full (Absorption) Costing Required by GAAP for external reporting purposes Inventory costs include: Direct materials used Direct labor incurred Generally variable Manufacturing overhead Slide 5-3 Generally variable Includes both fixed and variable costs Learning objective 1: Explain the difference between full (absorption) and variable costing Variable Costing Inventory costs includes: Direct materials used Direct labor incurred Variable manufacturing overhead Fixed manufacturing overhead treated as a period cost Helpful for internal decision making Not allowed for GAAP reporting Slide 5-4 Learning objective 1: Explain the difference between full (absorption) and variable costing Test Your Knowledge Which of the following complies with GAAP for external reporting purposes? a Absolute costing b Variable costing c Fixed costing d Full costing Answer: d Full costing, also known as absorption costing Slide 5-5 Learning objective 1: Explain the difference between full (absorption) and variable costing Full (Absorption) Costing Slide 5-6 Learning objective 1: Explain the difference between full (absorption) and variable costing Variable Costing Slide 5-7 Learning objective 1: Explain the difference between full (absorption) and variable costing Difference Between Full and Variable Costing The only difference between full and variable costing is their treatment of fixed manufacturing overhead Under full costing, fixed manufacturing overhead is included in inventory These costs enter into the determination of expense only when the inventory is sold Under variable costing, fixed manufacturing overhead becomes a period expense Slide 5-8 Learning objective 1: Explain the difference between full (absorption) and variable costing Variable Costing Income Statement Classifies all expenses in terms of their cost behavior, either fixed or variable With variable and fixed expenses separated, the contribution margin can be presented Contribution margin is revenues minus total variable expenses The contribution margin allows users to make reasonable estimates of how much profit will change with changes in sales Slide 5-9 Learning objective 2: Prepare an income statement using variable costing Variable Costing Income Statement Sales are $100,000 and contribution margin is $65,000 Calculate the contribution margin ratio: Calculate the change in contribution margin if sales change by $10,000 $10,000 * 0.65 = $6,500 Slide 5-10 Learning objective 2: Prepare an income statement using variable costing Clausen Tube – Income Statements Production (6,000 units) is less than sales (7,200 units) Slide 5-22 Learning objective 3: Discuss the effect of production on full and variable costing income Quantity Produced is Less Than Quantity Sold Then the quantity produced is less than the quantity sold, income will be greater under variable costing as opposed to full costing Beginning inventory under fixed costing includes fixed manufacturing overhead When the beginning inventory is charged to cost of goods sold the charge will be higher under full costing Slide 5-23 Learning objective 3: Discuss the effect of production on full and variable costing income Variable Costing for External Reporting Slide 5-24 Learning objective 3: Discuss the effect of production on full and variable costing income Test Your Knowledge Summit Manufacturing, Inc produces snow shovels The selling price is $25 Costs are: Production is 42,000 snow shovels Calculate full cost per unit Slide 5-25 Learning objective 3: Discuss the effect of production on full and variable costing income Test Your Knowledge Summit Manufacturing, Inc produces snow shovels The selling price is $25 Costs are: Production is 42,000 snow shovels Full cost is $13 per unit Slide 5-26 Learning objective 3: Discuss the effect of production on full and variable costing income Test Your Knowledge Summit Manufacturing, Inc produces snow shovels The selling price is $25 Costs are: Production is 42,000 snow shovels Calculate variable cost per unit Slide 5-27 Learning objective 3: Discuss the effect of production on full and variable costing income Test Your Knowledge Summit Manufacturing, Inc produces snow shovels The selling price is $25 Costs are: Production is 42,000 snow shovels Variable cost is $9 per unit Slide 5-28 Learning objective 3: Discuss the effect of production on full and variable costing income Impact of Method Selection on Income Statement Units produced = units sold No difference in net income Units produced greater than units sold Full costing yields higher net income Units Produced less than units sold Variable costing yields higher net income Slide 5-29 Learning objective 3: Discuss the effect of production on full and variable costing income Reducing Production Slide 5-30 Learning objective 3: Discuss the effect of production on full and variable costing income Test Your Knowledge Kincade Faucets produces a variety of faucets During the year, the company incurred $400,000 of depreciation expense on its manufacturing equipment How much depreciation expense will be in Finished Goods Inventory under variable costing? a b c d $400,000 $285,714 $0 None of the above Answer: a Depreciation is a fixed cost which is expensed as a period cost under variable costing Slide 5-31 Learning objective 3: Discuss the effect of production on full and variable costing income Impact of JIT on Income Companies using JIT typically have low levels of inventory Units produced are approximately equal to units sold Difference between full costing and variable costing is likely to be very small Slide 5-32 Learning objective 4: Explain the impact of JIT on the difference between full and variable costing income Benefits of Variable Costing for Internal Reporting Variable costing facilitates costvolume-profit (CVP) analysis Separates fixed and variable costs Allows managers to accurately estimate the impact of changes in volume on cost and profit Cannot be answered using full costing Slide 5-33 Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes Benefits of Variable Costing for Internal Reporting Variable costing limits management of earnings via production volume Managers are often compensated based on income in their division Full costing produces higher income when production is greater than sales Managers have an incentive to manage earnings under full costing Slide 5-34 Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes Impact of Changes in Sales Slide 5-35 Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes Copyright © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner 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