Chapter 14 - Measuring and assigning costs for income statements. The following will be discussed in this chapter: How are absorption costing income statements constructed? How are variable costing income statements constructed? How are throughput costing income statements constructed?...
Cost Management Measuring, Monitoring, and Motivating Performance Chapter 14 Measuring and Assigning Costs for Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Chapter 14: Measuring and Assigning Costs for Income Statements Learning objectives • Q1: How are absorption costing income statements constructed? • Q2: How are variable costing income statements constructed? • • • Q3: How are throughput costing income statements constructed? Q4: What Factors Affect the Choice of Production Volume Measures for Allocating Fixed Overhead? Q5: How income statement costing methods affect managers’ incentives and decisions? © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q1: Absorption Costing Income Statements • • • Under absorption costing, fixed manufacturing overhead is an inventoriable cost GAAP requires the use of absorption costing Absorption costing income statements are prepared using the traditional format • • • Expenses are grouped by function Manufacturing costs deducted above the gross margin subtotal Nonmanufacturing costs deducted below the gross margin subtotal © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q1: Absorption Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q1: Absorption Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q1: Absorption Costing Income Statement Example Russell Corporation produces a product that sells for $10 In 2011, there were 10,000 units in beginning finished goods inventory The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold The costs incurred in 2011 are shown below Given the cost information below, compute the inventoriable costs per unit under absorption costing Direct materials Direct labor Variable factory overhead Variable non-mfg costs Fixed mfg overhead Fixed non-mfg costs 2011 $60,000 128,000 68,000 55,800 100,000 70,000 Direct materials Direct labor Variable mfg overhead Fixed mfg overhead © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # $0.75 1.60 0.85 1.25 $4.45 Q1: Absorption Costing Income Statement Example Suppose that the Russell Corporation uses the LIFO inventory method Prepare an absorption costing income statement for 2011 Sales (# units sold @ $10) Cost of goods sold (# units sold @ $4.45) Gross margin Nonmfg costs ($70,000 + $55,800) Operating income $620,000 275,900 344,100 125,800 $218,300 Note that cost of goods sold is based on the 2011 per-unit manufacturing costs because: (1) Russell is using LIFO, and (2) production exceeded sales in 2005 © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q2: Variable Costing Income Statements • • • Under variable costing, fixed manufacturing overhead is a period cost Variable costing income statements are used internally only Variable costing income statements are prepared using the contribution format • • • Expenses are grouped by cost behavior Variable costs deducted above the contribution margin subtotal Fixed costs deducted below the contribution margin subtotal © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q2: Variable Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q2: Variable Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 10 Q2: Variable Costing Income Statement Example Russell Corporation produces a product that sells for $10 In 2011, there were 10,000 units in beginning finished goods inventory The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold The costs incurred in 2011 are shown below Compute the inventoriable costs per unit under variable costing Direct materials Direct labor Variable factory overhead Variable non-mfg costs Fixed mfg overhead Fixed non-mfg costs 2011 $60,000 128,000 68,000 55,800 100,000 70,000 Direct materials Direct labor Variable mfg overhead © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 11 $0.75 1.60 0.85 $3.20 Q2: Variable Costing Income Statement Example Suppose that the Russell Corporation uses the LIFO inventory method Prepare a variable costing income statement for 2011 Sales (# units sold @ $8) Variable costs: Cost of goods sold (# units sold @ $3.20) Nonmfg variable costs Contribution margin Fixed costs: Fixed mfg overhead Fixed nonmfg costs Operating income $620,000 198,400 55,800 365,800 100,000 70,000 $195,800 Note that cost of goods sold is based on the 2011 per-unit manufacturing costs because Russell is using LIFO © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 12 Q2: Variable Costing Income Statement Example Suppose that the Russell Corporation uses the LIFO inventory method Reconcile the income under variable costing you determined on the prior slide with the $218,300 income under absorption costing computed on slide #7 Variable costing income $195,800 Add: fixed overhead attached to the increase in inventory (18,000 units x $1.25/unit) Absorption costing income 22,500 $218, 300 © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 13 Q3: Throughput Costing Income Statements • • • Under throughput costing, all manufacturing costs except direct materials are period costs Throughput costing income statements are used internally only; useful when most manufacturing costs are not variable in the short run Throughput costing income statements are prepared using a new format • Sales – cost of goods sold (direct materials only) = throughput margin © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 14 Q3: Throughput Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 15 Q3: Throughput Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 16 Q3: Throughput Income Statement Example Russell Corporation produces a product that sells for $10 In 2011, there were 10,000 units in beginning finished goods inventory The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold The costs incurred in 2011 are shown below Suppose that the Russell Corporation uses the LIFO inventory method Prepare a throughput costing income statement for 2011 Direct materials Direct labor Variable factory overhead Variable non-mfg costs Fixed mfg overhead Fixed non-mfg costs 2011 $60,000 128,000 68,000 55,800 100,000 70,000 Note that DL and VO costs expensed based on units produced, not units sold Sales (# units sold @ $8) Cost of goods sold (# units sold @ $0.75) Throughput margin All other costs: Direct labor Variable mfg overhead Fixed mfg overhead Variable nonmfg overhead costs Fixed nonmfg costs Operating income © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 17 $620,000 46,500 573,500 128,000 68,000 100,000 55,800 70,000 $151,700 Q3: Throughput Costing Income Statement Example continued Reconcile the income under throughput costing you computed on the prior slide to the income under variable costing computed on slide #18 and to the income under absorption costing computed on slide #7 Throughput costing income $151,700 Add: Costs attached to the increase in inventory: Direct labor (18,000 units x $1.60/unit) 28,800 Variable overhead (18,000 units x $0.85/unit) 15,300 Variable costing income $195,800 Add: fixed overhead attached to the increase in inventory (18,000 units x $1.25/unit) Absorption costing income 22,500 $218, 300 © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 18 Q4: Actual versus Estimated Denominator Levels • • • Normal costing (chapter 5) uses an estimated, rather than an actual, denominator level for the overhead cost allocation base If an actual denominator level is used, information is not timely Using an estimated denominator level provides a smoothing effect, for two reasons: ã ã Numerator reason Denominator reason â John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 19 Q4: Various Measures of Production Volume • • Supply-based measures of capacity: • The maximum possible capacity, with no allowance for downtime, is known as theoretical capacity • Theoretical capacity, reduced by an allowance for normal downtime, is known as practical capacity Demand-based measures of capacity: • The average use of capacity of several years is known as normal capacity • The anticipated use of capacity for the upcoming year is known as budgeted capacity or expected capacity © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 20 Q4: Effect of Denominator Volume on the Income Statement • • • When denominator volume is different than actual volume, there is a fixed overhead volume variance The volume variance is the difference between budgeted fixed overhead and applied fixed overhead If material, the volume variance is closed to work in process, finished goods, and cost of goods sold at year-end © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 21 Q4: Absorption Costing Income Statement & Volume Variance Example Russell Corporation produces a product that sells for $10 In 2005, there were 10,000 units in beginning finished goods inventory The company expected to produce 100,000 units in 2011 However, it actually produced 80,000 units and sold 62,000 units The costs incurred in 2005 are shown below Compute the inventoriable costs per unit under absorption costing Direct materials Direct labor Variable factory overhead Variable non-mfg costs Fixed mfg overhead Fixed non-mfg costs 2011 $60,000 128,000 68,000 55,800 100,000 70,000 Direct materials Direct labor Variable mfg overhead Fixed mfg overhead $0.75 $1.60 $0.85 $1.00 $4.20 Note that choice of denominator level affects only the fixed overhead cost per unit © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 22 Q4: Absorption Costing Income Statement & Volume Variance Example Suppose that the Russell Corporation uses the LIFO inventory method and that the volume variance is considered material Assume that the balances in WIP, FG, and CGS, before any adjustment for the volume variance, were at a ratio of 1:2:7 at 12/31/11 There was no fixed overhead spending variance in 2011 Compute the volume variance and prepare the year-end entry to close the Fixed overhead control account Budgeted fixed overhead Fixed overhead applied (80,000 units x $1/unit) Unfavorable fixed overhead volume variance Fixed overhead control Work in process [(1/10) x 20,000] Finished goods [(2/10) x 20,000] Cost of good sold [(7/10) x 20,000] $100,000 80,000 $20,000 20,000 2,000 4,000 14,000 Note that the unfavorable volume variance equals the underapplied fixed overhead because there was no spending variance for fixed overhead © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 23 Q4: Absorption Costing Income Statement & Volume Variance Example Using the cost information on slide #8 and the volume variance you calculated on the prior slide, prepare an absorption costing income statement for 2011 Sales (# units sold @ $10) Cost of goods sold: (# units sold @ $4.20) Adjustment for volume variance Gross margin Nonmfg costs ($70,000 + $55,800) Operating income $620,000 $260,400 14,000 274,400 345,600 125,800 $219,800 © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 24 Q5: Decision Making and Manager Incentives • • • • Absorption costing is used for external reporting but may not be best for performance evaluation purposes Variable and throughput costing avoid incentives to build up inventory levels • No income statement benefit to building up inventory since fixed costs are not inventoried Throughput costing may be useful for some shortterm decision making Technology advances can help organizations utilize absorption costing for external purposes and another method for internal reporting © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 25 ... Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q2: Variable Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q2: Variable Costing Income Statements... Chapter 14: Measuring and Assigning Costs for Slide # Q1: Absorption Costing Income Statements © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # Q1: Absorption Costing Income... cost of goods sold is based on the 2011 per-unit manufacturing costs because Russell is using LIFO © John Wiley & Sons, Chapter 14: Measuring and Assigning Costs for Slide # 12 Q2: Variable Costing Income Statement Example