9-16
9-16 Variable and absorption costing, explaining income differences
1. Key inputs for income statement computations are:
| |April |May |
|Beginning inventory |0 |150 |
|Production |500 |400 |
|Goods available for sale |500 |550 |
|Units sold |350 |520 |
|Ending inventory |150 |30 |
The fixed cost per unit and total manufacturing costs per unit under absorption costing are:
| |April |May |
| (a) Fixed manufacturing costs |$2,000,000 |$2,000,000 |
|(b) Units produced |500 |400 |
|(c)=(a)÷(b) Fixed manufacturing costs per unit |$4,000 |$5,000 |
|(d) Variable manufacturing costs per unit |$10,000 |$10,000 |
|(e)=(c)+(d) Total manufacturing costs per unit |$14,000 |$15,000 |
(a) Variable costing
| |April 2003 |May 2003 |
|Revenuesa | |$8,400,000 | |$12,480,000 |
|Variable costs | | | | |
| Beginning inventory |$ 0 | |$1,500,000 | |
| Variable manufacturing costsb | 5,000,000 | | 4,000,000 | |
| Cost of goods available for sale |5,000,000 | |5,500,000 | |
| Deduct ending inventoryc | 1,500,000 | | 300,000 | |
| Variable cost of goods sold |3,500,000 | |5,200,000 | |
| Variable operating costsd | 1,050,000 | | 1,560,000 | |
| Total variable costs | | 4,550,000 | | 6,760,000 |
|Contribution margin | |3,850,000 | |5,720,000 |
|Fixed costs | | | | |
| Fixed manufacturing costs |2,000,000 | |2,000,000 | |
| Fixed operating costs | 600,000 | | 600,000 | |
| Total fixed costs | | 2,600,000 | | 2,600,000 |
|Operating income | |$1,250,000 | |$3,120,000 |
| | | | | |
a $24,000 × 350; $24,000 × 520 c $10,000 × 150; $10,000 × 30
b $10,000 × 500; $10,000 × 400 d $3,000 × 350; $3,000 × 520
9-16 (Cont’d.)
(b) Absorption costing
| |April 2003 |May 2003 |
|Revenuesa | |$8,400,000 | |$12,480,000 |
|Cost of goods sold | | | | |
| Beginning inventory |$ 0 | |$2,100,000 | |
| Variable manufacturing costsb |5,000,000 | |4,000,000 | |
|Fixed manufacturing costsc | 2,000,000 | | 2,000,000 | |
|Cost of goods available for sale |7,000,000 | |8,100,000 | |
|Deduct ending inventoryd | 2,100,000 | | 450,000 | |
| Cost of goods sold | | 4,900,000 | | 7,650,000 |
|Gross margin | |3,500,000 | |4,830,000 |
|Operating costs | | | | |
|Variable operating costse |1,050,000 | |1,560,000 | |
|Fixed operating costs | 600,000 | | 600,000 | |
|Total operating costs | | 1,650,000 | | 2,160,000 |
|Operating income | |$1,850,000 | |$ 2,670,000 |
| | | | | |
a $24,000 × 350; $24,000 × 520 d ($14,000 × 150; $15,000 × 30)
b $10,000 × 500; $10,000 × 400 e ($3,000 × 350; $3,000 × 520)
c ($4,000 × 500); ($5,000 × 400)
2. – = –
April:
$1,850,000 – $1,250,000 = ($4,000 × 150) – ($0)
$600,000 = $600,000
May:
$2,670,000 – $3,120,000 = ($5,000 × 30) – ($4,000 × 150)
– $450,000 = $150,000 – $600,000
– $450,000 = – $450,000
The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May).
| | | | | | |
17. Throughput costing (continuation of Exercise 9-16)
|1. |April 2003 |May 2003 |
|Revenuesa | |$8,400,000 | |$12,480,000 |
|Direct material cost of goods sold | | | | |
|Beginning inventory |$ 0 | |$1,005,000 | |
|Direct materials in goods manufacturedb |3,350,000 | |2,680,000 | |
|Cost of goods available for sale |3,350,000 | |3,685,000 | |
|Deduct ending inventoryc |1,005,000 | |201,000 | |
| Total direct material cost of goods sold | 2,345,000 | | 3,484,000 |
|Throughput contribution |6,055,000 | |8,996,000 |
|Other costs | | | |
|Manufacturing costs |3,650,000d | |3,320,000e | |
|Other operating costs | 1,650,000f | | 2,160,000g | |
|Total other costs | | 5,300,000 | | 5,480,000 |
|Operating income | |$ 755,000 | |$3,516,000 |
| | | | | |
a $24,000 × 350; $24,000 × 520 e ($3,300 × 400) + $2,000,000
b $6,700 × 500; $6,700 × 400 f ($3,000 × 350) + $600,000
c $6,700 × 150; $6,700 × 30 g($3,000 × 520) + $600,000
d($3,300 × 500) + $2,000,000
2. Operating income under:
| |April |May |
|Absorption costing |$1,850,000 |$2,670,000 |
|Variable costing |1,250,000 |3,120,000 |
|Throughput costing |755,000 |3,516,000 |
In April, throughput costing has the lowest operating income whereas in May, throughput costing has the highest operating income. Throughput costing puts greater emphasis on sales as the source of operating income than does either absorption or variable costing.
9-17 (Cont’d.)
3. Throughput costing puts a penalty on producing without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed in the period of incurrence, whereas under variable costing they would be capitalized. As a result, throughput costing provides less incentive to produce for inventory than either variable costing or absorption costing.
9-18 Variable and absorption costing, explaining income differences
1. Key inputs for income statement computations are:
| |January |February |March |
|Beginning inventory |0 |300 |300 |
|Production |1,000 |800 |1,250 |
|Goods available for sale |1,000 |1,100 |1,550 |
|Units sold |700 |800 |1,500 |
|Ending inventory |300 |300 |50 |
The fixed manufacturing costs per unit and total manufacturing costs per unit under absorption costing are:
| |January |February |March |
|(a) Fixed manufacturing costs |$400,000 |$400,000 |$400,000 |
|(b) Units produced |1,000 |800 |1,250 |
|(c)=(a)÷(b) Fixed manufacturing costs per unit |$400 |$500 |$320 |
|(d) Variable manufacturing costs per unit |$900 |$900 |$900 |
|(e)=(c)+(d) Total manufacturing costs per unit |$1,300 |$1,400 |$1,220 |
9-18 (Cont’d.)
(a) Variable Costing
| |January 2004 |February 2004 |March 2004 |
|Revenuesa | |$1,750,000 | |$2,000,000 | |$3,750,000 |
|Variable costs | | | | | | |
|Beginning inventoryb |$ 0 | |$270,000 | |$ 270,000 | |
|Variable manufacturing costsc | 900,000 | | 720,000 | | 1,125,000 | |
|Cost of goods available for sale |900,000 | | 990,000 | |1,395,000 | |
|Ending inventoryd |270,000 | |270,000 | |45,000 | |
|Variable cost of goods sold | 630,000 | |720,000 | |1,350,000 | |
|Variable operating costse |420,000 | |480,000 | |900,000 | |
|Total variable costs | |1,050,000 | |1,200,000 | |2,250,000 |
|Contribution margin | |700,000 | |800,000 | | 1,500,000 |
|Fixed costs | | | | | | |
|Fixed manufacturing costs |400,000 | |400,000 | |400,000 | |
|Fixed operating costs |140,000 | |140,000 | |140,000 | |
|Total fixed costs | |540,000 | |540,000 | |540,000 |
|Operating income | |$ 160,000 | |$ 260,000 | |$ 960,000 |
a $2,500 × 700; $2,500 × 800; $2,500 × 1,500
b $? × 0; $900 × 300; $900 × 300
c $900 × 1,000; $900 × 800; $900 × 1,250
d $900 × 300; $900 × 300; $900 × 50
e $600 × 700; $600 × 800; $600 × 1,500
9-18 (Cont'd.)
(b) Absorption Costing
| |January 2004 |February 2004 |March 2004 |
|Revenuesa | |$1,750,000 | |$2,000,000 | |$3,750,000 |
|Cost of goods sold | | | | | | |
|Beginning inventoryb |$ 0 | |$ 390,000 | |$ 420,000 | |
|Variable manufacturing costsc |900,000 | |720,000 | | 1,125,000 | |
|Fixed manufacturing costsd | 400,000 | | 400,000 | | 400,000 | |
|Cost of goods available for sale |1,300,000 | |1,510,000 | |1,945,000 | |
|Deduct ending inventorye | 390,000 | | 420,000 | | 61,000 | |
|Cost of goods sold | | 910,000 | | 1,090,000 | | 1,884,000 |
|Gross margin | |840,000 | |910,000 | |1,866,000 |
|Operating costs | | | | | | |
|Variable operating costsf |420,000 | |480,000 | |900,000 | |
|Fixed operating costs | 140,000 | | 140,000 | | 140,000 | |
|Total operating costs | | 560,000 | | 620,000 | | 1,040,000 |
|Operating income | |$ 280,000 | |$ 290,000 | |$ 826,000 |
a $2,500 × 700; $2,500 × 800; $2,500 × 1,500
b ($?× 0; $1,300 × 300; $1,400 × 300)
c $900 × 1,000, $900 × 800, $900 × 1,250
d ($400 × 1,000); ($500 × 800); ($320 × 1,250)
e ($1,300 × 300); ($1,400 × 300); ($1,220 × 50)
f $600 × 700; $600 × 800; $600 × 1,500
9-18 (Cont’d.)
2. – = –
January: $280,000 – $160,000 = ($400 × 300) – $0
$120,000 = $120,000
February: $290,000 – $260,000 = ($500 × 300) – ($400 × 300)
$30,000 = $30,000
March: $826,000 – $960,000 = ($320 × 50) – ($500 × 300)
– $134,000 = – $134,000
The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in January) and out of inventories as they decrease (as in March).
9-19 Throughput costing (continuation of Exercise 9-18)
1.
| |January |February |March |
|Revenuesa | |$1,750,000 | |$2,000,000 | |$3,750,000 |
|Direct material cost of goods sold | | | | | | |
|Beginning inventoryb |$ 0 | |$150,000 | |$ 150,000 | |
|Direct materials in goods manufacturedc | 500,000 | | 400,000 | | 625,000 | |
|Cost of goods available for sale |500,000 | |550,000 | |775,000 | |
|Deduct ending inventoryd |150,000 | |150,000 | |25,000 | |
|Total direct material cost of goods sold | |350,000 | |400,000 | |750,000 |
|Throughput contribution | |1,400,000 | |1,600,000 | |3,000,000 |
|Other costs | | | | | | |
|Manufacturinge |800,000 | |720,000 | |900,000 | |
|Operatingf |560,000 | |620,000 | |1,040,000 | |
|Total other costs | |1,360,000 | |1,340,000 | |1,940,000 |
|Operating income | |$ 40,000 | |$ 260,000 | |$1,060,000 |
a $2,500 × 700; $2,500 × 800; $2,500 × 1,500
b ($? × 0; $500 × 300; $500 × 300)
c $500 × 1,000; $500 × 800; $500 × 1,250
d $500 × 300; $500 × 300; $500 ×50
e ($400 × 1,000) + $400,000
($400 × 800) + $400,000
($400 × 1,250) + $400,000
f ($600 × 700) + $140,000
($600 × 800) + $140,000
($600 × 1,500) + $140,000
9-19 (Cont'd.)
2. Operating income under:
| |January |February |March |
|Absorption costing |$280,000 |$290,000 |$826,000 |
|Variable costing |160,000 |260,000 |960,000 |
|Throughput costing |40,000 |260,000 |1,060,000 |
Throughput costing puts greater emphasis on sales as the source of operating income than does absorption or variable costing.
3. Throughput costing puts a penalty on producing without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed when incurred, whereas under variable costing they would be capitalized as an inventoriable cost.
9-20 Variable vs. Absorption Costing
1.
Income Statement for the Zwatch Company, Variable Costing
For the Year Ended December 31, 2004
|Revenues: $22 × 345,400 | |$7,598,800 |
|Variable costs | | |
| Beginning inventory: $5.10 × 85,000 |$ 433,500 | |
| Variable manufacturing costs: $5.10 × 294,900 | 1,503,990 | |
| Cost of goods available for sale |1,937,490 | |
| Deduct ending inventory: $5.10 × 34,500 | 175,950 | |
| Variable cost of goods sold |1,761,540 | |
| Variable operating costs: $1.10 × 345,400 | 379,940 | |
| Total variable costs (at standard costs) |2,141,480 | |
| Adjustment for variances | 0 | |
| Total variable costs | | 2,141,480 |
|Contribution margin | |5,457,320 |
|Fixed costs | | |
| Fixed manufacturing overhead costs |1,440,000 | |
| Fixed operating costs |1,080,000 | |
| Adjustment for fixed cost variances | 0 | |
| Total fixed costs | | 2,520,000 |
|Operating income | | $2,937,320 |
9-20 (Cont’d.)
Absorption Costing Data
Fixed manufacturing overhead allocation rate =
Fixed MOH /Denominator level machine-hours = $1,440,000/6,000
= $240 per machine-hour
Fixed manufacturing overhead allocation rate per unit =
Fixed manufacturing overhead allocation rate/standard production rate = $240/50
= $4.80 per unit
Income Statement for the Zwatch Company, Absorption Costing
For the Year Ended December 31, 2004
|Revenues: $22 × 345,400 | |$7,598,800 |
|Cost of goods sold | | |
| Beginning inventory ($5.10 + $4.80) × 85,000 |$ 841,500 | |
| Variable manuf. costs: $5.10 × 294,900 |1,503,990 | |
| Fixed manuf. costs: $4.80 × 294,900 | 1,415,520 | |
| Cost of goods available for sale |$3,761,010 | |
| Deduct ending inventory: ($5.10 + $4.80) × 34,500 |(341,550) | |
| Adjust for manuf. variances ($4.80 × 5,100)a | 24,480 | |
| Cost of goods sold | | 3,443,940 |
|Gross margin | |4,154,860 |
|Operating costs | | |
| Variable operating costs: $1.10 × 345,400 |$ 379,940 | |
| Fixed operating costs |1,080,000 | |
| Adjust for operating cost variances | 0 | |
| Total operating costs | | 1,459,940 |
|Operating income | |$2,694,920 |
a Production volume variance
= [(6,000 hours × 50) – 294,900) × $4.80
= (300,000 – 294,900) × $4.80
= $24,480
2. Zwatch’s pre-tax profit margins –
|Under variable costing: | |
| Revenues | $7,598,800 |
| Operating income | 2,937,320 |
| Pre-tax profit margin | 38.7% |
| | |
|Under absorption costing: | |
| Revenues | $7,598,800 |
| Operating income | 2,694,920 |
| Pre-tax profit margin | 35.5% |
9-20 (Cont’d.)
3. Operating income using variable costing is about 9% higher than operating income calculated using absorption costing.
Variable costing operating income – Absorption costing operating income =
$2,937,320 – $2,694,920 = $242,400
Fixed manufacturing costs in beginning inventory under absorption costing –
Fixed manufacturing costs in ending inventory under absorption costing =
($4.80 × 85,000) – ($4.80 × 34,500) = $242,400
4. The factors the CFO should consider include:
a) Effect on managerial behavior, and
b) Effect on external users of financial statements.
Absorption costing has many critics. However, the dysfunctional aspects associated with absorption costing can be reduced by:
• Careful budgeting and inventory planning,
• Adding a capital charge to reduce the incentives to build up inventory, and
• Monitoring nonfinancial performance measures.
9-21 Absorption and variable costing
The answers are 1(a) and 2(c). Computations:
|1. Absorption Costing: | | |
|Revenuesa | |$4,800,000 |
|Cost of goods sold: | | |
|Variable manufacturing costsb |$2,400,000 | |
|Fixed manufacturing costsc |360,000 |2,760,000 |
|Gross margin | |2,040,000 |
|Operating costs: | | |
|Variable operatingd |1,200,000 | |
|Fixed operating |400,000 |1,600,000 |
|Operating income | |$ 440,000 |
a $40 × 120,000
b $20 × 120,000
c Fixed manufacturing rate = $600,000 ÷ 200,000 = $3 per output unit
Fixed manufacturing costs = $3 × 120,000
d $10 × 120,000
|2. Variable Costing: | | |
|Revenuesa | | |
|Variable costs: | | |
|Variable manufacturing cost of goods soldb | |$4,800,000 |
|Variable operating costsc |$2,400,000 | |
|Contribution margin |1,200,000 | |
|Fixed costs: | |3,600,000 |
|Fixed manufacturing costs | |1,200,000 |
|Fixed operating costs |600,000 | |
|Operating income |400,000 | |
| | |1,000,000 |
| | |$ 200,000 |
a $40 × 120,000
b $20 × 120,000
c $10 × 120,000
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