chapter 6

Under variable costing the cost of a unit of product consists of

-Direct Materials -Direct Labor Variable Overhead -Total Product Cost

Under absorption costing the cost of a unit of product consists of

-Direct Materials -Direct Labor -Variable overhead -Fixed Overhead -Total Product Cost

If fixed manufacturing overhead costs are released from inventory under absorption costing, what does this tell you about the level of production in relation to the level of unit sales?

-Under absorption costing, if inventories increase, fixed manufacturing overhead costs are differed in inventories, which in turn increase net operating income -if inventories decrease, fixed manufacturing overhead costs are released from inventories, which in turn decrease net operating income -If fixed manufacturing overhead costs are released from inventory, then inventory levels must have decreased, and therefore production must have been less than sales -Thus, when absorption costing is used, fluctuations in net operating income can be due to changes in inventories rather than to changes in sales.

VARIABLE

-fixed overhead is treated as period cost -used in managerial decision making because absorption causes managers to OVERPRODUCE

ABSORPTION

-includes fixed overhead as a product cost -required for external financial statements (GAAP)

What are the argument in favor of treating fixed manufacturing overhead costs as period costs

Advocates of variable costing view fixed manufacturing costs as capacity costs. They argue that fixed manufacturing costs would be incurred even if no units were produced.

Explain how fixed manufacturing overhead costs are shifted from one period to another under absorption costing

Because these costs are included in the work in progress account. Since absorption costing treats fixed cost as product cost, it is only recognized when a product is completed and transferred to finished goods. However a product may not always be completed during the period and thus its portion of fixed cost will be carried over to the next period.

Common fixed expenses

Common expenses that help support the operational activities of two or more segments

Fixed costs

Costs that remain stable irrespective of the number of production or range of activity up to a certain level

Absorption costing net operating income = Variable Costing Operating income

Unit produced = units sold No change in inventories

Absorption costing net operating income > Variable Costing Operating income

Units Produced > Units sold Inventories increase

Absorption costing net operating income < Variable Costing Operating income

Units produces < units sold Inventories decrease

Selling and Admin Expenses are never

treated as product costs, always reported as expenses on the income statement as incurred

Are selling and admin expenses treated as product costs or as period costs under variable costing

For variable costing Fixed manufacturing overhead is treated as a period cost under selling and distributing . so is SELLING AND ADMIN EXPENSE FOR BOTH VARIABLE AND FIXED -ONLY THOSE manufacturing costs that vary with output are treated as product costs. -direct material -direct labor -variable manufacturing overhead

Why aren't common fixed costs allocated to segments under the contribution approach?

To avoid overstating the segment costs and understating the segments margin. If common costs were allocated, some segments would appear to be losing money and managers may erronesouly eliminate them. if that segment was actually a profit making segment and it was eliminated the overall profit of the company would decline, and the common costs that were allocated to that segment would be reallocated to the remaining segments, making them appear erroneously unprofitable as well. Cycle would continue

What costs are assigned to a segment under the contribution approach

A cost will only be assigned to a segment if the costs are traceable to that segment, under the contribution approach. A traceable cost is only incurred as a result of the segments existence, if the segment is eliminated so is the cost. GENERAL COSTS are not allocated to segments under the contribution approach ex: salaries of executives that are incurred by various segments or departments

What is a segment of an organization? Give examples

A segment of any part or activity of an organization for which a manager seeks cost, revenue or profit data. Examples include: -Departments of an organization -Divisions within a department -Product lines -Market or sales territoires (i.e. geographical sales)

Distinguish between a traceable fixed cost and a common fixed cost. Give several examples of each

A traceable cost of a segment arises because of the existence of that segment. If the segment is eliminated so is the cost. ex: Salary of the departments supervisor -raw materials used by the department -cost of supplies used by the department -A common cost on the other hand supports more than one segment but is not traceable to any one segment as a whole. ex: salaries of the company exec. -corporate marketing and advertising -periodic depreciation of machines shared by several departments

What is the difference between absorption costing and variable costing

Absorption costing treats all costs of production as product costs (fixed and variable). Under absorption costing variable and fixed selling and admin expenses are treated as period costs and are deducted from revenue as incurred. ALSO CALLED FULL COST METHOD Variable costing treats only those of production that varies output as product costs. Fixed manufactoring overhead and both variable and fixed selling administrative expenses are treated as period costs and deducted from revenue as inccured, reported as an expense on the income statement.

Should a company allocate its common fixed costs to business segments when computing the breakeven point?

Company should not allocate its common fixed expenses to business segments while determining break even point because the common fixed expenses are not traceable to single segment and it is not influenced by the segment level of decisions. These costs are not eliminated or reduced even the specific segment is eliminated.

Explain how the contribution margin differs from the segment margins

Contribution margin = difference between sales revenue and variable expenses Segment margin goes one step further and is = to the amount remaining after deducting traceable fixed expenses from the CM The contribution margin is useful for making planning decisions were fixed costs don't change. The segment margin on the other hand is useful in assessing the overall profitability of that particular segment

How is it possible for a fixed cost that is traceable to a segment to become a common fixed cost if the segment is divided in further segments?

If a segment is divided into smaller units the cost will be shared amongst various segments. ex: If an advertising segment was broken down into print and TV advertising the costs may be traceable by the marketing of a specific product lines, but would be common cost to the geographic sales of where the product line is sold

How does lean production reduce or eliminate the difference in reported net operating income between absorption and variable costing?

Lean production reduces the the differences between absorption costing and variable costing by only producing goods to customer orders and the aim to eliminate finished goods entirely

What are the arguments in favor of treating fixed manufacturing overhead costs as period costs?

Manufactoring overhead contains the cost of direct labor and material. It is not associated wth the direct cost of the particular product. The amount gf cost of this overhead would remain constant even if there is no production process of the single product takes place. Hence it is concluded that manufacturing overhead costs cannot be treated as the product costs.

Under absorption costing, hows it possible to increase net operating income without increasing sales

Since absorption costing makes no distinction between variable and fixed costs, the fixed overhead rate per unit is computed first by considering the units produced and only the fixed cost relating to units sold is considered in the income statement. -Variable costing classifies cost as variable and fixed costs. The entire amount of fixed cost will be charged in the year of production irrespective of the number of units sold Thus, the difference among the fixed cost recognition under absorption costing and the fixed cost recognition under variable costing leads to rise in the operating income without increasing sales for a particular period.

How is it possible for a fixed cost that is traceable to a segment to become a common fixed cost if the segment is divided into further segments

The definition of a common cost is on that supports more than one segment, but is not traceable as a whole to any one segment

If the units produced exceeds the units sold, which method would you expect to show the higher net operating income, variable costing or absorption costing? Why?

When the units produced exceed unit sales and hence inventories increase, net operating income is higher under absorption costing than under variable costing. This occurs because some of the fixed manufacturing overhead of the period is deferred in inventories under absorption costing.

Breakeven Point

Where revenue of the company = the total cost incurred. At the breakeven point the profit will be zero