Management Accounting Chapter 6

Variable Costing

A costing method that includes only variable manufacturing costs-direct materials, direct labor, and variable manufacturing overhead-in unit product costs.

Traceable Fixed Costs

A fixed cost that is incurred because of the existence of a particular business segment and that would be eliminated if the segment were eliminated

Common Fixed Cost

A fixed cost that supports more than one business segment, but is not traceable in whole or in part to any one of the business segments.

What is a segment of an organization? Give several examples of segments.

A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Examples of segments include departments, operations, sales territories, divisions and product lines.

Segment Margin

A segment's contribution margin less its traceable fixed costs. It represents the margin available after a segment has covered all of its own traceable costs

What is the basic difference between absorption costing and variable costing?

Absorption and variable costing differ in how they handle fixed manufacturing overhead. Under absorption costing, fixed manufacturing overhead is treated as a product cost and hence is an asset until products are sold. Under variable costing, fixed manufacturing overhead is treated as a period cost and is immediately expensed on the income statement.

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

Absorption costing advocates argue that absorption costing does a better job of matching costs with revenues than variable costing. They argue that all manufacturing costs must be assigned to products to properly match the costs of producing units of product with the revenues from the units when they are sold. They believe that no distinction should be made between variable and fixed manufacturing costs for the purposes of matching costs and revenues.

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

Advocates of variable costing argue that fixed manufacturing costs are not really the cost of any particular unit of product. If a unit is made or not, the total manufacturing costs will be exactly the same. Therefore, how can one say that these costs are part of the costs of the products? These costs are incurred to have the capacity to make products during a particular period and should be charged against the period as period costs according to the matching principle.

Segment

Any part or activity of an organization about which managers seek cost, revenue, or profit data

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 sales?

If fixed manufacturing overhead cost is released from inventory, then inventory levels must have decreased and therefore production must have been less than sales.

If the units produced and unit sales are equal, which method would you expect to show the higher net operating income, variable costing or absorption costing? Why?

If production and sales are equal, net operating income should be the same under absorption and variable costing. When production equals sales, inventories do not increase or decrease and therefore under absorption costing fixed manufacturing overhead cost cannot be deferred in inventory or released from inventory.

If the Units produced exceed unit sales, which method would you expect to show the higher net operating income, variable costing or absorption costing? Why?

If production exceeds sales, absorption costing will usually show higher net operating income than variable costing. When production exceeds sales, inventories increase and under absorption costing part of the fixed manufacturing overhead cost of the current period is deferred in inventory to the next period. In contrast, all of the fixed manufacturing overhead cost of the current period is immediately expensed under variable costing.

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

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

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

Selling and Admin costs are treated as period costs in both variable and absorption costing methods

Under absorption costing, how is it possible to increase net operating income without increasing sales?

Under absorption costing net operating income can be increased by simply increasing the level of production without any increase in sales. If production exceeds sales, units of product are added to inventory

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

Under absorption costing, fixed manufacturing overhead costs are included in product costs, along with direct materials, direct labor, and variable manufacturing overhead. If some of the units are not sold by the end of the period as inventory. When the units are finally sold, the fixed manufacturing overhead cost that has been carried over with the units is included as part of that period's cost of goods sold.

What costs are assigned to a segment under the contribution approach?

Under the contribution approach, costs are assigned to a segment if and only if the costs are traceable to the segment (i.e. could be avoided if the segment were eliminated).

Absorption Costing

a costing method that includes all manufacturing costs-direct materials, direct labor, and both variable and fixed manufacturing overhead- in unit product cost