ACCT 3121 Chapter 9
Absorption Costing
"absorbs" all manufacturing costs into inventory costs and therefore includes both variable and fixed manufacturing costs.
Absorption Costing
helps managers to artificially inflate profits by encouraging the production of products that absorb the highest amount of fixed manufacturing costs.
master-budget capacity utilization
measure capacity levels in terms of demand for the output of the plant; planned production
Should a company with high fixed costs and unused capacity raise selling prices to try to fully recoup its costs?
No, companies in this situation might experience greater reductions in the demand of their products if they continue to raise selling prices. This would result in the fixed capacity costs being spread over fewer and fewer units, increasing reported costs, resulting in more pressure to raise prices.
Absorption Costing
Recall from earlier chapters how WIP, FG, and COGS includes DM, DL, VMOH, FMOH. This type of costing "absorbs" inventory of all manufacturing costs.
Manufacturing
The choice of variable vs. absorption is generally only important for what type of companies?
How does the capacity level chosen to compute the budgeted fixed overhead cost rate affect the production-volume variance?
The chosen capacity level is directly related to the size and direction of the production-volume variance. When the chosen capacity level exceeds the actual production level, there will be an unfavorable production-volume variance; when the chosen capacity level is less than the actual production level, there will be a favorable production-volume variance.
Variable Costing
The contribution-margin format of the income statement is used with
Inventory Costing
The inventory costing system that is chosen determines which manufacturing costs are treated as inventoriable costs
FMOH is included or not
The main difference between variable and absorption costing is
Variable Costing
To reduce the undesirable incentives to build up inventories that absorption costing can create, a number of companies use what for internal reporting?
Fixed Manufacturing Costs
Under variable costing, these costs are not inventoried; they are treated as period costs, however under absorption costing they are treated as inventoriable costs.
Practical Capacity
Using ________________________ as the denominator level sets the cost of capacity at the cost of supplying the capacity, regardless of the demand for the capacity.
Reconciliation Statement
Variable Operating Income + FMOH deferred (end inv units) (FMOH per unit × #units end inv) - FMOH prior year (beg inv units) (FMOH per unit × # units beg inv) = Absorption Operating Income
Contribution Format
What type of Income Statement does Variable Costing use?
Inventory
Where could you look to see if managers are pumping production to "lower" COGS?
Variable Costing
a method of inventory costing in which all variable manufacturing costs are included as inventoriable costs - variable manufacturing costs are capitalized; fixed manufacturing costs* and period costs are expensed (internal use of decision making, performance evaluation, etc) - fixed manufacturing costs are treated as period costs ~ a method of inventory costing in which ONLY variable manufacturing costs are included as inventoriable costs
Absorption Costing
income is influenced by changes in unit sales and units of production. Net operating income can be increased simply by producing more units even if those units are not sold. No manipulation of inventory
Variable Costing
income is only affected by changes in unit sales. It is not affected by the number of units produced. As a general rule, when sales go up net operating income goes up and vice versa.
Variable Costing
is also sometimes called direct costing but that name is misleading as it excludes direct nonmanufacturing costs and only includes variable costs that are part of production and not outside of production in the value chain - as marketing costs would be.
Absorption Costing
• DM, DL, VMOH, FMOH all go into the cost of inventory (WIP->FG->COGS) • Use the Traditional Format IS
Variable Costing
- DM, DL, VMOH into the cost of inventory - FMOH is expensed (period cost) - Contribution Format IS (break out variable and fixed)
Variable Costing
A method of inventory costing in which all variable manufacturing costs (direct and indirect) are included as inventoriable costs
ok
Beginning inventory + cost of goods manufactured = Cost of goods sold + Ending inventory (ok)
Explain the difference between the variable and absorption costing methods.
Absorption costing includes both fixed and variable manufacturing costs as inventoriable costs, whereas variable costing only includes variable manufacturing costs as inventoriable costs.
Which method(s) are required for external reporting? For internal reporting
Absorption costing is required for external reporting to shareholders and for income tax reporting. A company may use whichever method it chooses for internal reporting purposes.
Variable and Fixed Costs
Absorption-costing income statements usually do not differentiate between
Inventories
As companies reduce _______________, the choice of variable versus absorption costing becomes less important.
Inventories
Evaluating performance of managers over a long period, say over three-to five-years, helps to reduce undesirable buildup of
Practical Capacity
For benchmarking purposes it is best to use ________________________ because it best represents the long-run cost of capacity.
Practical Capacity
assumes you use the plant to its practical capacity. start with maximum and then recognize there will be down time for holidays, maintenance and repair, etc.
Theoretical Capacity
assuming use the plant to the maximum capacity
Absorption Costing
can obscure which costs will actually be different (relevant) across alternative courses of action. This will make it difficult to know the real relevant costs.
Absorption Costing
can obscure which costs will actually be different (relevant) across alternative courses of action. This will make it impossible to know the real relevant costs.
Variable Costing
correctly identifies the additional variable costs incurred to make one more unit. It also emphasizes the impact of fixed costs on profits.
Absorption Costing
deferring a portion to a future period -- stays in inventory -- higher amount in inventory
Absorption Costing
enables managers to increase operating income by increasing the unit level of sales, as well as by producing more units.
Variable Costing
excludes fixed manufacturing overhead from inventoriable costs and therefore, lease charges paid on factory building will not form part of inventoriable costs.
Variable Costing
expensing entire FMOH
Absorption Costing
gives the impression that fixed manufacturing overhead is variable with respect to the number of units produced, but it is not. This can lead to inappropriate pricing decisions and product discontinuation decisions.
Unit Cost of a Product
is always higher in absorption costing than in variable costing as absorption costing treats fixed manufacturing overhead as an inventoriable costs whereas variable costing treats it as period costs.
Normal Capacity Utilization
is the level of capacity that satisfies average customer demand over a period and takes into account seasonal, cyclical, and trend factors.
Master-budget capacity utilization
is the only method with no production-volume variance.
Absorption Costing
is the required inventory method for external financial reporting in most countries.
Adjusted Allocation-Rate Approach
restates all amounts in the general and subsidiary ledgers by using actual rather than budgeted cost rates.
ok
sometimes the full COGS isn't important for decision making. For example, we may want to only consider variable costs, because fixed costs won't differ between alternative actions. (Answer = ok)
Variable Costing
what costing is used for decision making?