CH 7 Variable Costing

Variable Costing Income Statement

Sales - Variable Expenses = contribution margin - Fixed expenses =Net income

Absorption Costing Income Statement

Sales -COGS = Gross Margin - Selling & Admin expenses =Net income

Absorption costing gross margin =

Sales - COGS

Under absorption costing, fixed overhead is treated like a variable cost because a portion of the total cost is:

allocated to each unit produced, rather than being expensed as one large sum.

selling and administrative expenses:

are always treated as period costs under both variable and absorption costing

When production exceeds sales, fixed MOH costs:

are deferred in inventory under absorption costing

Allocating ________________ fixed costs to a segment may cause an otherwise profitable segment to appear unprofitable.

common

In preparing segmented income statements:

compute contribution margin instead of gross margin

When sales are constant but production fluctuates:

net operating income will be erratic under absorption costing

Costs that can be traced directly to a segment should

not be allocated to other segments.

When a segment cannot cover its own costs, that segment should:

probably be dropped

The segment margin is a valuable tool for assessing the long-run ______________________ of a segment

profitability

Segment margin

segment revenue (made by a segment) - variable expenses (traceable fixed costs of that segment)

A Co.'s operations can be divided by product lines, geographical area, manufacturing plants, service centers or sales territories, which are known as

segments

CVP analysis is more difficult when using absorption costing than when using variable costing:

the analysis requires costs to be broken down between variable and fixed which is not done in absorption costing

The number of units produced does not affect the net operating income when using

variable costing

The 2 general costing approaches used by manufacturing companies to prepare income statements are:

variable costing absorption costing

GAAP & IRS Rules:

-require that the same method be used for both internal and external segment reporting -create problems in reconciling internal & external reports -require segmented financial data be included in annual reports -the absorption costing method must be used for external reporting in the US

Absorption costing is:

-required by GAAP & IRS -used by most companies for both internal and external reports -advocated believe fixed costs are an essential part of product production.

When a segment is eliminated, a:

-traceable fixed cost will disappear -common fixed cost will remain unchanged

variable selling costs are incurred

on units sold, not produced

Costs should be allocated to segments for internal decision-making purposes:

only when the allocation base actually drives the cost being allocated.

Break-even point in dollar sales for retail segment

segment traceable fixed expense -------------------------------------- segment CM ratio

From a decision making point of view, __________________margin is most useful for major capacity decisions and __________________ margin is most useful for short-term sales volume decisions.

segment; contribution

one mistake companies make when preparing segmented income statements is arbitrarily assigning __________ fixed costs to segments

untraceable

Segment contribution margin equals segment revenue minus the _________ expenses for the segment.

variable

Variable costing net income is computed by:

(units sold X CM) - Fixed Expenses

Total Selling and Administrative Expenses

(units sold X variable selling & admin Exp) + Fixed sell & Admin Expense

A segment should be discontinued when the segment:

-cannot cover its own costs -has a CM that cannot cover traceable fixed costs

Absorption costing income statement, selling & admin Expenses:

= amounts reported on a variable costing inc. state. reported as a single amount

Fixed manufacturing overhead costs are included as part of Work In Process inventory under:

Absorption costing only

Total Variable Cost

COGS + (cost/unit X units sold)

Unit product cost under absorption costing

DM + DL + MOH + Fixed MOH / units produced

Unit product cost using variable costing

DM + DL + Variable MOH (selling and Admin expenses never considered part of product cost)

Variable costing is also known as:

Direct costing and marginal costing

Total Fixed expenses using variable costing

Fixed MOH + Fixed Selling & Admin Expenses

Common fixed cost is

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

The use of ____________________ costing can lead to the omission of segment costs becaus nonmanufacturing costs are not included as costs of a product.

absorption

If units produced are greater than units sold:

absorption costing net operating income is greater than variable costing net operating income.

If units produced are less than units sold:

absorption costing net operating income is less than variable costing net operating income

Under variable costing the cost of a unit of inventory does not contain:

fixed manufacturing overhead

Absorption costing net operating income may not agree with the net operating income calculated for CVP analysis due to the way in which:

fixed manufacturing overhead is handled in absorption costing

The difference between reported net income on variable costing and absorption costing income statements is based on how:

fixed overhead is accounted for

Costs are categorized by ______________ when using absorption costing and by ________________ when using variable costing.

function; behavior

Absorption costing can lead managers to mistakenly believe that fixed MOH costs will ______________ in total as the number of units produced increases.

increases

Variable costing is attractive to managers as an alternative to absorption costing because:

to generate data for CVP analysis, considerable time would have to be invested to rework income statements constructed under absorption costing.

Fixed MOH cost per unit using absorption costing

total Fixed MOH/units produced

The salary of each plant manager at a manufacturing facility in the US is a:

traceable fixed cost to the plant and a common fixed cost for the individual product lines made in the plant

Dollar break-even for a Co. is calculated as:

traceable fixed expenses + Common fixed Exp ---------------------------------------------------- Overall CM ratio

Property tax for a store is a ___________________ fixed cost for the store, and a _____________________ fixed cost for each product line sold in the store.

traceable; common

COGS using variable costing

unit cost X units sold

COGS using Absorption costing

unit product cost X units sold

Absorption Costing Income Statement

-follows traditional format -costs are organized by function -used for GAAP and IRS

A Co. with 3 segments has $10,000 in common fixed expenses. All 3 segments are at the break-even point. As a result, the Co.:

-has an overall net operating loss of $10,000 -common fixed expenses have not been covered -common fixed expenses are not considered when computing segment break-even -Co. wide break-even sales will always be higher than the sum of the segment break-even sales

Decision-making problems that could occur when using absorption costing include:

-inappropriate pricing decisions -decisions made to drop products that are, in fact, profitable

Incorrectly or arbitrarily assigning common costs to segments:

-may make a segment appear unprofitable -sales will be lost -reallocated to remaining segments of company -makes remaining segments appear less profitable -net effect will be to reduce overall profits of co. and make it even more difficult to cover the common costs -holds managers responsible for costs they cannot control -does not impact the net income of co. as a whole

Absorption Costing for segmented income statements can lead to:

-omission of part of all "upstream" costs in value chain (research & devel. & product design) -omission of downstream costs (marketing, distribution & customer service) -product is undercosted (under-costing of segments) -management may develp & maintain products that in the long run result in losses

Common mistakes made by companies when assigning costs to segments include:

-omitting costs that should be included -inappropriately assigning traceable fixed costs -arbitrarily allocating common fixed costs

Variable costing is:

-preferred method for internal decision making -advocated believe -fixed costs do NOT directly related to product productions. -fixed manufacturing costs are period expenses

Variable Costing Income Statement

-follows CM format -costs are organized by behavior -can be used internally -separate variable expenses from fixed expenses

Using variable costing and the contribution approach for internal decision making:

-enables CVP analysis -facilitates explaining changes in net income -supports decision making

In absorption costing, selling & admin expenses

-equal the amts reported on a variable costing income statement -are reported as a single amt