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?