Cost Accounting 1-2 - Variable and Full Costing

Variable Costing

Emphasized the cost BEHAVIOR (variable vs. fixed). Used in managerial accounting as it enhances internal decision making and makes predicting costs much easier.

Full (Absorption) Costing

Emphasizes the cost FUNCTION (product vs. period). Required for GAAP reporting, based on the premise that inventory includes all costs necessary to get products ready to sell.

Sando produced 300 stools and sold 250 of them for $33 each. At the beginning of the month, it had 26 stools on hand. Total fixed production overhead cost is $2,040. Operating Income under variable costing is $1,548. Prepare a reconciliation in good form.

Fixed overhead cost per unit = $2,040 / 300 = $6.80. Change in finished units = 300 - 250 = 50 Fixed mfg. cost retained in inventory = 50 x $6.80 = $340. Reconciliation: NOI under Variable Costing $1,548 Fixed Mfg. Retained in Inventory 340 NOI under Absorption Costing $1,888

Variable vs. Full Costing when Production < Sales

Inventory levels decrease. The amount of fixed mfg. overhead expensed is greater under absorption costing. The amount of operating income is less under absorption costing.

Variable vs. Full Costing when Production = Sales

Inventory levels do not change. The same amount of fixed mfg. overhead is expensed under both methods. The amount of operating income is the same under both methods.

Variable vs. Full Costing when Production > Sales

Inventory levels increase. The amount of fixed mfg. overhead expensed is less under absorption costing. The amount of operating income is greater under absorption costing.

Ethical Concerns of Absorption Costing

Managers are able to manipulate income under absorption costing by producing more or fewer units. Absorption costing encourages managers to engage in gaming behavior in an attempt to modify the income statement. Producing more units spreads the fixed overhead cost over more units, reducing the cost per unit and increasing net income. By tying up money in inventory, resources are not used efficiently. Managers tend to manage in the manner that will best impact their bonuses. Producing more units even though sales is static increases a manager's bonus.

Timing Issues of Variable and Full Costing

Operating income and inventory amounts will differ under variable and full costing when the number of units sold differs from units produced. This happens because fixed mfg. overhead costs are capitalized under full costing and expensed under variable costing. In full costing, fixed manufacturing costs are attached to inventory and expensed when the units are sold (treated as product costs). In variable costing, fixed manufacturing costs are expensed when incurred (treated as period costs).

Full (Absorption) Costing Format

Sales (-) Cost of Goods Sold [Product costs including variable manufacting costs (direct materials, direct labor, variable manufacturing overhead) plus fixed manufacturing overhead] (=) Gross Margin / Gross Profit (-) Operating Expenses [Period costs (variable and fixed selling, general, and administrative costs)] (=) Net Operating Income 100,000 Sales (10,000 units) 33,000 COGS 67,000 Gross Margin 57,000 Operating Expenses 10,000 Net Operating Income

Variable Costing Format

Sales (-) Variable Costs [Product (manufacturing costs) and period (operating costs)] (=) Contribution Margin (-) Fixed Costs [Product (manufacturing costs) and period (operating costs)] (=) Net Operating Income 100,000 Sales 60,000 VC 40,000 CM 30,000 FC 10,000 Net Operating Income

Expanded Absorption Costing Income Statement

Sales 100,000 Cost of Goods Sold: Variable Mfg. Costs 22,000 Fixed Mfg. Costs 11,000 Total COGS 33,000 Gross Margin 67,000 Operating Expenses: Variable Op. Costs 38,000 Fixed Op. Costs 19,000 Total Operating Expenses 57,000 Net Operating Income 10,000 COGS = Product costs (direct materials, direct labor, variable mfg. overhead, fixed mfg. overhead) Operating Expenses = Period costs. Under absorption costing, product costs consist of both variable and fixed manufacturing costs.

Expanded Variable Costing Income Statement

Sales 100,000 Variable Costs: Variable Mfg. Costs 22,000 Variable Op. Costs 38,000 Total Variable Costs 60,000 Contribution Margin 40,000 Fixed Costs: Fixed Mfg. Costs 11,000 Fixed Op. Costs 19,000 Total Fixed Costs 30,000 Net Operating Income 10,000 Variable Mfg. Costs = Product Costs (direct materials, direct labor, variable mfg. overhead). Variable operating costs, fixed mfg. costs, fixed op. costs = Period costs. Under variable costing, product costs consist of only variable manufacturing costs.

Sando produced 300 stools and sold 250 of them for $33 each. At the beginning of the month, it had 26 stools on hand. The following costs are available for Sando: Direct materials per unit - $4.00 Direct labor per unit - $3.30 Variable factory overhead per unit - $1.90 Total fixed production overhead cost - $2,040 Variable administrative cost per unit - $2.25 Total fixed administrative cost - $1,800 Produce Absorption Income Statement

Sales = 250 x $33 = $8,250 Variable Mfg. Costs = [250 x ($4.00 + $3.30 + $1.90)] = $2,300 Fixed Mfg. Costs = $2,040 / 300 = $6.80 ; $6.80 x 250 = $1,700 Variable Op. Costs = 250 x $2.25 = $563 Sales 8,250 Cost of Goods Sold: Variable Mfg. Costs 2,300 Fixed Mfg. Costs 1,700 Total COGS 4,000 Gross Margin 4,250 Operating Expenses: Variable Op. Costs 563 Fixed Op. Costs 1,800 Total Fixed Costs 2,363 Net Operating Income 1,887

Sando produced 300 stools and sold 250 of them for $33 each. At the beginning of the month, it had 26 stools on hand. The following costs are available for Sando: Direct materials per unit - $4.00 Direct labor per unit - $3.30 Variable factory overhead per unit - $1.90 Total fixed production overhead cost - $2,040 Variable administrative cost per unit - $2.25 Total fixed administrative cost - $1,800 Produce Variable Income Statement

Sales = 250 x $33 = $8,250 Variable Mfg. Costs = [250 x ($4.00 + $3.30 + $1.90)] = $2,300 Variable Op. Costs = 250 x $2.25 = $563 Sales 8,250 Variable Costs: Variable Mfg. Costs 2,300 Variable Op. Costs 563 Total Variable Costs 2,863 Contribution Margin 5,388 Fixed Costs: Fixed Mfg. Costs 2,040 Fixed Op. Costs 1,800 Total Fixed Costs 3,840 Net Operating Income 1,548

Sando produced 300 stools and sold 250 of them for $33 each. At the beginning of the month, it had 26 stools on hand. The following costs are available for Sando: Variable mfg. costs per unit - $9.20 Total fixed production overhead cost - $2,040 Variable administrative cost per unit - $2.25 Total fixed administrative cost - $1,800 What happens if Sandro produces 400 stools?

Sales = 250 x $33 = $8,250 Variable mfg. costs = 250 x $9.20 = $2,300 Fixed mfg. costs = $2,040 / 300 = $6.80 ;$6.80 x 250 = $1,700 Sales 8,250 Cost of Goods Sold: Variable Mfg. Costs 2,300 Fixed Mfg. Costs 1,700 Total COGS 4,000 Gross Margin for 300 Stools 4,250 Fixed mfg. costs = $2,040 / 400 = $5.10 ; $5.10 x 250 = $1,275 Sales 8,250 Cost of Goods Sold: Variable Mfg. Costs 2,300 Fixed Mfg. Costs 1,275 Total COGS 3,575 Gross Margin for 400 Stools 4,675

Contribution Margin (Variable Costing)

The amount generated to cover fixed costs and contribute to profit. Sales - Variable Costs. Contribution Margin per Unit = Contribution Margin / Units Sold. $4.00 is generated for each unit sold to cover fixed costs and contribute to profit. Contribution Margin Ratio = Contribution Margin / Sales. 40 cents per sales dollar is available to cover fixed costs and contribute to profit.

Gross Margin (Full Costing)

The amount generated to cover operating expenses and contribute to profit. Sales - Cost of Goods Sold. Gross Margin per Unit = Gross Margin / Units Sold. $6.70 is generated per unit sold to cover operating expenses and contribute to profit. Gross Margin Ratio = Gross Margin / Sales. 67 cents per sales dollar is available to cover operating expenses and contribute to profit.

Variable and Full (Absorption) Costing

Two methods to measure product costs.

Reconciling Full and Variable Costing Income

When production volume is greater than sales volume the fixed overhead expensed under variable costing is greater than under absorption costing. Operating income is greater under absorption costing. Variable operating income + (change in units x fixed overhead / unit) = absorption operating income. When production volume is less than sales volume the fixed overhead expensed under variable costing is less than under absorption costing. Operating income is greater under variable costing. Variable operating income - (change in units x fixed overhead / unit) = absorption operating income.