ACCT 2302 EXAM 2

Advantages of Variable Costing and the Contribution Approach

- Management finds it more useful - Consistent with CVP analysis - Net operating income is closer to net cash flow - Consistent with standard costs and flexible budgeting - Easier to estimate profitability of products and segments - Profit is not affected by changes in inventories - Impact of fixed cots on profits emphasized

Variable Costing

- Preferred by some managers for internal decision making - Must be used when an income statement is prepared in the contribution format - Under..., only those costs that vary with output are traded as product costs - The cost of a unit of product includes direct materials, direct labor, and only the variable portion of manufacturing overhead - Fixed manufacturing overhead is not treated as a product cost under this method. Rather, fixed manufacturing overhead is treated as a period cost and, like selling and administrative expenses, it is expensed in its entirety each period - In the contribution income statement of variable costing, all of the other variable costs are listed together and all the fixed costs are listed together - When sales go up, net income goes up. When sales go down, net operating income goes down. When sales stay the same, net operating income will be constant.

Absorption Costing

- The type of costing described in chapters 2 and 3 - Required by GAAP and generally used for external financial reports - Treats all manufacturing costs as product costs, regardless of whether they are fixed or variable - The cost of a unit of product under absorption method consists of direct materials, direct labor and both variable and fixed manufacturing overhead - In an absorption costing income statement, costs are categorized by function -- manufacturing versus selling and administrative - Fixed manufacturing overhead costs appear to be variable with respect to the number of units sold, but they are not.

Activity Based Costing

- is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity - is just one of the many ways to group costs to aid in decision making - is a supplement to, rather than a replacement for a company's formal accounting system - can use this costing as an alternative to calculate unit product costs for the purposes of managing overhead and making decisions

Five steps to Activity Based Costing

1. Identify and define activities and cost pools 2. Assign costs to activity cost pools 3. Calculate Activity Rates (POHR for each cost pool) 4. Assign costs to cost objects 5. Prepare management reports

Activity Cost Pool

A "bucket" in which costs are accumulated that relate to a single activity measure in the ABC system. Ex. customer orders, product design, order size, customer relations

Common Fixed Cost

A fixed cost that supports the operations of more than one segment, but is not traceable to one segment. If the segment is eliminated, the fixed cost will remain.

management analysis

Absorption costing can cause a problem for... because the net operating income may go up even when sales stay constant just because of increasing inventories. In these cases, the higher net operating income is not the result of lower selling costs or more efficient operations. Rather, the number of units produced exceeded the number of units sold and so some of the fixed manufacturing overhead costs were deferred in inventories in that month.

Quantity of units produced

Absorption costing can increase profits by increasing the... (not sold)

Other

Assigned all overhead costs that are not associated with the other cost pools

Yes through absorption costing

Can a company increase profits by increasing inventory?

GAAP

Companies must use absorption costing in preparing their financial statements in accordance with... However, they may choose to use variable costing for internal reports.

Activity Based Costing

Differs from traditional cost accounting in that: 1. Bot manufacturing and non manufacturing costs may be assigned to products 2. Some manufacturing costs may be excluded from product costs 3. A number of overhead cost pools are used, each of which is allocated to products and other costing objecting using its own unique measure of activity 4. The allocation bases often differ from those used in traditional costing system 5. The overhead rates, or activity rates, may be based on the level of activity at capacity rather than on the budgeted level of activity

Unit Product Cost - Variable

Direct Materials + Direct Labor + Variable Manufacturing Overhead

Unit Product Cost - Absorption

Direct materials + Direct labor + Variable manufacturing overhead + Fixed Manufacturing Overhead

unit sales/units produced

In contrast, when ... exceed the ... and inventories decrease, net operating income is lower under absorption costing than under variable costing. This occurs because some of the fixed manufacturing overhead of previous periods is released from inventories under absorption costing.

deferred

In general, when the units produced exceed unit sales and hence inventories increase, net operating income is higher under absorption costing than under variable costing. This occurs because some of the fixed manufacturing overhead of the period is... under absorption costing.

Segmented Income Statement Format

Sales - Variable Expenses = Contribution Margin - Traceable Fixed Expenses = Divisional Segment Margin (Profitability Line) - Common Fixed Expenses = Net Operating Income

direct materials, direct labor, and both variable and fixed manufacturing overhead

The cost of a unit product under the absorption method cosists of...

additional variable costs

The variable costing method correctly identifies the... that will be incurred to make one more unit. It also emphasizes the impact of fixed costs on profits.

vary

Under variable costing, only those costs that... with output are treated as product costs.

cost of a unit product

Under variable costing, the... includes direct materials, direct labor and only the variable portion of manufacturing overhead.

contribution format

Variable costing must be used when an income statement is prepared in the...

net operating income

When the units produced and units sold are equal, ... will be the same under absorption and variable costing.

Traceable Fixed Cost

a fixed cost that is incurred because of the existence of the segment. If the segment did not exist, the fixed cost would not exist.

Contribution Income Statement of variable costing

all of the variable costs are listed together and all of the fixed costs are listed together.

Customer Relations

assigned all costs associated with maintaining relations with customers

Order Size

assigned all costs of resources consumed as a consequence of the number of units produced

Product designs

assigned all costs of resources consumed by designing products

Customer Orders

assigned all costs of resources that are consumed by taking and processing customer orders

Organization-Sustaining activities

carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made

Fixed manufacturing overhead

is not treaded as a product cost under the variable costing method. Rather, it is treated as a period cost under this method and, like selling and administrative expenses, it is expensed in its entirety each period.

Batch-Level Activities

performed each time a batch is handled or processed, regardless of how many units are in the batch

Unit-Level Activities

performed each time a unit is produced

Customer-level activities

relate to specific customers and include activities such as sales calls, catalog mailings, and general technical support that are not tied to any specific product

Product-level activities

relate to specific products and typically must be carried out regardless of how many batches are run or units of product are produced or sold