Cost Behaviour and Income Statements

1. Cost Behaviour and Income Statements Absorption Income Statement Sales $20,000 Cost of Goods Sold: Direct material $7,000 Direct labour 4,000 Factory overhead 4,00015,000 Gross margin 5,000 Selling expenses 3,000 Administrative expenses 1,000 Total selling & administrative expenses 4,000 Operating Income $1,000 Contribution Income Statement Sales $20,000 Variable expenses: Direct material $7,000 Direct labour 4,000 Variable overhead 1,000 Variable selling 1,000 Variable administrative 100 Total variable expenses 13,100 Contribution margin 6,900 Fixed expenses: Manufacturing $3,000 Selling 2,000 Administrative 900 Total fixed expenses 5,900 Operating Income $1,000

2. Cost Flows: Absorption Costing Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead Inventoried Costs on Balance Sheet Expense on Income Statement Costs to Account For Initially applied to inventory as unexpired costs Become expenses when inventory is sold As goods are sold Become expenses immediately Expires immediately All selling & administrative costs

3. Cost Flows: Variable Costing Direct material Direct labour Variable manufacturing overhead Inventoried Costs on Balance Sheet Expense on Income Statement Costs to Account For Initially applied to inventory as unexpired costs Become expenses when inventory is sold As goods are sold Fixed manufacturing overhead Become expenses immediately Expires immediately All selling & administrative costs

4. New Topic: Cash vs Accrual Basis • Cash Basis • Revenue (=cash receipts) • Less Expenses ( = cash payments) • Net Income • Used by many small retailers, and other small businesses that don’t report to external users. • Can be misleading… examples: • Net Income in the period may be higher because the customer paid in advance for services • Net Income may be lower because the company paid Sept. utility bill in Oct. • Accrual Basis • Revenue (= when earned) • Less Expenses ( = when incurred) • Net Income • Required for GAAP • “Revenue Recognition” principle • Record revenue when it is earned • “Matching” principle • Record expenses in the same period as the revenue they helped earn.

5. Apple's 2009 earnings up nearly 44% under new accounting rules – analyst • Previously, “any product that offered free upgrades to software and services installed on a device like an iPhone required subscription accounting (revenue deferred over 8 quarters in the case of the iPhone and Apple TV)”. • Apple was spreading the revenue over a two year period in equal chunks. • Source: http://brainstormtech.blogs.fortune.cnn.com/2009/09/24/apples-2009-earnings-up-nearly-44-under-new-accounting-rules-analyst/

6. Apple's 2009 earnings up nearly 44% under new accounting rules – analyst • Most “of the value of the device was realized at the time of purchase… we believe about 90% of the value of an iPhone is realized at the time of purchase”. • Old GAAP rules said Apple was only allowed to recognize 12.5% (1/8th) of the revenue from each sale at the time of purchase • New GAAP rules say the percentage will be decided on a case-by-case basis for each given product – but substantially more of the revenue will be recorded at the time of sale.