Chapter 5 Variable Costing

1. Chapter 5 Variable Costing Contains Fixed Manufacturing Overhead

2. Presentation Outline • Absorption Costing v. Variable Costing • A Comparison of Income Data for Absorption Costing and Variable Costing • An Illustration

3. I. Absorption Costing v. Variable Costing • Cost Classifications • Fixed Manufacturing Overhead • Format of Income Statement • Report Usage

4. A. Cost Classifications Absorption Costing Variable Costing Product costs include: > Direct materials > Direct labor > Variable mfg. overhead > Fixed mfg. overhead Product costs include: > Direct materials > Direct labor > Variable mfg. overhead Period costs include: > Selling & admin. expenses Period costs include: > Selling & admin. expenses > Fixed mfg. overhead

5. B. Fixed Manufacturing Overhead Absorption Costing Variable Costing Fixed manufacturing overhead is treated as a product cost. Fixed manufacturing overhead is treated as a period cost and deducted in full each year from revenues. Fixed mfg. overhead is never an asset. Fixed mfg. overhead Balance Sheet

6. C. Format of Income Statement Full (Absorption) Costing Variable Costing Sales - Cost of goods sold = Gross margin - Selling & admin. expenses = Net income Sales - Variable expenses = Contribution margin - Fixed expenses = Net income See Illustration 5-2 on page 166.

7. D. Report Usage • Absorption costing is required for external reporting. • Variable costing is permitted for internal use only.

8. II. A Comparison of Income Data for Absorption Costing and Variable Costing A. Production = Sales (no change in inventories) B. Production > Sales (inventories increase) C. Production < Sales (inventories decrease)

9. Production = Sales (No change in inventories) Absorption Costing Net Income Variable Costing Net Income If there is no change in inventories, then there is generally no change in the fixed manufacturing overhead costs in inventories under absorption costing.

10. B. Production > Sales (Inventories increase) Absorption Costing Net Income Variable Costing Net Income If inventories increase, then some of the current fixed manufacturing overhead costs will be deferred in inventories under absorption costing.

11. C. Production < Sales (Inventories decrease) Absorption Costing Net Income Variable Costing Net Income If inventories decrease, then some of the prior fixed manufacturing overhead costs that had been deferred in inventories under absorption costing, will be released as a current charge against income.

12. Selling price per unit $2,000 Variable costs per unit: Direct materials $ 600 Direct labor $ 225 Variable manufacturing overhead $ 75 Variable selling and administrative expenses $ 40 Fixed costs per year: Fixed manufacturing overhead $1,200,000 Fixed selling expenses $ 100,000 Fixed administrative expenses $ 500,000 Annual production in units 5,000 III. An Illustration

15. Year 1 Assumption:Production = Sales 5,000 units = 5,000 units

18. Year 2 Assumption:Production > Sales 5,000 units = 4,800 units

22. Year 3 Assumption:Production < Sales 5,000 units = 5,200 units

26. A Comparison of Incomes When total production over the 3 year period = total sales over that period, total net income under the approaches is equal.