Inventory Costing and Capacity Analysis

1. Inventory Costingand Capacity Analysis Chapter 9

2. Learning Objective 1 Identify what distinguishes variable costing from absorption costing.

3. Inventory-Costing Methods The difference between variable costing and absorption costing is based on the treatment of fixed manufacturing overhead.

4. Variable Costing Direct Materials Variable Factory Labor Variable Overhead Work in Process Inventory

5. Variable Costing Work in Process Inventory Finished Goods Inventory Fixed Factory Labor Cost of Goods Sold Income Summary

6. Learning Objective 2 Prepare income statements under absorption costing and variable costing.

7. Comparing Income Statements The following data pertain to Davenport Fixtures: Year 1Year 2Total Beginning inventory -0- 2,000 -0- Produced 10,000 11,500 21,500 Sold 8,00013,00021,000 Ending inventory 2,000 500 500

8. Comparing Income Statements The following information is on a per unit basis: Sales price: $71.00 Variable manufacturing costs: Direct materials: $ 4.00 Direct manufacturing labor: $21.00 Indirect manufacturing costs: $24.00 Fixed manufacturing costs: $ 4.50

9. Comparing Income Statements(Absorption Costing) Total fixed production costs are $54,000 at a normal capacity of 12,000 units. Fixed nonmanufacturing costs are $30,000 per year. Variable nonmanufacturing costs are $2.00 per unit sold.

10. Comparing Income Statements(Absorption Costing) Revenues $568,000 Cost of goods sold 428,000 Volume variance (U) 9,000 Gross margin $131,000 Nonmanufacturing costs 46,000 Operating income $ 85,000

11. Comparing Income Statements(Absorption Costing) Revenues for Year 1 are $568,000. What is the cost of goods sold? 8,000 × $49 = $392,000 What is the manufacturing contribution margin? $568,000 – $392,000 = $176,000 Net contribution margin = $160,000

12. Comparing Income Statements (Variable Costing) Revenues $568,000 Cost of goods sold 392,000 Variable nonmanufacturing costs 16,000 Contribution margin $160,000 Fixed manufacturing costs 54,000 Fixed nonmanufacturing costs 30,000 Operating income $ 76,000

13. Learning Objective 3 Explain differences in operating income under absorption costing and variable costing.

14. Operating Income(Absorption Costing) What are revenues for Year 2? 13,000 × $71 = $923,000 What is the cost of goods sold? 13,000 × $53.50 = $695,500 Is there a volume variance? (12,000 – 11,500) × $4.50 = $2,250 underallocated fixed manufacturing costs

15. Operating Income(Absorption Costing) What is the gross margin? $923,000 – ($695,500 + $2,250) = $225,250 What are the nonmanufacturing costs? 13,000 units sold × $2.00 = $26,000 variable costs + $30,000 fixed costs = $56,000

16. Operating Income(Absorption Costing) What is the operating income before taxes? $225,250 – $56,000 = $169,250 What is the operating income for the two years combined? $85,000 + $169,250 = $254,250

17. Income Statements (Absorption Costing) Year 1Year 2 Combined Revenues $568,000 $923,000 $1,491,000 Cost of goods sold 428,000 695,500 1,123,500 Volume variance (U) 9,000 2,250 11,250 Gross margin $131,000 $225,250 $ 356,250 Nonmfg. costs 46,000 56,000 102,000 Operating income $ 85,000 $169,250 $ 254,250

18. Operating Income(Variable Costing) Revenues for Year 2 are $923,000. What is the cost of goods sold? 13,000 × $49 = $637,000 What is the manufacturing contribution margin? $923,000 – $637,000 = $286,000

19. Operating Income(Variable Costing) What is the net contribution margin? $286,000 – $26,000 variable nonmanufacturing costs = $260,000 net contribution margin What is the operating income before taxes? $260,000 – $54,000 fixed manufacturing costs – $30,000 fixed nonmanufacturing costs = $176,000

20. Income Statements(Variable Costing) Year 1Year 2Combined Revenues $568,000 $923,000 $1,491,000 Cost of goods sold 392,000 637,000 1,029,000 Mfg. contr. margin$176,000 $286,000 $ 462,000 Variable nonmfg. 16,000 26,000 42,000 Net contr. margin $160,000 $260,000 $ 420,000

21. Income Statements(Variable Costing) Year 1Year 2Combined Net contr. margin $160,000 $260,000 $420,000 Fixed mfg. costs 54,000 54,000 108,000 Fixed nonmfg. costs 30,000 30,000 60,000 Operating income $ 76,000 $176,000 $252,000

22. Comparison of Variableand Absorption Costing Variable costing operating income Year1: $76,000 Absorption costing operating income Year1: $85,000 Absorption costing operating income is $9,000 higher. Why?

23. Comparison of Variableand Absorption Costing Production exceeds sales in Year 1. The 2,000 units in ending inventory are valued as follows: Absorption costing: 2,000 × $53.50 = $107,000 Variable costing: 2,000 × $49.00 = $ 98,000 Difference: $ 9,000

24. Comparison of Variableand Absorption Costing Variable costing operating income Year 2: $176,000 Absorption costing operating income Year 2: $169,250 Variable costing operating income is $6,750 higher. Why?

25. Comparison of Variableand Absorption Costing Sales exceeded units produced in Year 2. 13,000 – 11,500 = 1,500 decrease in inventory Absorption costing: 1,500 × $53.50 = $80,250 Variable costing: 1,500 × $49.00 = $73,500 Higher cost of goods sold under absorption costing: $ 6,750

26. Comparison of Variableand Absorption Costing Variable costing combined net income: $252,000 Absorption costing combined net income: $254,250 Absorption costing is higher by $2,250 500 units in inventory × $4.50 = $2,250

27. Comparison of Variableand Absorption Costing Absorption costing operating income – Variable costing operating income EQUALS Fixed manufacturing costs in ending inventory under absorption costing – Fixed manufacturing costs in beginning inventory under absorption costing

28. Learning Objective 4 Understand how absorption costing can provide undesirable incentives for managers to build up finished goods inventory.

29. Inventory Buildup Assume that Davenport Fixtures produced 4,400 units in Year 1 and sold 4,100. What is the production volume variance? (12,000 – 4,400) × $4.50 = $34,200 U What is the net operating income or loss for the period?

30. Inventory Buildup Revenues (4,100 × $71) $291,100 Cost of goods sold (4,100 × $53.50) 219,350 Volume variance 34,200 Gross margin $ 37,550 Nonmanufacturing costs 38,200 Net loss $ 650

31. Inventory Buildup How many units are in ending inventory? 4,400 – 4,100 = 300 How much cost is in ending inventory? 300 × $53.50 = $16,050

32. Inventory Buildup Suppose that management decides to produce 9,000 units next year. Sales remain the same (4,100 units). What is the volume variance? (12,000 – 9,000) × $4.50 = $13,500 U What is the operating income or loss?

33. Inventory Buildup Revenues (4,100 × $71) $291,100 Cost of goods sold (4,100 × $53.50) 219,350 Volume variance 13,500 Gross margin $ 58,250 Nonmanufacturing costs 38,200 Net income $ 20,050

34. Inventory Buildup How many units are in ending inventory? 300 + 9,000 – 4,100 = 5,200 How much cost is in ending inventory? 5,200 × $53.50 = $278,200

35. Learning Objective 5 Differentiate throughput costing from variable costing and absorption costing.

36. Throughput Costing Revenues $568,000 Variable direct materials cost of goods sold 32,000 Throughput contribution margin $536,000 Manufacturing costs 504,000 Nonmanufacturing costs 46,000 Operating loss $ 14,000

37. Throughput Costing Manufacturing Costs: Labor $21.00 × 10,000 $210,000 Indirect costs $24.00 × 10,000 240,000 Fixed costs 54,000 Total manufacturing costs $504,000 What are other nonmanufacturing costs for the year?

38. Nonmanufacturing Costs: Variable $2.00 × 8,000 $16,000 Fixed 30,000 Total $46,000 Throughput Costing

39. Variable costing operating income: $76,000 Throughput costing operating loss: $14,000 Difference in operating income: $90,000 Throughput Costing How can this difference be explained?

40. Throughput Costing The 2,000 units in ending inventory are valued as follows: Variable 2,000 × $49 = $98,000 Throughput 2,000 × $4 = $8,000 $90,000 difference

41. Absorption costing operating income: $85,000 Throughput costing operating loss: $14,000 Difference in operating income: $99,000 Throughput Costing How can this difference be explained?

42. Throughput Costing The 2,000 units in ending inventory are valued as follows: Absorption 2,000 × $53.50 = $107,000 Throughput 2,000 × $4 = $8,000 $99,000 difference

43. Comparison of InventoryCosting Methods Actual Costing Variable Costing Absorption Costing Throughput Costing

44. Comparison of InventoryCosting Methods Normal Costing Variable Costing Absorption Costing Throughput Costing

45. Comparison of InventoryCosting Methods Standard Costing Variable Costing Absorption Costing Throughput Costing

46. Learning Objective 6 Describe the various capacity concepts that can be used in absorption costing.

47. Alternative Denominator-LevelConcepts Theoretical capacity Practical capacity Normal capacity Master-budget capacity

48. Budgeted Fixed ManufacturingOverhead Rate Lloyd’s Bicycles produces bicycle parts for domestic and foreign markets. Fixed overhead costs are $200,000 within the relevant range of the various capacity volume.

49. Budgeted Fixed ManufacturingOverhead Rate Assume that the theoretical capacity is 10,000 machine-hours, practical capacity is 85%, normal capacity is 75%, and master-budget capacity is 60%. What is the budgeted fixed manufacturing overhead rate at the various capacity levels?

50. Budgeted Fixed ManufacturingOverhead Rate Theoretical 100%: $200,000 ÷ 10,000 = $20.00/machine-hour Practical 85%: $200,000 ÷ 8,500 = $23.53/machine-hour Normal 75%: $200,000 ÷ 7,500 = $26.67/machine-hour Master-budget 60%: $200,000 ÷ 6,000 = $33.33/machine-hour