1. describe and illustrate income reporting under variable costing and absorption costing. 2....

1. Describe and illustrate income reporting under variable costing and absorption costing.

2. Describe and illustrate income analysis under variable costing and absorption costing.

Chapter 19 - ObjectivesChapter 19 - ObjectivesChapter 19 - ObjectivesChapter 19 - Objectives

Two Costing MethodsTwo Costing Methods

Used for external financial reporting

Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost

Absorption CostingAbsorption Costing

Two Costing MethodsTwo Costing Methods

Variable CostingVariable Costing Used for internal planning and decision

making Does not include fixed factory overhead

as a product cost

Absorption Costing Compared to Absorption Costing Compared to Variable CostingVariable Costing

Variable Costing

Absorption Costing

Cost of Goods ManufacturedCost of Goods Manufactured

Cost of Goods ManufacturedCost of Goods Manufactured

DirectDirectMaterialsMaterials

DirectDirectLaborLabor

VariableVariableFactory OHFactory OH

FixedFixedFactory OHFactory OH

Period ExpensePeriod Expense

Variable Costing Income StatementSales (15,000 x $50) $750,000Variable cost of goods sold:

Variable cost of goods mfg.(15,000 x $25) $375,000

Less ending inventory 0Variable cost of goods sold 375,000

Manufacturing margin $375,000Variable selling and administrative

expenses (15,000 x $5) 75,000Contribution margin $300,000Fixed costs:

Fixed manufacturing costs $150,000Fixed selling and administrative

expenses 50,000 200,000Income from operations $100,000

Units Manufactured Equal Units SoldUnits Manufactured Equal Units Sold

Sales (15,000 x $50) $750,000Cost of goods sold: Cost of goods manufactured

(15,000 x $35) $525,000Less ending inventory 0Cost of goods sold 525,000

Gross profit $225,000Selling and administrative expenses

($75,000 + $50,000) 125,000Income from operations $100,000

Sales (15,000 x $50) $750,000Cost of goods sold: Cost of goods manufactured

(15,000 x $35) $525,000Less ending inventory 0Cost of goods sold 525,000


($75,000 + $50,000) 125,000Income from operations $100,000 Income from operations $100,000

Absorption Costing Income Statement

Units Manufactured Equal Units SoldUnits Manufactured Equal Units Sold

When the number of units manufactured equals the number of units sold, income from operations will be

the same under both methods.

Variable Costing Income Statement

Sales (12,000 x $50) $600,000Variable cost of goods sold:

Variable cost of goods manufactured (15,000 x $25) $375,000

Less ending inventory (3,000 x $25) 75,000 Variable cost of goods sold 300,000

Manufacturing margin $300,000Variable selling and admin. expenses 60,000Contribution margin $240,000Fixed costs:

Fixed manufacturing costs $150,000Fixed selling and admin. expenses 50,000 200,000

Income from operations $ 40,000

Units Manufactured Exceed Units SoldUnits Manufactured Exceed Units Sold

Absorption Costing Income StatementSales (12,000 x $50) $600,000Cost of goods sold:

Cost of goods manufactured (15,000 x $35) $525,000

Less ending inventory (3,000 x $35) 105,000 Cost of goods sold 420,000

Gross profit $180,000Selling and administrative expenses [(12,000 x $5) + $50,000] 110,000Income from operations $ 70,000


Operating Income:Absorption costing $70,000Variable costing 40,000 Difference $30,000


Why is absorption costing income higher when units manufactured exceed units sold?

Why is absorption costing income higher when units manufactured exceed units sold?

Analysis:Units manufactured 15,000Units sold 12,000Ending inventory units 3,000Fixed cost per unit x $10 Difference $30,000


Operating Income:Absorption costing $70,000Variable costing 40,000 Difference $30,000

Sales (15,000 x $50) $750,000Variable cost of goods sold:

Beginning inventory (5,000 x $25) $125,000Variable cost of goods manufactured

(10,000 x $25) 250,000 375,000Manufacturing margin $375,000Variable selling and admin. expenses 75,000Contribution margin $300,000Fixed costs:

Fixed manufacturing costs $150,000Fixed selling and admin. expenses 50,000 200,000

Income from operations $100,000

Units Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units SoldVariable Costing Income Statement

Sales (15,000 x $50) $750,000Cost of goods sold:

Beginning inventory (5,000 x $35) $175,000Cost of good manufactured

(10,000 x $45) 400,000Cost of goods sold 575,000


($75,000 + $50,000) 125,000Income from operations $ 50,000

Absorption Costing Income StatementUnits Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units Sold

Operating Income:Variable costing $100,000Absorption costing 50,000 Difference $ 50,000

Units Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units Sold

Why is variable costing income higher when units manufactured are

less than units sold?

Why is variable costing income higher when units manufactured are

less than units sold?

Units Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units Sold

Analysis:Units sold 15,000Units manufactured 10,000Beginning inventory units 5,000Fixed cost per unit x $10 Difference $50,000

Operating Income:Variable costing $100,000Absorption costing 50,000 Difference $ 50,000

IFIF Units Sold < Units produced

THENTHEN Variable Costing < Absorption CostingIncome Income

IFIF Units Sold > Units produced

THENTHEN Variable Costing > Absorption CostingIncome Income

Income Analysis Under Variable Income Analysis Under Variable Costing and Absorption CostingCosting and Absorption Costing


Frand Manufacturing Company has no beginning

inventory and sales are estimated to be 20,000 units at

$75 per unit, regardless of production levels.

Frand Manufacturing Company has no beginning

inventory and sales are estimated to be 20,000 units at

$75 per unit, regardless of production levels.



Proposal 1: 20,000 Units to Be Manufactured and Sold

Total Cost Unit CostManufacturing costs:

Variable $ 700,000 $35Fixed 400,000 20 Total costs $1,100,000 $55

Selling and administrative exp.Variable ($5 per unit sold) $ 100,000Fixed 100,000 Total expenses $ 200,000



Total Cost Unit CostManufacturing costs:

Variable $ 875,000 $35Fixed 400,000 16 Total costs $1,275,000 $51

Selling and administrative exp.Variable ($5 per unit sold) $ 100,000Fixed 100,000 Total expenses $ 200,000

Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold

Frand Manufacturing CompanyAbsorption Costing Income Statements

20,000 Units Manufactured


Sales $1,500,000 $1,500,000Cost of goods sold:

Cost of goods manufactured(20,000 units x $55) $1,100,000





Cost of goods manufactured(20,000 units x $55) $1,100,000(25,000 units x $51) $1,275,000





Cost of goods manufactured(20,000 units x $55) $1,100,000(25,000 units x $51) $1,275,000

Less ending inventory:(5,000 units x $51) 255,000

Cost of goods sold $1,100,000 $1,020,000Gross profit $ 400,000 $ 480,000Selling and administrative expenses

($100,000 + $100,000) 200,000 200,000Income from operations $ 200,000$ 200,000 $ 280,000$ 280,000

Frand Manufacturing CompanyVariable Costing Income Statements



Sales $1,500,000 $1,500,000Variable cost of goods sold:

Variable cost of goods manufactured:(20,000 units x $35) $ 700,000(25,000 units x $35) $ 875,000




Sales $1,500,000 $1,500,000Variable cost of goods sold:

Variable cost of goods manufactured:(20,000 units x $35) $ 700,000(25,000 units x $35) $ 875,000

Less ending inventory:(0 units x $35) 0(5,000 units x $35) 175,000

Variable cost of goods sold $ 700,000 $ 700,000Manufacturing margin $ 800,000 $ 800,000

ContinuedContinuedContinuedContinued




Manufacturing margin $ 800,000 $ 800,000Variable selling and administrative

expenses 100,000 100,000Contribution margin $ 700,000 $ 700,000Fixed costs:

Fixed manufacturing costs $ 400,000 $ 400,000Fixed selling and administrative

expenses 100,000 100,000Total fixed costs $ 500,000 $ 500,000

Income from operations $ 200,000 $ 200,000



Sales $1,500,000Variable cost of goods sold:

Variable cost of goods manufactured:(30,000 units x $35) $1,050,000

Less ending inventory:(10,000 units x $35) 350,000

Variable cost of goods sold $ 700,000Manufacturing margin $ 800,000

ContinuedContinuedContinuedContinued

Suppose 30000 units were manufactured



Manufacturing margin $ 800,000Variable selling and administrative

expenses 100,000Contribution margin $ 700,000Fixed costs:

Fixed manufacturing costs $ 400,000Fixed selling and administrative

expenses 100,000Total fixed costs $ 500,000

Income from operations $ 200,000

Management’s Use of Costing MethodsManagement’s Use of Costing MethodsManagement’s Use of Costing MethodsManagement’s Use of Costing Methods

1. Controlling costs

2. Pricing products

3. Planning production

4. Analyzing market segments

5. Analyzing contribution margins

Variable costing reports and absorption costing reports are useful in the following situations:

Accounting Reports and Accounting Reports and Management DecisionsManagement DecisionsAccounting Reports and Accounting Reports and Management DecisionsManagement Decisions

ACCOUNTING REPORTS

Absorption Costing and Variable Costing

MANAGEMENT

1. describe and illustrate income reporting under variable costing and absorption costing. 2....

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