2009 foster school of business cost accounting l.ducharme 1 inventory costing and capacity analysis...
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2009 Foster School of Business Cost Accounting L.DuCharme 1
Inventory Costingand Capacity
Analysis
Chapter 9
2009 Foster School of Business Cost Accounting L.DuCharme 2
Overview—Chapter 9
• Inventory Costing Methods
• Denominator Issues
• Example: working backwards
• BEPs: VC versus AC
• Solution to extra problem (on webpage)
2009 Foster School of Business Cost Accounting L.DuCharme 3
Absorption Costing
• All manufacturing cost are considered inventoriable:
– All variable mfg. costs (both direct & indirect)– All fixed mfg. costs (both direct & indirect)
• Separates costs by business function.• Other costing terms:
(1) Super-full absorption costing: includes some mfg. related admin costs—used for tax.
(2) Full-product costing: costs from all areas of value chain are attached to product costs—for L-T pricing.
2009 Foster School of Business Cost Accounting L.DuCharme 4
Variable Costing
• All variable manufacturing costs are considered inventoriable.
• Separates costs by cost behavior.
• Some managers call this direct costing which is a poor choice of name. Why?
2009 Foster School of Business Cost Accounting L.DuCharme 5
Throughput Costing
• Also called super-variable costing.
• Only variable direct materials are inventoriable. Assumes that only DM are variable in the short run.
• Reduces incentives to build up inventories.
• Relatively new and not widely used.
2009 Foster School of Business Cost Accounting L.DuCharme 6
STOP! The big picture
• Managers make a number of accounting choices that affect income, for example:
Costing
Systems
Fixed Mfg. Costs
Flow of Costs
Actual AC Job FIFO
Normal VC Process LIFO
Standard Tput Avg.
Other Specific I.D.
Standard
Retail
2009 Foster School of Business Cost Accounting L.DuCharme 7
Inventory-Costing Methods
The difference between variable costingand absorption costing is based on the
treatment of fixed manufacturing costs.
AC includes fixed mfg. costs in cost of inventory, while VC does not. VC expenses all fixed costs as period costs.
2009 Foster School of Business Cost Accounting L.DuCharme 8
Comparing Income Statements:Absorption vs. Variable Costing
The following data pertain to Davenport Pencils:
Produce one product: #2 pencils. 1 box = 1 gross.Sales price = $8/box; Sold 40,000 boxesDM = $3 / box; DL = $0.50 / boxVMOH = $0.25 / boxFMOH = $100,000 / yearSales commission = $0.75 / boxFixed admin. expenses = $30,000 / yearBudget = actual production = 50,000 boxes
2009 Foster School of Business Cost Accounting L.DuCharme 9
Comparing Income Statements
What is the cost per box under VC?
$3.00 + 0.50 + 0.25 = $3.75
What is the cost per box under AC?
$3.00 + 0.50 + 0.25 + 2.00* = $5.75
* Fixed mfg. OH rate = $2.00 / box = $100,000 / 50,000 boxes
2009 Foster School of Business Cost Accounting L.DuCharme 10
Comparing Income Statements
Absorption Costing
Revenue $320,000CoGS 230,000 GM 90,000S&A 60,000Op. Inc. $ 30,000
Variable Costing
Revenue $320,000 VC 180,000 CM 140,000FC 130,000Op. Inc. $ 10,000
2009 Foster School of Business Cost Accounting L.DuCharme 11
Comparison of Variableand Absorption Costing
Variable costing operating income : $10,000
Absorption costing operating income : $30,000
Absorption costing operating income is $20,000 higher.
Why?
2009 Foster School of Business Cost Accounting L.DuCharme 12
Comparison of Variableand Absorption Costing
Production exceeds sales.
The 10,000 unit increase in ending inventoryare valued as follows:
Absorption costing: 10,000 × $5.75 = $ 57,500
Variable costing: 10,000 × $3.75 = $ 37,500
Difference: $ 20,000
2009 Foster School of Business Cost Accounting L.DuCharme 13
Comparison of Variableand Absorption Costing
COGS
Absorption costing: 40,000 X $5.75 = $230,000
Variable costing: 40,000 X $3.75 = $150,000Plus all the fixed mfg. OH = $100,000
Lower costs recognized underabsorption costing: $ 20,000
2009 Foster School of Business Cost Accounting L.DuCharme 14
Comparison of Variableand Absorption Costing
Under absorption costing, each of the additional 10,000 boxes in ending inventory is storing $2/box cost that will be expensed later
when sold.
10,000 units of inventory × $2.00 = $20,000
2009 Foster School of Business Cost Accounting L.DuCharme 15
Comparison of Variableand Absorption Costing
Absorption costingoperating income
Variable costingoperating income
Fixed manufacturingcosts in endinginventory under
absorption costing
Fixed manufacturingcosts in beginninginventory under
absorption costing
–
EQUALS
–
2009 Foster School of Business Cost Accounting L.DuCharme 16
Absorption Costing & Inventory Buildup
How might you mitigate the incentive to build up inventory?
What happens over the long run?
2009 Foster School of Business Cost Accounting L.DuCharme 17
Alternative Denominator-LevelConcepts
Theoretical capacity
Practical capacity
Normal capacity
Master-budget capacity
2009 Foster School of Business Cost Accounting L.DuCharme 18
Budgeted Fixed Manufacturing Overhead Rate
Lloyd’s Bicycles produces bicycle partsfor domestic and foreign markets.
Fixed overhead costs are $200,000 within therelevant range of the various capacity volume.
2009 Foster School of Business Cost Accounting L.DuCharme 19
Budgeted Fixed Manufacturing Overhead Rate
Assume that the theoretical capacity is10,000 machine-hours, practical capacity
is 85%, normal capacity is 75%, andmaster-budget capacity is 60%.
What is the budgeted fixed manufacturingoverhead rate at the various capacity levels?
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Budgeted Fixed Manufacturing Overhead 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
2009 Foster School of Business Cost Accounting L.DuCharme 21
Effect of Denominator Level Choice
• The larger the denominator level, the:– Lower the budgeted FM rate.– Lower Fixed Mfg. costs in E.Inv.– Higher the unfavorable PVV for fixed OH
Remember—Fixed mfg. are either expensed in the period or stored in E.Inv.
What denominator level would you want to use for tax purposes? [practical is required for tax]
2009 Foster School of Business Cost Accounting L.DuCharme 22
Decision Making
Assume that Lloyd’s Bicycles’ standardhours are 2 hours per unit.
What is the budgeted fixed manufacturingoverhead cost per unit?
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Decision Making
Theoretical capacity: $20 × 2 = $40.00
Practical capacity: $23.53 × 2 = $47.06
Normal capacity: $26.67 × 2 = $53.34
Master-budget capacity: $33.33 × 2 = $66.66
2009 Foster School of Business Cost Accounting L.DuCharme 24
Exercise—working backward
QQQ Company has op. income of $120,000 under absorption costing, and op. income would be $100,000 under variable costing.
FMOH = $500,000
Budgeted and actual production = 200,000 units.Did inventory increase or decrease during the period? By how much?
2009 Foster School of Business Cost Accounting L.DuCharme 25
In-class problem
• Answer depends on the FMOH rate for B.Inv and choice of inventory cost-flow method (FIFO, WA, LIFO, etc.).
• Assume no change in FMOH rate. Then choice of cost-flow method does not matter.
• FMOH rate = $500k / 200k = $2.50 / unit
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Calculation of BE points
• Unique solution under Variable Costing:BEPvc = Total FC / UCM
• Solution depends on production level under Absorption Costing:BEPac = [Total FC + (FM rate* (BEPac – Units
Produced))] / UCMBEPac = [Total FC – (FMR*UP)] / (UCM – FMR)
What happens to the BEP when more units are produced?
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