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Chapter7VariableCosting:
AToolforManagementLearningObjective1Explainhowvariablecostingdiffersfromabsorptioncostingandcomputeunitproductcostsundereachmethod.OverviewofAbsorption
andVariableCostingDirectMaterialsDirectLaborVariableManufacturingOverheadFixedManufacturingOverheadVariableSellingandAdministrativeExpensesFixedSellingandAdministrativeExpensesVariable
CostingAbsorption
CostingProduct
CostsPeriod
CostsProduct
CostsPeriod
CostsQuickCheck
Whichmethodwillproducethehighestvaluesforworkinprocessandfinishedgoodsinventories?a.Absorptioncosting.b.Variablecosting.c.Theyproducethesamevaluesforthese
inventories.d.Itdepends...HarveyCompanyproducesasingleproduct
withthefollowinginformationavailable:UnitCostComputationsUnitproductcostisdeterminedasfollows:Underabsorptioncosting,sellingandadministrativeexpensesare
alwaystreatedas
periodexpenses
anddeductedfromrevenueasincurred.UnitCostComputationsLearningObjective2Prepareincomestatementsusingbothvariableandabsorptioncosting.IncomeComparisonof
AbsorptionandVariableCosting
Let’sassumethefollowingadditionalinformationforHarveyCompany.20,000unitsweresoldduringtheyearatapriceof$30each.Therewerenounitsinbeginninginventory.
Now,let’scomputenetoperating
incomeusingbothabsorption
andvariablecosting.AbsorptionCostingVariable
manufacturing
costsonly.Allfixed
manufacturing
overheadis
expensed.VariableCostingLearningObjective3Reconcilevariablecostingandabsorptioncostingnetoperatingincomesandexplainwhythetwoamountsdiffer.ComparingtheTwoMethodsFixedmfg.Overhead$150,000Unitsproduced25,000units==$6.00perunitWecanreconcilethedifferencebetween
absorptionandvariableincomeasfollows:ComparingtheTwoMethodsExtendedComparisonsofIncomeDataHarveyCompanyYearTwoUnitCostComputationsSincetherewasnochangeinthevariablecosts
perunit,totalfixedcosts,orthenumberof
unitsproduced,theunitcostsremainunchanged.AbsorptionCostingThesearethe25,000unitsproducedinthecurrentperiod.VariableCostingAllfixed
manufacturing
overheadis
expensed.Variable
manufacturing
costsonly.Wecanreconcilethedifferencebetween
absorptionandvariableincomeasfollows:Fixedmfg.Overhead$150,000Unitsproduced25,000units==$6.00perunitComparingtheTwoMethodsComparingtheTwoMethodsSummaryofKeyInsightsEffectofChangesinProduction
onNetOperatingIncomeLet’srevisetheHarveyCompanyexample.Inthepreviousexample,
25,000unitswereproducedeachyear,
butsalesincreasedfrom20,000unitsinyear
oneto30,000unitsinyeartwo.Inthisrevisedexample,
productionwilldiffereachyearwhile
saleswillremainconstant.EffectofChangesinProduction
HarveyCompanyYearOneUnitproductcostisdeterminedasfollows:UnitCostComputationsforYearOneSincethenumberofunitsproducedincreased
inthisexample,whilethefixedmanufacturingoverhead
remainedthesame,theabsorptionunitcostisless.AbsorptionCosting:YearOneVariableCosting:YearOneVariable
manufacturing
costsonly.Allfixed
manufacturing
overheadis
expensed.EffectofChangesinProduction
HarveyCompanyYearTwoUnitproductcostisdeterminedasfollows:UnitCostComputationsforYearTwoSincethenumberofunitsproduceddecreasedinthe
secondyear,whilethefixedmanufacturingoverhead
remainedthesame,theabsorptionunitcostisnowhigher.AbsorptionCosting:YearTwoThesearethe20,000unitsproducedinthecurrent
periodatthehigherunitcostof$17.50each.VariableCosting:YearTwoAllfixed
manufacturing
overheadis
expensed.Variable
manufacturing
costsonly.Netoperatingincomeisnotaffectedbychangesin
productionusingvariablecosting.Netoperatingincomeisaffectedbychangesinproduction
usingabsorptioncostingeventhoughthenumberofunits
soldisthesameeachyear.ConclusionsComparingtheTwoMethodsLearningObjective4Understandtheadvantagesanddisadvantagesofbothvariableandabsorptioncosting.ImpactontheManagerOpponentsofabsorptioncostingarguethat
shiftingfixedmanufacturingoverheadcosts
betweenperiodscanleadtofaultydecisions.Theseopponentsarguethatvariablecostingincome
statementsareeasiertounderstandbecausenetoperating
incomeisonlyaffectedbychangesinunitsales.This
producesnetoperatingincomefiguresthatare
moreconsistentwithmanagers’expectations.CVPAnalysis,DecisionMaking
andAbsorptioncosting
AbsorptioncostingdoesnotsupportCVPanalysisbecauseitessentiallytreatsfixedmanufacturingoverheadasavariablecostbyassigningaperunitamountofthefixedoverheadtoeachunitofproduction.Treatingfixedmanufacturingoverheadasa
variablecostcan:Leadtofaultypricingdecisionsandkeep-or-drop
decisions.Producepositivenetoperatingincomeeven
whenthenumberofunitssoldislessthanthe
breakevenpoint.ExternalReportingToconformto
GAAPrequirements,
absorptioncostingmustbeusedfor
externalfinancialreports.Sincetopexecutives
areusuallyevaluatedbasedon
externalreportstoshareholders,
theymayfeelthatdecisions
shouldbebasedon
absorptioncostingdata.AdvantagesofVariableCosting
andtheContributionApproachAdvantagesManagementfinds
itmoreuseful.ConsistentwithCVPanalysis.Netoperatingincomeiscloserto
netcashflow.Profitisnotaffectedby
changesininventories.Consistentwithstandard
costsandflexiblebudgeting.Impactoffixedcostsonprofitsemphasized.Easiertoestimateprofitability
ofproductsandsegments.AdvantagesofVariableCosting
andtheContributionApproachThedatarequiredforCVPanalysiscanbetakendirectlyfromacontributionformatincomestatement.Profitsmoveinthesamedirectionassales,assumingotherthingsremainthesame.Managersoftenassumethatunitproductcostsarevariable.Undervariablecosting,thisassumptionistrue.Fixedcostsappearexplicitlyonacontributionformatincomestatement;thustheimpactoffixedcostsonprofitsisemphasized.Variablecostingdatamakeiteasiertoestimatetheprofitabili
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