Lecture Cost management: Measuring, monitoring, and motivating performance (2e): Chapter 14 - Eldenburg, Wolcott’s

Chapter 14 - Measuring and assigning costs for income statements. The following will be discussed in this chapter: How are absorption costing income statements constructed? How are variable costing income statements constructed? How are throughput costing income statements constructed?...

Cost Management

Measuring, Monitoring, and Motivating Performance

Chapter 14 Measuring and Assigning Costs for Income Statements

Learning objectives

• Q1 : How are absorption costing income statements constructed?

• Q2 : How are variable costing income statements constructed?

• Q3 : How are throughput costing income statements

constructed?

• Q4 : What Factors Affect the Choice of Production Volume

Measures for Allocating Fixed Overhead?

• Q5 : How do income statement costing methods affect managers’

incentives and decisions?

manufacturing overhead is an inventoriable cost.

costing.

prepared using the traditional format.

• Expenses are grouped by function.

• Manufacturing costs deducted above the gross margin subtotal.

• Nonmanufacturing costs deducted below the gross

Q1: Absorption Costing Income Statements

Q1: Absorption Costing Income Statements

Statement Example

Russell Corporation produces a product that sells for $10 In 2011, there were 10,000 units in beginning finished goods inventory The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold The costs incurred in 2011 are shown below Given the cost information below, compute the inventoriable costs per unit under absorption costing.

2011

Direct materials $60,000

Direct labor 128,000

Variable factory overhead 68,000

Variable non-mfg costs 55,800

$4.45

Suppose that the Russell Corporation uses the LIFO inventory method Prepare an absorption costing income statement for 2011

Q1: Absorption Costing Income

Statement Example

Note that cost of goods sold is based on the 2011 per-unit manufacturing costs because:

(1) Russell is using LIFO, and

(2) production exceeded sales in 2005.

overhead is a period cost.

used internally only.

• Expenses are grouped by cost behavior.

• Variable costs deducted above the contribution margin subtotal.

• Fixed costs deducted below the contribution margin

subtotal.

Q2: Variable Costing Income Statements

Q2: Variable Costing Income Statements

Russell Corporation produces a product that sells for $10 In 2011, there were 10,000 units in beginning finished goods inventory The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold The costs incurred in 2011 are shown below Compute the inventoriable costs per unit under variable costing.

2011

Direct materials $60,000

Direct labor 128,000

Variable factory overhead 68,000

Variable non-mfg costs 55,800

Suppose that the Russell Corporation uses the LIFO inventory method Prepare a variable costing income statement for 2011

Q2: Variable Costing Income Statement Example

Note that cost of goods sold is based on the 2011 per-unit manufacturing

costs because Russell is using LIFO

Variable costs:

Suppose that the Russell Corporation uses the LIFO inventory method Reconcile the income under variable costing you determined on the prior slide with the $218,300 income under absorption costing computed on slide #7.

Q2: Variable Costing Income Statement Example

Add: fixed overhead attached to the increase in inventory

costs except direct materials are period

costs.

used internally only; useful when most

manufacturing costs are not variable in the short run.

prepared using a new format.

• Sales – cost of goods sold (direct materials only) = throughput margin

Q3: Throughput Costing Income Statements

Q3: Throughput Costing Income Statements

Sales (# units sold @ $8) $620,000

Cost of goods sold (# units sold @ $0.75) 46,500

Variable nonmfg overhead costs 55,800

Q3: Throughput Income Statement Example

Russell Corporation produces a product that sells for $10 In 2011, there were 10,000 units in beginning finished goods inventory The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold The costs incurred in 2011 are shown below Suppose that the Russell Corporation uses the LIFO inventory method Prepare a throughput costing income statement for 2011

2011

Direct materials $60,000

Variable factory overhead 68,000

Variable non-mfg costs 55,800

Fixed mfg overhead 100,000

Fixed non-mfg costs 70,000

Note that DL and VO

costs expensed based

on units produced, not

units sold

Cost of goods sold (# units sold @ $0.75) 46,500

Variable nonmfg overhead costs 55,800

Reconcile the income under throughput costing you computed on the prior slide to the income under variable costing computed on slide #18 and to the income under absorption costing computed on slide #7

Add: Costs attached to the increase in inventory:

Direct labor (18,000 units x $1.60/unit) 28,800

Variable overhead (18,000 units x $0.85/unit) 15,300

Add: fixed overhead attached to the increase in inventory

(18,000 units x $1.25/unit) 22,500

Add: Costs attached to the increase in inventory:

Direct labor (18,000 units x $1.60/unit) 28,800Variable overhead (18,000 units x $0.85/unit) 15,300

Add: fixed overhead attached to the increase in inventory

estimated, rather than an actual, denominator level for the overhead cost allocation base.

information is not timely.

provides a smoothing effect, for two reasons:

• Numerator reason

• Denominator reason

• Supply-based measures of capacity:

• The maximum possible capacity, with no allowance for downtime, is known as

• Theoretical capacity, reduced by an allowance for normal downtime, is known as practical

• Demand-based measures of capacity:

• The average use of capacity of several years

is known as normal capacity

• The anticipated use of capacity for the upcoming year is known as budgeted capacity

on the Income Statement

than actual volume, there is a fixed

between budgeted fixed overhead and applied fixed overhead.

to work in process, finished goods, and cost of goods sold at year-end.

Q4 : Absorption Costing Income Statement & Volume Variance Example

2011

Direct materials $60,000

Direct labor 128,000

Variable factory overhead 68,000

Variable non-mfg costs 55,800

Fixed mfg overhead 100,000

Fixed non-mfg costs 70,000

Russell Corporation produces a product that sells for $10 In 2005, there were 10,000 units in beginning finished goods inventory The company expected to produce 100,000 units in 2011 However, it actually produced 80,000 units and sold 62,000 units The costs incurred in 2005 are shown below Compute the inventoriable costs per unit under absorption costing.

Direct materials $0.75

Variable mfg overhead $0.85 Fixed mfg overhead $1.00

$4.20

Note that choice of denominator level affects only the fixed

overhead cost per unit.

Q4 : Absorption Costing Income Statement & Volume Variance Example

Suppose that the Russell Corporation uses the LIFO inventory method and that the volume variance is considered material Assume that the balances in WIP, FG, and CGS, before any adjustment for the volume variance, were at a ratio of 1:2:7 at 12/31/11 There was no fixed overhead spending variance in 2011 Compute the volume variance and prepare the year-end entry to close the Fixed overhead control account.

Note that the unfavorable volume variance equals the underapplied fixed overhead

Fixed overhead applied (80,000 units x $1/unit) 80,000

Unfavorable fixed overhead volume variance $20,000

Cost of good sold [(7/10) x 20,000] 14,000

Q4 : Absorption Costing Income Statement

& Volume Variance Example

Using the cost information on slide #8 and the volume variance you calculated on the prior slide, prepare an absorption costing income statement for 2011

Cost of goods sold:

Cost of goods sold:

• Absorption costing is used for external reporting but may not be best for performance evaluation purposes.

• Variable and throughput costing avoid incentives

to build up inventory levels.

• No income statement benefit to building up

inventory since fixed costs are not inventoried.

• Throughput costing may be useful for some term decision making.

short-• Technology advances can help organizations

utilize absorption costing for external purposes

and another method for internal reporting