or ABSORPTION AND MARGINAL COSTING Cost accumulation - an approach to product costing that identifies which manufueturing costs are recorded as part of the product cost, " Cost presentation - an approach to product costing that focuses on how costs are shown on external financial statements or internal management report. + Absorption Costing also known as Full Costing or Traditional Costing is used for external reporting purposes. It is a cost accumulation and reporting method of accounting that treats all manufacturing costs (direct materials, direct labour, variable and fixed manufacturing overhead) as inventoriable costs or product costs. This means that both variable and fixed MOH are included in inventories and cost of goods manufactured/sold. This type of costing is also required for income tax reporting. However, itis rarely relevant for management decision-making and can lead to inaccurate decisions. Absorption costing presents expenses on the income statement in groups depending on their functional classifications (gro. s based on the similar reason for their incurrence). It includes Cost of Goods Sold and detailed selling‘and'admtistrative expenses. In absorption costing, non-manufacturing costs are considered period costs and are expensed in the income statement. Variable Costing also known as Direet Costing or Marginal Costing is only used for internal reporting purposes. It is a cost accumulation and reporting method that includes only variable production costs (direct materials, direct labour, and variable overhead) as inventoriable or product costs. Fixed MOH is treated as a period cost. Variable costing presents expenses on the income statement according to cost behaviour (variable and fixed), although the expenses may also be presented by functional classification within the behavioural groups. The cost of goods sold is called Variable Cost of Goods Sold because it contains only the variable production costs related to the units sold. The Product Contribution Margin j; i i i ‘cost of goods sold. It indicates the amount of revenue available to cover period (fixed) costs and to provide net income. Product contribution margin is also called manufacturing margin. Total Contribution Margin is the difference between revenue and all variable costs irrespective of the area of incurrence (production or non- production). Variable costing is used when: (2) entering a new market, 2) discontinuing a product, @) making or buying component parts, (4) expanding or contracting production of existing product, (5) taking special orders at less than full cost. ‘Variable costing is also helpful in preparing segmented reports, e.g. reports on products, locations, departments, Under Variable costing, inventoriable costs consists of direct materials, direct labour and variable MOH. [Fixed ‘MOH is not inventoried; it is charged to income as a period cost, as are selling and administrative costs.] fferences between Variable and Absorption Costing 1. ‘The way in which product cost is defined: Under Absorption costing, fixed MOH is included as a product cost. Under Variable Costing, fixed MOH is treated as a period cost. 2. The format of the Income Statement: Absorption Costing uses the traditional income statement that categorizes costs by their function only. Variable Costing utilises an income statement format thatgroups costs by both their function and behaviour. ‘ariable costing data is easily incorporated into a CONTRIBUTION FORMAT INCOME STATEMENT. Presentation of Variable Costing Income Sates Presentation of Absorption Costing Income Statement 6d met) Gunite 56d method) sales XXXX ff] sates = KX Less: Variable Costs Less: Produet Costs: Direst Materials 200 Direct Materials. xox Direct Labour ox Direct Labour ax Variable Manufacturing Overhead 20x Variable MOH. x Total Variable Product Cost Xxx) |}} tout Variable Product Cost XXX Product Contribution Margin —..omenm XX__ ||| Add: Fixed Manufacturing Overnead* — xa Less: Variable Selling Expense (XX) ff Tota Product Costs wun XXX CONTRIBUTION MARGIN TIED XC | Gross Margin XX Less: Fixed Expenses Less: Non-Manufacturng Expense: Fixed Manufacturing Overhead = Variable Selling & Admin Expenses xx Fixed Selling and Administrative Expenses xx Fixed Selling and Admin Expenses xX Total Fined Expenses. : ‘Total Non-Manufacturing Expenses . | i Net Income Net Income “Applied to units SOLD In the Variable Costing Income Statement, multiply by the units SOLD and not by the units produced. In Absorption Costing Income statement, if you multiply by the units sold to determine Total Variable Product Cost, then the Fixed MOH must be applied to ONLY the units sold. If you multiply by the units produced to determine Total Variable Product Cost, use the full Fixed MOH and then deduct the Full cost of the ending inventory. Inventory buildup - Ending inventory is greater than beginning inventory, in an accounting period. Inventory liquidation - Ending inventory is less than beginning inventory, for any accounting period. ‘Net Income calculated under Absorption Costing method is different from Net Income calculated under Variable Costing method. The differences between absorption costing and variable costing profits are called phantom profits. vantom profits result from the fixed MOH in the Ab 1 been expensed during the period. “Absorption costing income will equal variable costing income if production is equal to sales. If production is greater than sales, Absorption costing income will be the larger one. Absorption costing expenses all of the current period fixed overhead cost, as well as releasing some fixed MOH cost from inventory. Variable costing shows only the current period fixed OH on the income statement, so that the additional fixed OH released from beginning inventory makes absorption costing income lower when production is less than sales. To reconcile the difference in net income between the two methods, focus must be placed on the difference in the value of the beginning and ending inventories of both methods. The reconciliation statement Absorption Costing Net Income Net Tn Less: (Fixed overhead in ending inventory) oats vaierbony Add: Fixed overhead in beginning inventory ia Loy wWerhaad ui. laguinung Variable Costing Net Income renter Absorpiace Costing Na Dicom,2. os ‘Vernon Jordan Cricket Company sells a special cricket bat for $200 each. In March, the company manufactured 6 600 bats ‘The production information for March was Direct manufacturing labour per unit 15 minutes Fixed selling and administrative costs $40 000 Fixed manufacturing overhead 132000 Direct materials cost per unit 20 Direct manufacturing labour per hour 240 ‘Variable manufacturing overhead per unit 40 Variable selling expenses per unit 20 ‘Compute the cost per unit under both absorption and variable costing. ‘The following data are available for Stafford Company for the year ended September 30, 2005. Sales 25 000 units at $100 each Expected and actual production 30 000 units Manufacturing costs incurred! Direct materials $20 per unit Direct labour $30 per unit Variable overhead $15 per unit Fixed manufacturing overhead $360 000 ‘Non-manufacturing costs incurred: $e selling expenses $144 800 Fixed selling and administrative expenses $77 400 Present the variable costing and absorption costing income statements. ‘Berbice Industries Lid. is a manufacturer of only one product, The company has provided the following data concerning its most recent month of operations uit Selling price e ad . $108 Units in beginning inventory s ° Units produced... = 1100 Units sold 900 Units in ending inventory ose 200) Variable costs per unit: Direct materials eed $28 Direct labour 30 Variable manufacturing overieed : 7 Variable selling and administrative expenses u Fixed costs: Fixed manufacturing overhead $14 300 Fixed selling and administrative expenses 1800 A) Compute the unit product cost under absorption costing and under variable/marginal costing. B) Prepare an income statement forthe month using the variable/marginal costing, ©) Prepare an income statement forthe month using the absorption costing method. Nichols Bakery Inc, Located in Lane Bridge, Georgetown, during 2004 had sales of 75 000 units. The company started with 10000 units and produced 100 000 units during the year. Other information for the year included a) b) ° 9 ese ct manufacturing labour $187 500 ‘Variable manufacturing overhead 100 000 Direct materials 150 000 Variable selling expenses 100 000 Fixed administrative expenses 100 000 Fixed manufacturing overhead. 200 000 Compute the number of units in ending finished goods inventory. ‘Compute the per unit product cost under both absorption and variable costing Compute the value of ending finished goods inventory under both absorption and variable costing. Compute the value of the beginning finished goods inventory under both absorption and variable costing (assuming ‘the same product cost) ‘Compute the cost of goods sold under both absorption and variable costing, Calculate the net incomes under both absorption and variable costing, Propare a statement reconciling the net incomes.Dion Warwick Company was concerned that increases in sales did not result in increased profits for 2005, Both variable unit and total fixed manufacturing costs for 2004 and 2005 remained constant at $20 and $2 000 000 respectively In 2004, the company produced 100 000 units and sold 80 000 units ata price of $50 per unit. ‘There was no beginning inventory in 2004. In 2005, the company made 70 000 units and sold 90 000 units ata price of $50. Selling and administrative expenses were all fixed at $100 000 each year. a) Prepare income statements for each year using absorption costing. b) Prepare income statements for each year using variable costing. ©) Prepare a statement reconciling the net ineome. Sierra Company produces and sells a single product. The following costs relate to its production and sale: Variable costs per unit: Direct materials 39 Direct labour : 10 Manufacturing overhead 3 Selling and administrative expenses 3 Fixed costs per year: Fixed manufacturing overhead 150.000 Fixed selling and administrative expenses 400 000 During the last year, 25 000 units were produced and 22 000 unis were sold, ‘The Finished Goods inventory aceoun atthe end ofthe year shows a balance of $72,000 for the 3 000 unsold units, 8) _ Ib the company using absorption costing or variable costing to cost units in the Finished Goods inventory account? Show computations to support your answer. b) Assume that the company wishes to prepare financial statements for the year to issue to its stockholders, i) Isthe $72 000 figure for Finished Goods inventory the correct amount to use on these statements for extemal reporting purposes? Expl ji) Atwhat dollar amount should ihe 3 000 units be caried inthe inventory for extemal reporting Purposes? Tami Tyler opened Tami’s Creations Ine, a small manufturing company, at the beginning ofthe year. To get the company through its frst quarter of operations, it has been nevessary for Tami fo place @ considerable strain on her own personal finances. The following income statement for the first quarter was prepared by a friend who has just completed a course in ‘managerial accounting at university, TAMI’S CREATIONS, INC Income Statement, for the quarter ended 31 March 2010 Sales (28 000 units) $1 120000 Less variable expenses: ‘Variable cost of goods sold* $462 000 Variable selling and administrative 168.000 630.000 Contribution Margin 490 000 Less fixed expenses: Fixed manufacturing overhead 300 000 Fixed selling and administrative 200000 500.000 Net Loss er $110 000) ‘Consists of direct material, direct labour snd variable maawfactuing overhead, ‘Tami is discouraged over the loss shown for the. bank loan. Another friend, a CPA, insists that and argues that if absorption casting had been quarter. ‘At this point Tami is manufacturing for the first quarter follows: ‘quarter, particularly since she had planned to use the statement as support for a the company should be using absorption costing rather than variable costing, Used the company would probably have reported at least some profit forthe 1g only one product, a swimsuit. Production and cost data relating to the swimsuit Units produced 30.000 Units sold ‘i 28 000 Variable costs per uni ct materials. a ess) Direct labour... ee tatoo) Variable manufacturing overtead 1.00 Variable selling and administrative 6.00 ) Compute the unit product cost under absorption costing,b) _Redo the company’s income statement for the quarter using absorption costing. ©) Reconcile the variable and absorption costing net income (loss) figures. ) Was the CPA correct in suggesting that the company really earned a profit for the quarter? Explain, ©) During the second quarter of operations, the company again produced 30 000 units but sold 32.000 units. (Assume no change in total fixed costs.) i) _ Prepare income statements for the quarter using variable and absorption costing, il) _Reconeile the variable costing and absorption costing net income figures. Peggy McGeary produces and sells a decorative pillow for $75.00 per unit. In the first month of operation, she produced 2,000 pillows of which 1,750 units were sold. Actual fixed costs are the same as the amount budgeted for the month, Other information for the month includes: $20.00 per unit $ 3.00 per unit $ 7.00 per unit $15.00 per unit Variable manufacturing costs Variable marketing costs Fixed manufacturing costs ‘Administrative expenses, all fixed What s the cost of goods sold per unit using variable costing? ji, Whats the cost of goods sold using variable costing? What is the ~ » contribution margin using variable costing? iv. What s the operating income using variable costing? ‘Alva Bynoe Inc. manufactures and sells coffee tables for $40.00 per unit. In the first month of operation, 3,000 units were produced and 2,250 units were sold. Actual fixed costs are the same as the amount budgeted for the month. Other information for the month includes: Variable manufacturing costs $19 per unit Variable marketing costs $ | per unit Fixed manufacturing costs '$30,000 per month ‘Administrative expenses, all fixed. ‘$6,000 per month Ending inventories: 750 units |. What s the cost of goods sold per unit when using absorption costing? il, _ Whatis the gross margin when using absorption costing? Vi. What is the ‘operating income when using absorption costing? 10. (E71) Chuck Wagon Gils, Inc., makes a single product—a handmade specialty barbecue gril that it sells for $210, Data for last year's operations follow: Units in beginning inventory a 2 Units Units produced seme: 20,000 Units sold 19,000 Units in ending inventory a 4,000 Variable costs per unit: Direct materials Direct labor Variable manufacturing overhead Variable selling and administrative Total variable cost per unit Fixed costs: Fixed manufacturing overhead $700,000 Fixed selling and administrative 285,000 Total fixed costs ‘$985,000Required. 1 ‘Assume that the company uses variable costing. Compute the unit product cost for one barbecue gril 2 ‘Assume that the company uses variable costing. Prepare an income statement for the year in good form using the contribution format. 3 ‘What is the company's break-even point in terms of the number of barbecue grils sold? 11. Refer to the date in No.10 for Chuck Wagon Grills. Assume in this exercise that the company uses absorption costing 1 Compute the unit product cost for one barbecue gril 2. Prepare an income statement for the yearin good form, 12. Which of the following cost(s) are inventoried when using variable costing? Direct manufacturing costs Variable marketing costs Fixed manufacturing costs Both (a) and (b). 13. Which ofthe folowing cost(s) are inventoried when using absorption costing? 4. Direct manufacturing costs 2. Variable marketing costs 3. Fixed manufacturing costs 4, Both (a) and (c)