inventory costing and capacity analysis

Inventory Costing

and Capacity Analysis

JOIN KHALID AZIZECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,

B.COM.FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4

ICAP MODULE B, B.COM, BBA, MBA & PIPFA.COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP

MODULE D, BBA, MBA & PIPFA.

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R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

Fresh classes of icmap stage 1-3Fundamentals of fa(1)

Cost accounting(2)Financial accounting(3)

Cost accounting-appraisal(3)From 22nd February, 2010

FRESH CLASSES OF MA-ECONOMICS PREVIOUS- MICRO ECONOMICS

STATISTICS FINAL – MACRO ECONOMICS

FROM 15TH FEBRUARY 2010

Learning Objective 1

Identify what distinguishesvariable costing from

absorption costing.

Inventory-Costing Methods

The difference between variable costingand absorption costing is based on the

treatment of fixed manufacturing overhead.

Variable Costing

DirectMaterials

VariableFactoryLabor

VariableOverhead

Work in Process Inventory

Variable Costing

Work in ProcessInventory

Finished GoodsInventory

Cost of Goods Sold

Income Summary

Fixed FactoryLabor


Prepare income statementsunder absorption costing

and variable costing.

Comparing Income Statements

The following data pertain to Davenport Fixtures: Year 1 Year 2 Total

Beginning inventory -0- 2,000 -0-Produced 10,000 11,500 21,500Sold 8,000 13,000 21,000Ending inventory 2,000 500 500

Comparing Income Statements

The following information is on a per unit basis:Sales price: Rs71.00Variable manufacturing costs:

Direct materials: Rs 4.00Direct manufacturing labor: Rs21.00Indirect manufacturing costs: Rs24.00

Fixed manufacturing costs: Rs 4.50

Comparing Income Statements(Absorption Costing)

Total fixed production costs are Rs54,000at a normal capacity of 12,000 units.

Fixed nonmanufacturing costs areRs30,000 per year.

Variable nonmanufacturing costs areRs2.00 per unit sold.


Revenues Rs568,000Cost of goods sold 428,000Volume variance (U) 9,000

Gross margin Rs131,000Nonmanufacturing costs 46,000

Operating income Rs 85,000


Revenues for Year 1 are Rs568,000.What is the cost of goods sold?

8,000 × Rs49 = Rs392,000What is the manufacturing contribution margin?

Rs568,000 – Rs392,000 = Rs176,000Net contribution margin = Rs160,000

Comparing Income Statements (Variable Costing)

Revenues Rs568,000Cost of goods sold 392,000Variable nonmanufacturing costs 16,000

Contribution margin Rs160,000Fixed manufacturing costs 54,000Fixed nonmanufacturing costs 30,000

Operating income Rs 76,000


Explain differences in operatingincome under absorption

costing and variable costing.

Operating Income(Absorption Costing)

What are revenues for Year 2?13,000 × Rs71 = Rs923,000

What is the cost of goods sold?13,000 × Rs53.50 = Rs695,500

Is there a volume variance?(12,000 – 11,500) × Rs4.50 = Rs2,250

underallocated fixed manufacturing costs


What is the gross margin?Rs923,000 – (Rs695,500 + Rs2,250) = Rs225,250

What are the nonmanufacturing costs?13,000 units sold × Rs2.00 = Rs26,000

variable costs + Rs30,000 fixed costs = Rs56,000


What is the operating income before taxes?Rs225,250 – Rs56,000 = Rs169,250What is the operating income for the

two years combined?Rs85,000 + Rs169,250 = Rs254,250

Income Statements (Absorption Costing)

Year 1 Year 2 CombinedRevenues Rs568,000 Rs923,000 Rs1,491,000

Cost of goods sold 428,000 695,500 1,123,500Volume variance (U) 9,000 2,250 11,250

Gross margin Rs131,000 Rs225,250 Rs 356,250Nonmfg. costs 46,000 56,000 102,000

Operating income Rs 85,000 Rs169,250 Rs 254,250

Operating Income(Variable Costing)

Revenues for Year 2 are Rs923,000.What is the cost of goods sold?

13,000 × Rs49 = Rs637,000What is the manufacturing contribution margin?

Rs923,000 – Rs637,000 = Rs286,000

Operating Income(Variable Costing)

What is the net contribution margin?Rs286,000 – Rs26,000 variable nonmanufacturing costs

= Rs260,000 net contribution marginWhat is the operating income before taxes?

Rs260,000 – Rs54,000 fixed manufacturing costs– Rs30,000 fixed nonmanufacturing costs = Rs176,000

Income Statements(Variable Costing)

Year 1 Year 2 CombinedRevenues Rs568,000 Rs923,000 Rs1,491,000Cost of goods sold 392,000 637,000 1,029,000Mfg. contr. margin Rs176,000 Rs286,000 Rs 462,000Variable nonmfg. 16,000 26,000 42,000Net contr. margin Rs160,000 Rs260,000 Rs 420,000

Income Statements(Variable Costing)

Year 1 Year 2 CombinedNet contr. margin Rs160,000 Rs260,000 Rs420,000Fixed mfg. costs 54,000 54,000 108,000Fixed nonmfg. costs 30,000 30,000 60,000Operating income Rs 76,000 Rs176,000 Rs252,000

Comparison of Variableand Absorption Costing

Variable costing operating income Year 1: Rs76,000Absorption costing operating income Year 1: Rs85,000Absorption costing operating income is Rs9,000 higher.

Why?


Production exceeds sales in Year 1.The 2,000 units in ending inventory

are valued as follows:Absorption costing: 2,000 × Rs53.50 =Rs107,000Variable costing: 2,000 × Rs49.00 = Rs 98,000Difference: Rs 9,000





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Variable costing operating income Year 2: Rs176,000Absorption costing operating income Year 2: Rs169,250

Variable costing operating income is Rs6,750 higher.

Why?


Sales exceeded units produced in Year 2.13,000 – 11,500 = 1,500 decrease in inventory

Absorption costing: 1,500 × Rs53.50 = Rs80,250Variable costing: 1,500 × Rs49.00 = Rs73,500Higher cost of goods sold underabsorption costing: Rs 6,750


Variable costing combined net income: Rs252,000Absorption costing combined net income: Rs254,250Absorption costing is higher by Rs2,250

500 units in inventory × Rs4.50 = Rs2,250


Absorption costingoperating income

Variable costingoperating income

Fixed manufacturingcosts in endinginventory under

absorption costing

Fixed manufacturingcosts in beginninginventory under

absorption costing

–

EQUALS

–


Understand how absorptioncosting can provide undesirable

incentives for managers tobuild up finished goods inventory.

Inventory Buildup

What is the production volume variance?(12,000 – 4,400) × Rs4.50 = Rs34,200 UWhat is the net operating income or loss

for the period?

Assume that Davenport Fixtures produced4,400 units in Year 1 and sold 4,100.

Inventory Buildup

Revenues (4,100 × Rs71) Rs291,100Cost of goods sold (4,100 × Rs53.50) 219,350Volume variance 34,200

Gross margin Rs 37,550Nonmanufacturing costs 38,200

Net loss Rs 650

Inventory Buildup

4,400 – 4,100 = 300How much cost is in ending inventory?

300 × Rs53.50 = Rs16,050

How many units are in ending inventory?

Inventory Buildup

Sales remain the same (4,100 units).What is the volume variance?

(12,000 – 9,000) × Rs4.50 = Rs13,500 U

Suppose that management decides toproduce 9,000 units next year.

What is the operating income or loss?

Inventory Buildup

Revenues (4,100 × Rs71) Rs291,100Cost of goods sold (4,100 × Rs53.50) 219,350Volume variance 13,500Gross margin Rs 58,250Nonmanufacturing costs 38,200Net income Rs 20,050

Inventory Buildup

300 + 9,000 – 4,100 = 5,200How much cost is in ending inventory?

5,200 × Rs53.50 = Rs278,200

How many units are in ending inventory?


Differentiate throughputcosting from variable costing

and absorption costing.

Throughput Costing

Revenues Rs568,000Variable direct materials cost of goods sold 32,000Throughput contribution margin Rs536,000Manufacturing costs 504,000Nonmanufacturing costs 46,000Operating loss Rs 14,000

Throughput Costing

Manufacturing Costs:Labor Rs21.00 × 10,000 Rs210,000Indirect costs Rs24.00 × 10,000 240,000Fixed costs 54,000

Total manufacturing costs Rs504,000What are other nonmanufacturing costs for the year?





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Throughput Costing

Nonmanufacturing Costs:Variable Rs2.00 × 8,000

Rs16,000Fixed 30,000Total Rs46,000

Throughput Costing

Variable costing operating income: Rs76,000Throughput costing operating loss: Rs14,000

Difference in operating income: Rs90,000

How can this difference be explained?

Throughput Costing

The 2,000 units in ending inventoryare valued as follows:

Variable2,000 × Rs49 = Rs98,000

Throughput2,000 × Rs4 = Rs8,000

Rs90,000 difference

Throughput Costing

Absorption costing operating income:Rs85,000Throughput costing operating loss: Rs14,000

Difference in operating income: Rs99,000

How can this difference be explained?

Throughput Costing

The 2,000 units in ending inventoryare valued as follows:

Absorption2,000 × Rs53.50 =

Rs107,000

Throughput2,000 × Rs4= Rs8,000

Rs99,000 difference

Comparison of InventoryCosting Methods

Actual Costing

AbsorptionCosting

ThroughputCosting

VariableCosting


Normal Costing

AbsorptionCosting

ThroughputCosting

VariableCosting


Standard Costing

AbsorptionCosting

ThroughputCosting

VariableCosting


Describe the variouscapacity concepts

that can be used inabsorption costing.

Alternative Denominator-LevelConcepts

Theoretical capacity

Practical capacity

Normal capacity

Master-budget capacity

Budgeted Fixed ManufacturingOverhead Rate

RUSTAM’s Bicycles produces bicycle partsfor domestic and foreign markets.

Fixed overhead costs are Rs200,000 within therelevant range of the various capacity volume.

Budgeted Fixed ManufacturingOverhead 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?

Budgeted Fixed ManufacturingOverhead RateTheoretical 100%:

Rs200,000 ÷ 10,000 = Rs20.00/machine-hourPractical 85%:

Rs200,000 ÷ 8,500 = Rs23.53/machine-hourNormal 75%:

Rs200,000 ÷ 7,500 = Rs26.67/machine-hourMaster-budget 60%:

Rs200,000 ÷ 6,000 = Rs33.33/machine-hour


Understand the major factorsmanagement considers in choosing

a capacity level to compute thebudgeted fixed overhead cost rate.





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Choosing a Capacity Level

What factors are consideredin choosing a capacity level?

Productcosting

Pricingdecision

Performanceevaluation

Financialstatements

Regulatoryrequirements Difficulty

Decision Making

Assume that RUSTAM’s Bicycles’ standardhours are 2 hours per unit.

What is the budgeted fixed manufacturingoverhead cost per unit?

Decision Making

Theoretical capacity: Rs20 × 2 = Rs40.00

Practical capacity: Rs23.53 × 2 = Rs47.06

Normal capacity: Rs26.67 × 2 = Rs53.34

Master-budget capacity: Rs33.33 × 2 = Rs66.66


Describe how attempts torecover fixed costs of capacity

may lead to price increasesand lower demand.

Downward Demand Spiral

The downward demand spiral is the continuingreduction in demand that occurs when the pricesof competitors are not met and demand drops.


Explain how the capacitylevel chosen to calculate

the budgeted fixed overheadcost rate affects the

production-volume variance.

Effect on Financial Statements

Assume that RUSTAM’s Bicycles actually used8,400 machine-hours during the year.

What is the production volume variance?

Production Volume Variance

Production volume variance= (Denominator level – Actual level)

× Budgeted fixed manufacturing overhead rateTheoretical capacity:

(10,000 – 8,400) × Rs20.00 = Rs32,000 UPractical capacity:

(8,500 – 8,400) × Rs23.53 = Rs2,353 U

Production Volume Variance

Normal capacity:(7,500 – 8,400) × Rs26.67 = Rs24,003

Master-budget capacity:(6,000 – 8,400) × Rs33.33 = Rs79,992





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inventory costing and capacity analysis

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