session 9 analysis - otto von guericke university · pdf fileinventory costing and capacity...
TRANSCRIPT
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Cost Accounting Horngreen, Datar, Foster
Inventory Costing and Capacity Analysis
Session 9
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Cost Accounting Horngreen, Datar, Foster
Learning Objectives
� Distinguish variable costing from absorption costing� Explain differences in operating income under absorption costing and
variable costing� Understand how absorption costing can provide undesirable incentives
for managers� Differentiate throughput costing from variable costing and absorption
costing� Denominator-level capacity concepts that can be used in absorption
costing� Explain effects of the denominator level on the production-volume
variance� How attempts to recover fixed costs of capacity may lead to a downward
demand spiral
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 1
Identify what distinguishesvariable costing fromabsorption costing.
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Cost Accounting Horngreen, Datar, Foster
Inventory-Costing Methods
� The difference between variable costing and absorption costing is based on the treatment of fixed manufacturing overhead.
DirectMaterials
VariableFactoryLabor
(variable)Overhead
Work in Process Inventory
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Cost Accounting Horngreen, Datar, Foster
Variable Costing
Work in ProcessInventory
Finished GoodsInventory
Cost of Goods Sold
Income Summary
Fixed FactoryOverhead
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Cost Accounting Horngreen, Datar, Foster
Absorption Costing
Work in ProcessInventory incl fixed
costs
Finished GoodsInventory
Cost of Goods Sold
Income Summary
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 2
Prepare income statementsunder absorption costing
and variable costing.
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements
� The following data pertain to Davenport Fixtures:
Year 1 Year 2 TotalBeginning inventory -0- 2,000 -0-Produced 10,000 11,500 21,500Sold 8,000 13,000 21,000Ending inventory 2,000 500 500
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements
� The following information is on a per unit basis:
Sales price: $71.00Variable manufacturing costs:
Direct materials: $ 4.00Direct manufacturing labor: $21.00Indirect manufacturing costs: $24.00
Fixed manufacturing costs: $ 4.50
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements(Absorption Costing)
� Total fixed production costs are $54,000 at a normal capacity of 12,000 units.
� Fixed nonmanufacturing costs are $30,000 per year.� Variable nonmanufacturing costs are $2.00 per unit sold.
Revenues $568,000Cost of goods sold 428,000Volume variance (U) 9,000Gross margin $131,000Nonmanufacturing costs 46,000Operating income $ 85,000
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements(Absorption Costing)
� Revenues for Year 1 are $568,000.� What is the cost of goods sold?
• 8,000 × $53,5 = $428,000
� What is the Gross margin?• $568,000 – $428,000 –$9.000 = $131,000• Operating Income = $131,000 - $46,000 = $85,000
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements (Variable Costing)
Revenues $568,000Cost of goods sold 392,000Variable nonmanufacturing costs 16,000Contribution margin $160,000Fixed manufacturing costs 54,000Fixed nonmanufacturing costs 30,000Operating income $ 76,000
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 3
Explain differences in operatingincome under absorption
costing and variable costing.
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Cost Accounting Horngreen, Datar, Foster
Operating Income (Absorption Costing)
� What are revenues for Year 2?• 13,000 × $71 = $923,000
� What is the cost of goods sold?• 13,000 × $53.50 = $695,500
� Is there a volume variance?• (12,000 – 11,500) × $4.50 = $2,250
� underallocated fixed manufacturing costs� What is the gross margin?
• $923,000 – ($695,500 + $2,250) = $225,250� What are the nonmanufacturing costs?
• 13,000 units sold × $2.00 = $26,000� variable costs + $30,000 fixed costs = $56,000
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Cost Accounting Horngreen, Datar, Foster
Operating Income (Absorption Costing)
� What is the operating income before taxes?• $225,250 – $56,000 = $169,250
� What is the operating income for the two years combined?• $85,000 + $169,250 = $254,250
Year 1 Year 2 CombinedRevenues $568,000 $923,000 $1,491,000Cost of goods sold 428,000 695,500 1,123,500Volume variance (U) 9,000 2,250 11,250Gross margin $131,000 $225,250 $ 356,250Nonmfg. costs 46,000 56,000 102,000Operating income $ 85,000 $169,250 $ 254,250
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Cost Accounting Horngreen, Datar, Foster
Operating Income (Variable Costing)
� Revenues for Year 2 are $923,000.� What is the cost of goods sold?
• 13,000 × $49 = $637,000
� What is the manufacturing contribution margin?• $923,000 – $637,000 = $286,000
� What is the net contribution margin?• $286,000 – $26,000 variable nonmanufacturing costs = $260,000 net
contribution margin
� What is the operating income before taxes?• $260,000 – $54,000 fixed manufacturing costs – $30,000 fixed
nonmanufacturing costs = $176,000
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Cost Accounting Horngreen, Datar, Foster
Income Statements (Variable Costing)
Year 1 Year 2 CombinedRevenues $ 568,000 $923,000 $1,491,000Cost of goods sold 392,000 637,000 1,029,000Mfg. contr. margin $176,000 $286,000 $ 462,000Variable nonmfg. 16,000 26,000 42,000Net contr. margin $160,000 $260,000 $ 420,000Fixed mfg. costs 54,000 54,000 108,000Fixed nonmfg. costs 30,000 30,000 60,000Operating income $ 76,000 $176,000 $252,000
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Cost Accounting Horngreen, Datar, Foster
Comparison of Variableand Absorption Costing
� Variable costing operating income Year 1: $76,000� Absorption costing operating income Year 1: $85,000� Absorption costing operating income is $9,000 higher.
� Variable costing operating income Year 2: $176,000� Absorption costing operating income Year 2: $169,250� Variable costing operating
income is $6,750 higher.Why?
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Cost Accounting Horngreen, Datar, Foster
Comparison of Variable and Absorption Costing
� Production exceeds sales in Year 1� The 2,000 units in ending inventory are valued as follows:� Absorption costing: 2,000 × $53.50 = $107,000� Variable costing: 2,000 × $49.00 = $ 98,000� Difference: $ 9,000
� Sales exceeded units produced in Year 2.� 13,000 – 11,500 = 1,500 decrease in inventory� Absorption costing: 1,500 × $53.50 = $80,250� Variable costing: 1,500 × $49.00 = $73,500� Higher cost of goods sold under absorption costing: $ 6,750
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Cost Accounting Horngreen, Datar, Foster
Comparison of Variable and Absorption Costing
� Variable costing combined net income: $252,000� Absorption costing combined net income: $254,250� Absorption costing is higher by $2,250 � 500 units in inventory × $4.50 = $2,250
Absorption costingoperating income
Variable costingoperating income
Fixed manufacturingcosts in endinginventory under
absorption costing
Fixed manufacturingcosts in beginning
inventory underabsorption costing
–
EQUALS
–
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 4
Understand how absorptioncosting can provide undesirable
incentives for managers tobuild up finished goods inventory.
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Cost Accounting Horngreen, Datar, Foster
Undesirable effects of producing for inventory
� Production of items that absorb minimal fixed manufacturing costs may be delayed.
� A plant manager may accept a particular order to increase production even though another plant in the same company is better suited to handle that order.
� A plant manager may defer maintenance.
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Cost Accounting Horngreen, Datar, Foster
Revising Performance Evaluation
� Budget carefully and use inventory planning.� Discontinue the use of absorption costing for internal
reporting and instead use variable costing.� Incorporate a carrying charge for inventory.� Lengthen the time period used to evaluate performance.� Include nonfinancial as well as financial variables in the
measures used to evaluate performance.• Ending inventory in units this period ÷ Ending inventory in units last
period• Sales in units this period ÷ Ending inventory in units this period
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Cost Accounting Horngreen, Datar, Foster
Inventory Buildup
� Assume that Davenport Fixtures produced 4,400 units in Year 1 and sold 4,100.
� What is the production volume variance? • (12,000 – 4,400) × $4.50 = $34,200 U
� What is the net operating income or loss for the period?
Revenues (4,100 × $71) $291,100Cost of goods sold (4,100 × $53.50) 219,350Volume variance 34,200Gross margin $ 37,550Nonmanufacturing costs 38,200Net loss $ 650
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Cost Accounting Horngreen, Datar, Foster
Inventory Buildup
� How many units are in ending inventory?• 4,400 – 4,100 = 300
� How much cost is in ending inventory?• 300 × $53.50 = $16,050
� Suppose that management decides to produce 9,000 units next year.
� Sales remain the same (4,100 units). What is the volume variance?
� (12,000 – 9,000) × $4.50 = $13,500 U� What is the operating income or loss?
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Cost Accounting Horngreen, Datar, Foster
Inventory Buildup
� How many units are in ending inventory?• 300 + 9,000 – 4,100 = 5,200
� How much cost is in ending inventory?• 5,200 × $53.50 = $278,200
Revenues (4,100 × $71) $291,100Cost of goods sold (4,100 × $53.50) 219,350Volume variance 13,500Gross margin $ 58,250Nonmanufacturing costs 38,200Net income $ 20,050
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 5
Differentiate throughputcosting from variable costing
and absorption costing.
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
Revenues $568,000Variable direct materials
cost of goods sold 32,000Throughput contribution margin $536,000Manufacturing costs 504,000Nonmanufacturing costs 46,000Operating loss $ 14,000
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
Manufacturing Costs:Labor $21.00 × 10,000 $210,000Indirect costs $24.00 × 10,000 240,000Fixed costs 54,000Total manufacturing costs $504,000
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
� What are other nonmanufacturing costs for the year? � Nonmanufacturing Costs:
• Variable $2.00 × 8,000 $16,000• Fixed 30,000• Total $46,000
� Variable costing operating income: $76,000� Throughput costing operating loss: $14,000� Difference in operating income: $90,000� How can this difference be explained?
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
The 2,000 units in ending inventoryare valued as follows:
Variable2,000 × $49 = $98,000
Throughput2,000 × $4 = $8,000
$90,000 difference
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
� Absorption costing operating income: $85,000� Throughput costing operating loss: $14,000� Difference in operating income: $99,000� How can this difference be explained?
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
The 2,000 units in ending inventoryare valued as follows:
Absorption2,000 × $53.50 =
$107,000
Throughput2,000 × $4= $8,000
$99,000 difference
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Cost Accounting Horngreen, Datar, Foster
Comparison of Inventory Costing Methods
Actual CostingActual Costing
AbsorptionAbsorptionCostingCosting
ThroughputThroughputCostingCosting
VariableVariableCostingCosting
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Cost Accounting Horngreen, Datar, Foster
Comparison of Inventory Costing Methods
Normal CostingNormal Costing
AbsorptionAbsorptionCostingCosting
ThroughputThroughputCostingCosting
VariableVariableCostingCosting
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Cost Accounting Horngreen, Datar, Foster
Comparison of Inventory Costing Methods
Standard CostingStandard Costing
AbsorptionAbsorptionCostingCosting
ThroughputThroughputCostingCosting
VariableVariableCostingCosting
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 6
Describe the variouscapacity conceptsthat can be used inabsorption costing.
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Cost Accounting Horngreen, Datar, Foster
Alternative Denominator-Level Concepts
� The choice of the denominator used to allocate budgeted fixed manufacturing costs to products can greatly affect the numbers a normal or standard (absorption) costing system will report prior to the end of an accounting period.
� Theoretical capacity� Practical capacity� Normal capacity� Master-budget capacity
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Cost Accounting Horngreen, Datar, Foster
Theoretical Capacity
� Theoretical capacity xt
(maximum or ideal capacity) is the denominator level concept that is based on producing at full (peak) efficiency all the time.
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Cost Accounting Horngreen, Datar, Foster
Practical Capacity
� Practical capacity xp
is the denominator-level concept that reduces theoretical capacity by unavoidable operating interruptions.
� The use of practical capacity is required by the Internal Revenue Service (IRS).
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Cost Accounting Horngreen, Datar, Foster
Normal Capacity
� Normal capacity xn
is the denominator-level concept based on the level of capacity utilization that satisfies average customer demand over several periods.
� It includes seasonal, cyclical, and trend factors.
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Cost Accounting Horngreen, Datar, Foster
Master-Budget Capacity
� Master-budget capacity xm
is the denominator-level concept based on the expected level of capacity utilization for the next budget period (typically one year).
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 7
Understand the major factorsmanagement considers in choosing
a capacity level to compute thebudgeted fixed overhead cost rate.
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Cost Accounting Horngreen, Datar, Foster
Choosing a Capacity Level
What factors are consideredin choosing a capacity level?
Productcosting
Pricingdecision
Performanceevaluation
Financialstatements
Regulatoryrequirements Difficulty
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Cost Accounting Horngreen, Datar, Foster
Learning Objective 8
Describe how attempts torecover fixed costs of capacity
may lead to price increasesand lower demand.
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Cost Accounting Horngreen, Datar, Foster
Downward Demand Spiral
� The use of normal capacity utilization or master-budget capacity utilization can result in capacity costs being spread over a small number of output units.
� The downward demand spiral is the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops.
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Cost Accounting Horngreen, Datar, Foster
True or False??
� When variable costing is used, the firm will be looking for the gross margin.
� The income under variable costing will never be the same as the income under absorption costing.
� Under variable costing, only the quantity of units sold drives operating income, the production level has no impact at all.
� Theoretical capacity is the capacity level that represents what the firm is able to obtain under reasonable circumstances.
� In the short run, capacity costs are usually fixed.
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Cost Accounting Horngreen, Datar, Foster
Pick your Choice I:
� TTF, Inc., which just began business this year, has the following information about JJI, the only product that it produces and sells. JJI sells for $25 per unit. During the current year, 20,000 units of JJI were sold. During the period, TTF manufactured 22,000 units of JJI. The following costs were available: variable costs per unit: direct materials -$ 8; direct labor - $4; variable manufacturing overhead - $2; variable selling - $3. The indirect fixed costs for TTF were manufacturing costs $55,000 and marketing $33,000. What is the unit cost to be recorded in inventory under absorption costing?
� $14.00 � $16.50 � $17.00 � $19.50
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Cost Accounting Horngreen, Datar, Foster
Pick your Choice II:
� POR has the following information with regard to capacity. Theoretical capacity is 100,000 units, practical capacity is 80,000 units, normal capacity is 75,000 units, and the current period master-budget capacity is 70,000 units. During the current period the actual level achieved was 72,000 units. If the fixed manufacturing costs for the period were budgeted at $300,000 and the firm uses normal capacity as its activity level, what would the production-volume variance be for the current period?
� $0 � $12,000 Unfavorable � $12,000 Favorable � $15,000 Unfavorable