Measuring and Assigning Costs For Income Statements

John Wiley & Sons, 2005
Chapter 14: Measuring and Assigning Costs for Income Statements

Eldenburg & Wolcotts Cost Management, 1e Slide # 1
Cost Management
Measuring, Monitoring, and Motivating Performance

Prepared by
Gail Kaciuba
Midwestern State University
Chapter 14
Measuring and Assigning Costs for Income Statements
Chapter 14: Measuring and Assigning Costs for
Income Statements
Learning objectives
Q1: How are absorption costing income statements constructed?
Q2: What factors affect the choice of production volume
measures for allocating fixed overhead?
Q3: How are variable costing income statements constructed?
Q4: How are throughput costing income statements constructed?
Q5: What are the uses and limitations of absorption, variable, and
throughput costing income statements?
Q1: Absorption Costing Income Statements
Under absorption costing, fixed
manufacturing overhead is an inventoriable
cost.
GAAP requires the use of absorption
costing.
Absorption costing income statements are
prepared using the traditional format.
Expenses are grouped by function.
Manufacturing costs deducted above the gross margin
subtotal.
Nonmanufacturing costs deducted below the gross
margin subtotal.
Q1: Absorption Costing Income
Statement Example
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, and actually did produce, 80,000 units, and 62,000
units were sold. The costs incurred in 2005 are shown below. Given the
cost information below, compute the inventoriable costs per unit under
absorption costing.
2005
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
Direct materials $0.75
Direct labor 1.60
Variable mfg overhead 0.85
Fixed mfg overhead 1.25
$4.45
Suppose that the Russell Corporation uses the LIFO inventory method.
Prepare an absorption costing income statement for 2005.
Q1: Absorption Costing Income
Statement Example
Note that cost of goods sold is based on the 2005 per-unit
manufacturing costs because:
(1) Russell is using LIFO, and
(2) production exceeded sales in 2005.
Sales (# units sold @ $10) $620,000
Cost of goods sold (# units sold @ $4.45) 275,900
Gross margin 344,100
Nonmfg costs ($70,000 + $55,800) 125,800
Operating income $218,300
Nonmfg costs ($70,000 + $55,800) 125,800
Q2: Actual versus Estimated Denominator Levels
Normal costing (chapter 5) uses an
estimated, rather than an actual,
denominator level for the overhead cost
allocation base.
If an actual denominator level is used,
information is not timely.
Using an estimated denominator level
provides a smoothing effect, for two
reasons:
Numerator reason
Denominator reason
Q2: Various Measures of Production Volume
Supply-based measures of capacity:
The maximum possible capacity, with no
allowance for downtime, is known as
theoretical capacity.
Theoretical capacity, reduced by an allowance
for normal downtime, is known as practical
capacity.
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
or expected capacity.
Q2: Effect of Denominator Volume
on the Income Statement
When denominator volume is different
than actual volume, there is a fixed
overhead volume variance.
The volume variance is the difference
between budgeted fixed overhead and
applied fixed overhead.
If material, the volume variance is closed
to Work in process, Finished goods, and
Cost of goods sold at year-end.
Q2: Absorption Costing Income Statement & Volume
Variance Example
2005
expected to produce 100,000 units in 2005. 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 labor $1.60
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.
Q2: 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 12/31/05. There was no fixed overhead
spending variance in 2005. 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 because there was no spending variance for fixed overhead.
Budgeted fixed overhead $100,000
Fixed overhead applied (80,000 units x $1/unit) 80,000
Unfavorable fixed overhead volume variance $20,000
Fixed overhead control 20,000
Work in process [(1/10) x 20,000] 2,000
Finished goods [(2/10) x 20,000] 4,000
Cost of good sold [(7/10) x 20,000] 14,000
Q2: 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 2005.
Cost of goods sold:
(# units sold @ $4.20) $260,400
Adjustment for volume variance 14,000 274,400
Nonmfg costs ($70,000 + $55,800) 125,800
Cost of goods sold:
(# units sold @ $4.20) $260,400
Adjustment for volume variance 14,000 274,400
Nonmfg costs ($70,000 + $55,800) 125,800
Q3: Variable Costing Income Statements
Under variable costing, fixed manufacturing
overhead is a period cost.
Variable costing income statements are
used internally only.
Variable costing income statements are
prepared using the contribution format.
Expenses are grouped by cost behavior.
Variable costs deducted above the contribution margin
subtotal.
Fixed costs deducted below the contribution margin
subtotal.
Q3: Variable Costing Income Statement Example
units were sold. The costs incurred in 2005 are shown below. Compute
the inventoriable costs per unit under variable costing.
2005
Direct labor 1.60
Variable mfg overhead 0.85
$3.20
Prepare a variable costing income statement for 2005.
Note that cost of goods sold is based on the 2005 per-unit
manufacturing costs because Russell is using LIFO.
Variable costs:
Nonmfg variable costs 55,800
Contribution margin 365,800
Fixed costs:
Fixed nonmfg costs 70,000
Variable costs:
Nonmfg variable costs 55,800
Contribution margin 365,800
Fixed costs:
Reconcile the income under variable costing you determined on the prior
slide with the $218,300 income under absorption costing computed on
slide #4.
Variable costing income $195,800
Add: fixed overhead attached to the increase in inventory
(18,000 units x $1.25/unit) 22,500
Absorption costing income $218, 300
Q4: Throughput Costing Income Statements
Under throughput costing, all manufacturing
costs except direct materials are period
costs.
Throughput costing income statements are
used internally only; useful when most
manufacturing costs are not variable in the
short run.
Throughput costing income statements are
prepared using a new format.
Sales cost of goods sold (direct materials only) =
throughput margin
Throughput margin 573,500
All other costs:
Variable mfg overhead 68,000
Variable nonmfg overhead costs 55,800
Q4: Throughput Costing Income Statement
Example
units were sold. The costs incurred in 2005 are shown below. Suppose
that the Russell Corporation uses the LIFO inventory method. Prepare a
throughput costing income statement for 2005.
2005
Note that DL and VO
costs expensed based
on units produced, not
units sold
Throughput margin 573,500
All other costs:
Variable mfg overhead 68,000
Variable nonmfg overhead costs 55,800
Q4: Throughput Costing Income Statement
Example continued
Reconcile the income under throughput costing you computed on the prior
slide to the income under variable costing computed on slide #13 and to
the income under absorption costing computed on slide #4.
Throughput costing income $151,700
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
(18,000 units x $1.25/unit) 22,500
Throughput costing income $151,700
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
(18,000 units x $1.25/unit) 22,500
Q5: Uses and Limitations of the Three Income
Statement Methods
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.
Throughput costing may be useful for some short-
term decision making.
Under absorption costing, if practical capacity is
used as the denominator level,
the fixed overhead rate is a useful measure of the cost
of capacity, and
the volume variance helps measure the use of capacity.

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John Wiley & Sons, 2005

Chapter 14: Measuring and Assigning Costs for Income Statements

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