Managerial Accounting
Wild and Shaw
Third Edition
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 6
Variable Costing and
Performance Reporting
Conceptual Learning
Objectives
C1: Describe how absorption costing
can result in over-production.
C2: Explain the role of variable costing in
pricing special orders.
6-3
Analytical Learning Objectives
A1: Compute and interpret breakeven
volume in units.
6-4
Procedural Learning
Objectives
P1: Compute unit cost under both
absorption and variable costing.
P2: Prepare and analyze an income
statement using absorption costing
and using variable costing.
P3: Prepare a contribution margin report.
P4: Convert income under variable
costing to the absorption cost basis.
6-5
C1
Absorption Costing &
Variable Costing
Absorption costing (also called full
costing), assumes that products
absorb all costs incurred to
produce them.

While widely used for financial reporting (GAAP), this
costing method can result in misleading product cost
information for business decisions.
6-6
C2
Absorption Costing & Variable
Costing
Under variable costing, only
costs that change in total with
changes in production level
are included in product costs.
6-7
P1
Distinguishing Between Absorption
Costing and Variable Costing: Absorption
Costing
Absorption Costing
Direct
Materials
Direct
Labor
Variable
Overhead
Fixed
Overhead
Product Cost
6-8
P1
Distinguishing Between Absorption
Costing and Variable Costing:
Variable Costing
Variable Costing
Direct
Materials
Direct
Labor
Product Cost
Variable
Overhead
Fixed
Overhead
Period Cost
6-9
P1
Difference Between Absorption Costing and Variable
Costing: Computing Unit Cost
Exhibit 6.1 Summary Cost Data
Direct materials cost………………………………………….
$4 per unit
Direct labor cost………………………………………….
$8 per unit
Overhead cost
Variable overhead cost……………………………………..
$180,000
Fixed overhead cost…………………………………………..
600,000
Total overhead cost…………………………………………..
$780,000
Expected units produced…………………………………..
60,000 units
6-10
P1
Difference Between Absorption Costing and Variable
Costing: Computing Unit Cost
Exhibit 6.2 Unit Cost Computation
Absorption Variable
Costing Costing
Direct labor cost per unit……………...
$8
$8
Direct materials cost per unit………….
4
4
Overhead cost
Variable overhead cost per unit…..
3
3
Fixed overhead cost per unit……...
10
Total product cost per unit…………….
$25
$15
6-11
P1
Analysis of Income Reporting for Both
Absorption and Variable Costing
Exhibit 6.3 Summary Cost Information
Production Costs
Direct materials cost
Direct labor cost
Variable overhead cost
Non-Production Costs
$4 per unit Variable selling and administrative expenses
$2 per unit
$8 per unit Fixed selling and administrative expenses $200,000 per year
$3 per unit
Units Produced Units Sold Units in Ending Inventory
2009
2010
2011
60,000
60,000
60,000
60,000
40,000
80,000
0
20,000
0
6-12
A1
Analysis of Income Reporting for Both
Absorption and Variable Costing: Units
Produced Equal Units Sold
Exhibit 6.5 Production Cost Assignment for 2009
Cost of Goods Sold
(Expense)
Absorption Costing
Direct materials
60,000 x $4
$ 240,000
Direct labor
60,000 x $8
480,000
Variable overhead
60,000 x $3
180,000
Fixed overhead
60,000 x $10
600,000
Total costs
$1,500,000
Variable Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Cost difference
60,000 x $4
60,000 x $8
60,000 x $3
$ 240,000
240,000
180,000
$900,000
Ending Inventory
(Asset)
Period Cost
(Expense)
2009
Expense
0 x $4
0 x $8
0 x $3
0 x $10
$ 0
0
0
0
$0
$240,000
480,000
180,000
600,000
$1,500,000
0 x $4
0 x $8
0 x $3
$ 0
0
0
240,000
480,000
180,000
600,000
$1,500,000
$0
$600,000
$600,000
0
6-13
P2
Analysis of Income Reporting for Both
Absorption and Variable Costing: Units
Produced Exceed Units Sold
Exhibit 6.7 Production Cost Assignment for 2011
Cost of Goods Sold
(Expense)
Absorption Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Ending Inventory
(Asset)
Period Cost
(Expense)
2011
Expense
40,000 x $4
40,000 x $8
40,000 x $3
40,000 x $10
$ 160,000
320,000
120,000
400,000
$1,000,000
20,000 x $4 $ 80,000
20,000 x $8
160,000
20,000 x $3
60,000
20,000 x $10
200,000
$500,000
$160,000
320,000
120,000
400,000
$1,000,000
40,000 x $4
40,000 x $8
40,000 x $3
$ 160,000
320,000
120,000
________
20,000 x $4 $ 80,000
20,000 x $8
160,000
20,000 x $3
60,000
_______
$600,000
$160,000
320,000
120,000
600,000
$600,000
$300,000
$600,000
$1,200,000
Variable Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Cost difference
($200,000)
6-14
P2
Analysis of Income Reporting for Both
Absorption and Variable Costing: Units
Produced Are Less Than Units Sold
Exhibit 6.9 Production Cost Assignment for 2011
Cost of Good Sold
Ending Inventory
(Expense)
(Asset)
Absorption Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Period Cost
(Expense)
2011
Expense
80,000 x $4
80,000 x $8
80,000 x $3
80,000 x $10
$ 320,000
640,000
240,000
800,000
$2,000,000
0 x $4
0 x $8
0 x $3
0 x $10
$ 0
0
0
0
$0
$320,000
640,000
240,000
800,000
$2,000,000
80,000 x $4
80,000 x $8
80,000 x $3
$ 320,000
640,000
240,000
________
0 x $4
0 x $8
0 x $3
$ 0
0
0
Variable Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Cost difference
$1,200,000
___
$600,000
$320,000
640,000
240,000
600,000
$0
$600,000
$1,800,000
$200,000
6-15
P2
Income Reporting Summarized
Exhibit 6.10 Summary of Income Statements
Units Produced
Income for
Income for
and Sold
Absorption Costing Variable Costing Difference
2009 Units produced: 60,000
Units sold: 60,000
$580,000
$580,000
$0
2010 Units produced: 60,000
Units sold: 40,000
320,000
120,000
200,000
2011 Units produced: 60,000
Units sold: 80,000
840,000
1,040,000 -200,000
Totals Units produced: 180,000
Units sold: 180,000
$1,740,000
$1,740,000
$0
6-16
C1
Planning Production
Producing too
much inventory
Producing too
little inventory
Excess
inventory
Lost sales
Higher storage
and financing
costs
Customer
dissatisfaction
Greater risk of
obsolescence
6-17
C2
Setting Prices
Over the Long Run:
 Price must be high enough to cover all
costs, including variable costs and
fixed costs, and still provide an
acceptable return to owners
6-18
C2
Setting Prices
Over the Short Run:
 Fixed production costs such as the cost to maintain
plant capacity do not change with changes in
production levels.
 With excess capacity, increases in production level
would increase variable production costs, but not
fixed costs.
 While managers try to maintain the long-run price
on existing orders, which covers all production
costs, managers should accept special orders
provided the special order price exceeds variable
cost.
6-19
P3
Limitations of Reports Using Variable Costing
•Absorption costing is almost exclusively
used for external reporting (GAAP).
•For income tax purposes, absorption
costing is the only acceptable basis for
filings with the Internal Revenue Service
(IRS) under the Tax Reform Act of 1986.
•Absorption costing is the only acceptable
basis for both external reporting and tax
reporting.
6-20
End of Chapter 6
6-21