Financial and Managerial
Accounting
Wild, Shaw, and Chiappetta
Fifth Edition
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 19
Variable Costing and
Performance Reporting
Conceptual Learning
Objectives
C1: Describe how absorption costing
can result in overproduction.
C2: Explain the role of variable costing in
pricing special orders.
19-3
Analytical Learning Objectives
A1: Compute and interpret break-even
volume in units.
19-4
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.
19-5
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 managers’ business decisions.
19-6
C2
Absorption Costing &
Variable Costing
Under variable costing, only
costs that change in total with
changes in production level
are included in product costs.
19-7
P1
Distinguishing between Absorption Costing
and Variable Costing: Absorption Costing
Absorption Costing
Direct
Materials
Direct
Labor
Variable
Overhead
Fixed
Overhead
Product Cost
19-8
P1
Distinguishing between Absorption
Costing and Variable Costing:
Variable Costing
Variable Costing
Direct
Materials
Direct
Labor
Product Cost
Variable
Overhead
Fixed
Overhead
Period Cost
19-9
P1
Difference between Absorption Costing and Variable
Costing: Computing Unit Cost
Exhibit 19.1 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
19-10
P1
Difference between Absorption Costing and Variable
Costing: Computing Unit Cost
Exhibit 19.1 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
Variable OH cost per unit:
$180,000/ 60,000 units = $3/unit
Fixed OH cost per unit:
$600,000/ 60,000 units = $10/unit
Exhibit 19.2 Unit Cost Computation
Absorption Variable
Costing Costing
Direct materials cost per unit……………... $4
$4
Direct labor cost per unit………….
8
8
Overhead cost
Variable overhead cost per unit…..
3
3
Fixed overhead cost per unit……...
10
Total product cost per unit…………….
$25
$15
19-11
P1
Analysis of Income Reporting for Both
Absorption and Variable Costing
Production Costs
Direct materials cost
Direct labor cost
Variable overhead cost
Fixed overhead cost
$4 per unit
$8 per unit
$3 per unit
$600,000 per year
Nonproduction Costs
Variable selling and administrative expenses
$2 per unit
Fixed selling and administrative expenses
$200,000 per year
Units Produced Units Sold Units in Ending Inventory
2011
2012
2013
60,000
60,000
60,000
60,000
40,000
80,000
0
20,000
0
19-12
P2
Analysis of Income Reporting for Absorption
Costing: Units Produced Equal Units Sold
Exhibit 19.4 Income for 2011 ----Quantity Produced Equals Quantity Sold†
IceAge Company
Income Statement (Absorption Costing)
For Year Ended December 31, 2011
Sales (60,000 x $40)…………………………………………………………..
Cost of goods sold (60,000 x $25*)……………………………………………
Gross margin……………………………………………………………………
Selling and administrative expenses [$200,000 + (60,000 x $2)]…………
Net income………………………………………………………………………..
$2,400,000
1,500,000
900,000
320,000
$580,000
Notice that the net income is $580,000
*Units produced equal 60,000; units sold equal 60,000.
† See Exhibit 19.2 for unit cost computation under absorption and variable costing.
19-13
P2
Analysis of Income Reporting for Variable
Costing: Units Produced Equal Units Sold
Exhibit 19.4 Income for 2011-----Quantity Produced Equals Quantity Sold
IceAge Company
Income Statement (Variable Costing)
For Year Ended December 31, 2011
Sales (60,000 x $40)
Variable expenses
Variable production costs
(60,000 x $15*)
$900,000
Variable selling and administrative
expenses (60,000 x $2)
120,000
Contribution margin
Fixed expenses
Fixed overhead
600,000
Fixed selling and
administrative expense
200,000
Net income
We can see that the income under
variable costing is also $580,000. This
is because the number of units
produced are equal to the number of
units sold.
$2,400,000
1,020,000
1,380,000
$800,000
$580,000
19-14
P3
Contribution Margin Report
IceAge Company
Contribution Margin Report
For the Year Ended December 31, 2011
Sales
$ 2,400,000
Variable Expenses
Variable production costs
$900,000
Variable selling expenses
120,000 1,020,000
Contribution margin
$ 1,380,000
Contribution
margin is the
excess of
sales over
total variable
expenses
Contribution margin contributes to
covering fixed costs and earning
income
19-15
P3
Contribution Margin Report
IceAge Company
Contribution Margin Report
For the year ended December 31, 2011
Sales
Variable expenses
Variable production costs
Variable selling expenses
Contribution margin
$
900,000
120,000
$ 2,400,000
%
of sales
100.0%
1,020,000
$ 1,380,000
42.5%
57.5%
The contribution
margin ratio is
Contribution Margin
Sales
19-16
P2
Analysis of Income Reporting for Both
Absorption and Variable Costing:
Units Produced Equal Units Sold
Exhibit 19.5 Production Cost Assignment for 2011
Cost of Goods Sold
Ending Inventory
Period Cost
(Expense)
(Asset)
(Expense)
Absorption Costing
Direct materials
60,000 x $4
$ 240,000
0 x $4 $0
Direct labor
60,000 x $8
480,000
0 x $8
0
Variable overhead
60,000 x $3
180,000
0 x $3
0
Fixed overhead
60,000 x $10
600,000
0 x $10 0
Total costs
1,500,000
0
$240,000
480,000
180,000
600,000
$1,500,000
Variable Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
$240,000
480,000
180,000
600,000
$1,500,000
Cost difference
60,000 x $4
60,000 x $8
60,000 x $3
$ 240,000
240,000
180,000
0 x $4 $0
0 x $8
0
0 x $3
0
$900,000
0
$600,000
$600,000
2011
Expense
$0
19-17
P2
Analysis of Income Reporting for Variable
Costing: Units Produced Exceed Units Sold
Exhibit 19.6 Income for 2012-----Quantity Produced Equals Quantity Sold
IceAge Company
Income Statement (Variable Costing)
For Year Ended December 31, 2012
Sales (40,000 x $40)
Variable expenses
Variable production costs
(40,000 x $15*)
$600,000
Variable selling and administrative
expenses (40,000 x $2)
80,000
Contribution margin
Fixed expenses
Fixed overhead
600,000
Fixed selling and
administrative expense
$200,000
Net income
$1,600,000
680,000
920,000
$800,000
$120,000
19-18
P2
Analysis of Income Reporting for Absorption
Costing: Units Produced Exceed Units Sold
Exhibit 19.6 Income for 2012----Quantity Produced Exceeds Quantity Sold†
IceAge Company
Income Statement (Absorption Costing)
For Year Ended December 31, 2012
Sales (40,000 x $40)
Cost of goods sold (40,000 x $25*)
Gross margin
Selling and administrative expenses [$200,000 + (40,000 x $2)]
Net income
$1,600,000
1,000,000
600,000
280,000
$320,000
Income for 2012 is $320,000
*Units produced equal 60,000; units sold equal 40,000.
† See Exhibit 19.2 for unit cost computation under absorption and variable costing.
19-19
P2
Analysis of Income Reporting for Variable
Costing: Units Produced Exceed Units Sold
Exhibit 19.6 Income for 2012----Quantity Produced Exceeds Quantity Sold
IceAge Company
Income Statement (Variable Costing)
For Year Ended December 31, 2012
Sales (40,000 x $40)
$1,600,000
Variable expenses
Variable production costs
(40,000 x $15*)
$600,000
Under variable costing, the
Variable selling and administrative
expenses (40,000 x $2) net 80,000
680,000
income is only $120,000
Contribution margin
920,000
Fixed expenses
Fixed overhead
600,000
Fixed selling and
administrative expense
200,000
800,000
Net income
$120,000
19-20
P2
Analysis of Income Reporting for Variable
Costing: Units Produced Exceed Units Sold
Exhibit 19.6 Income for 2012 ---Quantity Produced Exceeds Quantity Sold
IceAge Company
Income Statement (Variable Costing)
For Year Ended December 31, 2012
Sales (40,000 x $40)
Variable expenses
Variable production costs
(40,000 x $15*)
$600,000
Variable selling and administrative
expenses (40,000 x $2)
80,000
Contribution margin
Fixed expenses
Fixed overhead
600,000
Fixed selling and
administrative expense
200,000
Net income
$1,600,000
Under absorption
costing,$200,000 of fixed
overhead is allocated to the
20,000 units in ending inventory
and is not expensed until680,000
future
periods. Variable costing920,000
expenses the entire $600,000 of
fixed overhead.
800,000
$120,000
19-21
P2
Analysis of Income Reporting for Both
Absorption and Variable Costing: Units
Produced Exceed Units Sold
Exhibit 19.7 Production Cost Assignment for 2012
Cost of Goods Sold
(Expense)
Absorption Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Ending Inventory
(Asset)
Period Cost
(Expense)
2012
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)
19-22
P2
Analysis of Income Reporting for Absorption
Costing: Units Produced Are Less Than
Units Sold
Exhibit 19.8 Income for 2013—Quantity Produced is Less Than Quantity Sold†
IceAge Company
Income Statement (Absorption Costing)
For Year Ended December 31, 2013
Sales (80,000 x $40)
Cost of goods sold (80,000 x $25*)
Gross margin
Selling and administrative expenses [$200,000 + (80,000 x $2)]
Net income
$3,200,000
2,000,000
1,200,000
360,000
$840,000
Income is now $840,000
*Units produced equal 60,000; units sold equal 80,000.
†
See Exhibit 19.2 for unit cost computation under absorption and variable costing.
19-23
P2
Analysis of Income Reporting for Variable
Costing: Units Produced Are Less Than
Units Sold
Exhibit 19.8 Continued
IceAge Company
Income Statement (Variable Costing)
For Year Ended December 31, 2013
Sales (80,000 x $40)
Variable expenses
Variable production costs (80,000 x $15*)
$1,200,000
Variable selling and administrative expenses ($80,000 x $2)
160,000
Contribution margin
Fixed expenses
Income under variable
Fixed overhead
600,000
costing is $1,040,000
Fixed selling and
administrative expense 200,000
Net income
$3,200,000
1,360,000
1,840,000
800,000
$1,040,000
19-24
Analysis of Income Reporting for Both
Absorption and Variable Costing: Units
P2
Produced Are Less Than Units Sold
Exhibit 19.9 Production Cost Assignment for 2013
Cost of Good Sold
Ending Inventory
(Expense)
(Asset)
Absorption Costing
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total costs
Period Cost
(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
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
2013
Expense
$
320,000
640,000
240,000
800,000
$ 2,000,000
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
19-25
P2
Summarizing Income Reporting
Exhibit 19.10 Summary of Income Statements
Units Produced
Income for
Income for
and Sold
Absorption Costing Variable Costing Difference
2011 Units produced: 60,000
Units sold: 60,000
$580,000
$580,000
$0
2012 Units produced: 60,000
Units sold: 40,000
320,000
120,000
200,000
2013 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
19-26
P4
Converting Reports under Variable
Costing to Absorption Costing
Exhibit 19.11 Converting Variable Costing Income to Absorption Costing Income
Variable costing income (from exhibit 19.10)
Add: Fixed overhead cost deferred in ending inventory (20,000 × $10)
Less: Fixed overhead cost recognized from beginning inventory (20,000 × $10)
Absorption costing income
2011
$580,000
0
0
$580,000
2012
$120,000
200,000
0
$320,000
2013
$1,040,000
0
-200,000
$840,000
19-27
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
19-28
C1
Planning Production: Income under
Absorption Costing for Different Production
Levels
Why is income under
absorption costing
affected by the
production level
when that for
variable costing is
not?
The answer lies in the different
treatment of fixed overhead
costs within the two methods.
19-29
C1
Planning Production
Exhibit 19.12 Unit Cost Under Absorption Costing
When 60,000 Units are Produced
Direct materials cost
$4 per unit
Direct labor cost
8 per unit
Variable overhead
3 per unit
Total variable cost
15 per unit
Fixed overhead ($600,000/60,000 units)
10 per unit
Total production cost
$25 per unit
When 100,000 Units are Produced
Direct materials
Direct labor
Variable overhead
Total variable cost
Fixed overhead ($600,000/100,000 units)
Total production cost
$4 per unit
8 per unit
3 per unit
15 per unit
6 per unit
$21 per unit
When 60,000 units are produced:
When 100,000 units are produced:
Fixed overhead per unit is:
Fixed overhead per unit is:
$600,000/ 60,000 units = $10/unit
$600,000/ 100,000 units = $6/unit
19-30
C1
Planning Production: Income under
Absorption Costing for Different Production
Levels
Exhibit 19.13
IceAge Company
Income Statement (Absorption Costing)
For Year Ended December 31, 2011
[60,000 Units Produced; 60,000 Units Sold]
Sales (60,000 x $40)
Cost of goods sold (60,000 x $25)
Gross margin
Selling and administrative expenses
Variable (60,000 x $2) $120,000
Fixed
200,000
Net income
$2,400,000
1,500,000
900,000
320,000
$580,000
Note: Income under absorption costing is
41% greater if management produces 40,000
more units than necessary and builds up
ending inventory.
IceAge Company
Income Statement (Absorption Costing)
For Year Ended December 31, 2011
[100,000 Units Produced; 60,000 Units Sold]
Sales (60,000 x $40)
Cost of goods sold (60,000 x $21)
Gross margin
Selling and administrative expenses
Variable (60,000 x $2) $120,000
Fixed
200,000
Net income
$2,400,000
1,260,000
1,140,000
320,000
$820,000
The 41% income increase is computed as:
$820,000-$580,000 = 0.41
$580,000
19-31
C1
Planning Production: Income under
Variable Costing for Different Production
Levels
Exhibit 19.14
For Year Ended December 31, 2011
[60,000 Units Produced; 60,000 Units Sold]
Sales (60,000 x $40)
Variable expenses
Variable production costs
(60,000 x $15)
$900,000
Variable selling and administrative
expenses (60,000 x $2)
120,000
Contribution margin
Fixed expenses
Fixed overhead
600,000
Fixed selling and
administrative expense
200,000
Net income
$2,400,000
1,020,000
1,380,000
800,000
$580,000
For Year Ended December 31, 2011
[100,000 Units Produced; 60,000 Units Sold]
Sales (60,000 x $40)
Variable expenses
Variable production costs
(60,000 x $15)
$900,000
Variable selling and administrative
expenses (60,000 x $2)
120,000
Contribution margin
Fixed expenses
Fixed overhead
600,000
Fixed selling and
administrative expense
200,000
Net income
$2,400,000
1,020,000
1,380,000
800,000
$580,000
19-32
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
19-33
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.
19-34
C2
Setting Prices
(Special Orders Illustration)
Exhibit 19.15 Computing Incremental Income for a Special Order
Rejecting Special Order
Accepting Special Order
Incremental sales
$ 0 Incremental sales (1,000 x $22)
Incremental costs
0 Incremental costs
Variable production cost (1,000 x $15)
____ Variable selling expense (1,000 x $2)
Incremental income
$ 0 Incremental income
$22,000
15,000
2,000
$ 5,000
From Exhibit 19.2 Unit Cost Computation at 60,000 units
Absorption
Costing
Direct materials cost per unit……………... $4
Direct labor cost per unit………….
8
Overhead cost
Variable overhead cost per unit…..
3
Fixed overhead cost per unit……...
10
Total product cost per unit…………….
$25
Should the company accept a special
order for 1,000 pairs of skates at an
offer price of $22 per pair?
19-35
P4
Limitations of Reports Using Variable Costing
•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 external reporting under both
U.S. GAAP and IFRS.
19-36
A1
Calculating Breakeven
We can use the data in the following contribution margin
format for IceAge to help us determine break-even point.
IceAge Company
Contribution Margin Report
For the Year Ended December 31, 2011
Sales
Variable expenses
Variable production costs $900,000
Variable selling expenses 120,000
Contribution margin
Fixed expenses
Net income
$2,400,000
1,020,000
1,380,000
800,000
$580,000
Per
Unit
$ 40
17
$ 23
19-37
A1
Calculating Breakeven
Contribution margin per unit =
Sales price per unit – Variable cost per unit
Break-even volume in units =
Total fixed costs
Contribution margin per unit
19-38
A1
Calculating Breakeven
IceAge’s Contribution Margin per Unit
= Sales price per unit – Variable cost per unit
= $40 - $17 = $23
IceAge’s Break-Even Volume in Units
$800,000
Total fixed costs =
$23 per unit
CM per unit
=
34,783 units (rounded)
19-39
End of Chapter 19
19-40