Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 14
Measuring and Assigning Costs for Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 14: Measuring and Assigning Costs for
Income Statements
Learning objectives
•
Q1: How are absorption costing income statements constructed?
•
Q2: How are variable costing income statements constructed?
•
Q3: How are throughput costing income statements
constructed?
•
Q4: What Factors Affect the Choice of Production Volume
Measures for Allocating Fixed Overhead?
•
Q5: How do income statement costing methods affect managers’
incentives and decisions?
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
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.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Absorption Costing Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Absorption Costing Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Absorption Costing Income
Statement Example
Russell Corporation produces a product that sells for $10. In 2011, 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 2011 are shown below. Given the
cost information below, compute the inventoriable costs per unit under
absorption costing.
Direct materials
Direct labor
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
© John Wiley & Sons, 2011
2011
$60,000
128,000
68,000
55,800
100,000
70,000
Direct materials
Direct labor
Variable mfg overhead
Fixed mfg overhead
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
$0.75
1.60
0.85
1.25
$4.45
Slide # 6
Q1: Absorption Costing Income
Statement Example
Suppose that the Russell Corporation uses the LIFO inventory method.
Prepare an absorption costing income statement for 2011.
Sales (# units sold @ $10)
Cost of goods sold (# units sold @ $4.45)
Gross margin
Nonmfg costs ($70,000 + $55,800)
Operating income
$620,000
275,900
344,100
125,800
$218,300
Note that cost of goods sold is based on the 2011 per-unit
manufacturing costs because:
(1) Russell is using LIFO, and
(2) production exceeded sales in 2005.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: 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.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: Variable Costing Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q2: Variable Costing Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Variable Costing Income Statement Example
Russell Corporation produces a product that sells for $10. In 2011, 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 2011 are shown below. Compute
the inventoriable costs per unit under variable costing.
Direct materials
Direct labor
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
© John Wiley & Sons, 2011
2011
$60,000
128,000
68,000
55,800
100,000
70,000
Direct materials
Direct labor
Variable mfg overhead
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
$0.75
1.60
0.85
$3.20
Slide # 11
Q2: Variable Costing Income Statement Example
Suppose that the Russell Corporation uses the LIFO inventory method.
Prepare a variable costing income statement for 2011.
Sales (# units sold @ $8)
Variable costs:
Cost of goods sold (# units sold @ $3.20)
Nonmfg variable costs
Contribution margin
Fixed costs:
Fixed mfg overhead
Fixed nonmfg costs
Operating income
$620,000
198,400
55,800
365,800
100,000
70,000
$195,800
Note that cost of goods sold is based on the 2011 per-unit
manufacturing costs because Russell is using LIFO.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q2: Variable Costing Income Statement Example
Suppose that the Russell Corporation uses the LIFO inventory method.
Reconcile the income under variable costing you determined on the prior
slide with the $218,300 income under absorption costing computed on
slide #7.
Variable costing income
$195,800
Add: fixed overhead attached to the increase in inventory
(18,000 units x $1.25/unit)
Absorption costing income
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
22,500
$218, 300
Slide # 13
Q3: 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
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q3: Throughput Costing Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q3: Throughput Costing Income Statements
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q3: Throughput Income Statement Example
Russell Corporation produces a product that sells for $10. In 2011, 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 2011 are shown below. Suppose
that the Russell Corporation uses the LIFO inventory method. Prepare a
throughput costing income statement for 2011.
Direct materials
Direct labor
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
2011
$60,000
128,000
68,000
55,800
100,000
70,000
Note that DL and VO
costs expensed based
on units produced, not
units sold
© John Wiley & Sons, 2011
Sales (# units sold @ $8)
Cost of goods sold (# units sold @ $0.75)
Throughput margin
All other costs:
Direct labor
Variable mfg overhead
Fixed mfg overhead
Variable nonmfg overhead costs
Fixed nonmfg costs
Operating income
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
$620,000
46,500
573,500
128,000
68,000
100,000
55,800
70,000
$151,700
Slide # 17
Q3: 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 #18 and to
the income under absorption costing computed on slide #7.
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
Variable costing income
$195,800
Add: fixed overhead attached to the increase in inventory
(18,000 units x $1.25/unit)
Absorption costing income
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
22,500
$218, 300
Slide # 18
Q4: 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
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: 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.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q4: 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.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q4: Absorption Costing Income Statement & Volume
Variance 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 100,000 units in 2011. 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 materials
Direct labor
Variable factory overhead
Variable non-mfg costs
Fixed mfg overhead
Fixed non-mfg costs
2011
$60,000
128,000
68,000
55,800
100,000
70,000
Direct materials
Direct labor
Variable mfg overhead
Fixed mfg overhead
$0.75
$1.60
$0.85
$1.00
$4.20
Note that choice of denominator level affects only the fixed
overhead cost per unit.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q4: 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 12/31/11. There was no fixed overhead
spending variance in 2011. Compute the volume variance and prepare the
year-end entry to close the Fixed overhead control account.
Budgeted fixed overhead
Fixed overhead applied (80,000 units x $1/unit)
Unfavorable fixed overhead volume variance
Fixed overhead control
Work in process [(1/10) x 20,000]
Finished goods [(2/10) x 20,000]
Cost of good sold [(7/10) x 20,000]
$100,000
80,000
$20,000
20,000
2,000
4,000
14,000
Note that the unfavorable volume variance equals the underapplied fixed
overhead because there was no spending variance for fixed overhead.
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q4: 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 2011.
Sales (# units sold @ $10)
Cost of goods sold:
(# units sold @ $4.20)
Adjustment for volume variance
Gross margin
Nonmfg costs ($70,000 + $55,800)
Operating income
© John Wiley & Sons, 2011
$620,000
$260,400
14,000
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
274,400
345,600
125,800
$219,800
Slide # 24
Q5: Decision Making and Manager Incentives
• 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.
• No income statement benefit to building up
inventory since fixed costs are not inventoried.
• Throughput costing may be useful for some shortterm decision making.
• Technology advances can help organizations
utilize absorption costing for external purposes
and another method for internal reporting
© John Wiley & Sons, 2011
Chapter 14: Measuring and Assigning Costs for Income Statements
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25