6-2
L
Learning
i Obj
Objective
ti 1
Variable Costing and Segment
Reporting: Tools for Management
Chapter
p
6
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W
W. Caldwell
Caldwell, D
D.B.A.,
B A CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Explain how variable
costing differs from
absorption costing and
compute unit product
costs under each
method.
method
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights rese
6-3
Overview of Variable and
Absorption Costing
Variable
Costing
Q i k Ch
Quick
Check
k
Absorption
Costing
Direct Materials
Product
Costs
Direct Labor
Variable Manufacturing Overhead
Product
P
d t
Costs
Fixed Manufacturing Overhead
Period
Costs
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
6-4
Period
Costs
Which method will produce the highest values
for
o work
o in p
process
ocess a
and
d finished
s ed goods
inventories?
a Absorption costing
a.
costing.
b. Variable costing.
c. They produce the same values for these
inventories.
d. It depends. . .
6-5
U it C
Unit
Costt C
Computations
t ti
6-6
U it C
Unit
Costt C
Computations
t ti
U it product
Unit
d t costt is
i determined
d t
i d as follows:
f ll
Harvey Company produces a single product
with the following
g information available:
Under absorption costing
costing, all production costs
costs, variable
and fixed, are included when determining unit product
cost. U
cost
Under
de variable
a ab e cost
costing,
g, o
only
y tthe
e variable
a ab e
production costs are included in product costs.
6-7
L
Learning
i Obj
Objective
ti 2
Prepare income
statements using both
variable and absorption
costing.
costing
6-8
Variable and Absorption Costing
Income Statements
Let’s assume the following additional information
for Harvey Company.
▫ 20,000 units were sold during the year at a price
of $30 each.
▫ There is no beginning inventory.
Now, let’s compute net operating
income using
g both absorption
p
and variable costing.
6-9
Variable Costing Contribution Format
Income Statement
All fixed
Variable
manufacturing
costs only.
6-10
Ab
Absorption
ti C
Costing
ti IIncome St
Statement
t
t
manufacturing
overhead is
expensed.
Unit product
p
cost.
Variable Costing
Sales ((20,000 × $30))
Less variable expenses:
Variable cost of goods sold (20,000 × $10)
Variable selling & administrative
expenses (20,000 × $3)
Total variable expenses
Contribution margin
Less fixed expenses:
Fixed manufacturing overhead
Fixed selling & administrative expenses
Net operating income
$ 600,000
$ 200,000
60,000
260,000
340 000
340,000
$ 150,000
100,000
Fixed manufacturing
g overhead deferred in
inventory is 5,000 units × $6 = $30,000.
250,000
$ 90,000
6-11
L
Learning
i Obj
Objective
ti 3
Reconcile variable costing
and absorption costing
net operating incomes
and explain why the two
amounts differ.
6-12
Comparing the Two Methods
6-13
6-14
Extended Comparisons of Income
Data Harvey Company – Year Two
Comparing the Two Methods
We can reconcile
W
il the
th difference
diff
between
b t
absorption and variable income as follows:
Variable costing net operating income
$ 90,000
Add: Fixed mfg
mfg. overhead costs
deferred in inventory
(5 000 units × $6 per unit)
(5,000
30 000
30,000
Absorption costing net operating income $ 120,000
Fixed mfg. overhead
$150,000
=
= $6 per unit
Units produced
25,000 units
6-15
U it C
Unit
Costt C
Computations
t ti
6-16
Variable Costing Contribution Format
Income Statement
All fixed
Variable
manufacturing
costs only.
only
manufacturing
f t i
overhead is
expensed.
Variable Costing
Since the variable costs per unit, total fixed costs,
and the number of units produced remained
unchanged, the unit cost computations also
remain unchanged
unchanged.
Sales (30
(30,000
000 × $30)
Less variable expenses:
Variable cost of goods sold (30,000 × $10)
Variable selling & administrative
expenses (30,000 × $3)
Total variable expenses
Contribution margin
Less fixed expenses:
Fixed manufacturing overhead
Fixed selling & administrative expenses
Net operating income
$ 900,000
900 000
$ 300,000
90,000
390,000
510,000
$ 150,000
100,000
250,000
$ 260,000
6-17
6-18
Comparing the Two Methods
Ab
Absorption
ti C
Costing
ti IIncome St
Statement
t
t
Unit product
p
cost.
We can reconcile
W
il the
th difference
diff
between
b t
absorption and variable income as follows:
Variable costing net operating income
$ 260,000
Deduct: Fixed manufacturing overhead
costs released from inventory
(5 000 units
(5,000
it × $6 per unit)
it)
30 000
30,000
Absorption costing net operating income $ 230,000
Fixed mfg. overhead
$150,000
=
= $6 per unit
Units produced
25,000 units
Fixed manufacturing overhead released from
inventory is 5,000 units × $6 = $30,000.
6-19
Comparing the Two Methods
6-20
S
Summary
off Key
K Insights
I i ht
6-21
6-22
Explaining Changes in Net Operating
Income
E bli CVP A
Enabling
Analysis
l i
Variable costing categorizes costs as fixed and
variable so it is much easier to use this income
statement format for CVP analysis.
analysis
Because absorption costing assigns fixed
manufacturing overhead costs to units produced ($6
per unit for Harvey Company), a portion of fixed
manufacturing overhead resides in inventory when
units remain unsold. The potential result is positive
operating income when the number of units sold is
less than the breakeven point.
Variable costing income is only affected by
changes in unit sales. It is not affected by
the number of units produced. As a general
rule, when sales go up, net operating
income goes up, and vice versa.
Absorption costing income is influenced by
changes in unit sales and units of
production. Net operating income can be
increased simply by producing more units
even if those units are not sold.
6-23
S
Supporting
ti D
Decision
i i M
Making
ki
Variable
V
i bl costing
ti correctly
tl id
identifies
tifi th
the additional
dditi
l
variable costs incurred to make one more unit ($10
per unit
it ffor Harvey
H
C
Company).
) It also
l emphasizes
h i
the impact of total fixed costs on profits.
Because absorption costing assigns fixed
manufacturing overhead costs to units produced ($6
per unit for Harvey Company), it gives the impression
that fixed manufacturing overhead is variable with
respect to the number of units produced, but it is not.
The result can be inappropriate pricing decisions and
product discontinuation decisions.
6-24
Variable Costing and the Theory of
Constraints (TOC)
Companies involved in TOC use a form of variable
costing. However, one difference of the TOC
approach is that it treats direct labor as a fixed cost
for three reasons:
 Many companies have a commitment to guarantee
workers a minimum number of paid hours.
 Direct labor is usually not the constraint.
 TOC emphasizes the role direct laborers play in driving
continuous improvement. Since layoffs often devastate
morale, managers involved in TOC are extremely
reluctant to lay off employees.
6-25
6-26
Decentralization and Segment
Reporting
L
Learning
i Obj
Objective
ti 4
An Individual Store
Prepare a segmented
i
income
statement that
h
differentiates traceable
fixed costs from common
fixed costs and use it to
make decisions.
Quick Mart
A segment is any part
or activity of an
organization about
which a manager
seeks cost, revenue,
or profit data.
A Sales Territory
A Service Center
6-27
K
Keys
to
t SSegmented
t d IIncome St
Statements
t
t
There are two keys to building
segmented income statements:
A contribution format should be used
because it separates fixed from variable
costs and it enables the calculation of a
contribution
t ib ti margin.
i
Traceable fixed costs should be separated
from common fixed costs to enable the
calculation
l l ti off a segmentt margin.
i
6-28
Id tif i T
Identifying
Traceable
bl Fi
Fixed
dC
Costs
t
T
Traceable
bl fixed
fi d costs
t arise
i because
b
off the
th
existence of a particular segment and would
disappear over time if the segment itself
disappeared.
No computer
division means . . .
No computer
division manager
manager.
6-29
Traceable Costs Can Become
Common Costs
Id tif i C
Identifying
Common Fi
Fixed
dC
Costs
t
Common fixed costs arise because of the
overall operation of the company and would
not disappear if any particular segment were
eliminated.
No computer
division but . . .
6-30
It is important to realize that the traceable
fixed costs of one segment may be a
common fixed cost of another segment.
We still have a
company president.
president
For example, the landing fee
paid to land an airplane at an
airport is traceable to the
particular flight, but it is not
traceable to first-class,
business-class, and
economy-class passengers.
6-31
S
Segment
tM
Margin
i
6-32
T
Traceable
bl and
d Common
C
Costs
C t
P
Profits
The segment margin
margin, which is computed by
subtracting the traceable fixed costs of a segment
from its contribution margin, is the best gauge of
the long-run profitability of a segment.
Fixed
Costs
Traceable
Time
Don
Don’tt allocate
common costs to
segments.
Common
6-33
6-34
L
Levels
l off Segmented
S
t d St
Statements
t
t
L
Levels
l off Segmented
S
t d St
Statements
t
t
Webber Inc
Webber,
Inc. has two divisions
divisions.
Our approach to segment reporting uses the
contribution format.
W bb
Webber,
Inc.
I
Computer Division
Television Division
Let’s look more closely at the Television
Division’s
Division
s income statement.
Income Statement
Contribution Margin Format
Television Division
Sales
$ 300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Di i i
Division
margin
i
$ 60,000
60 000
Costt off goods
C
d
sold consists of
variable
manufacturing
costs.
Fixed and
variable costs
are listed in
p
separate
sections.
6-35
L
Levels
l off Segmented
S
t d St
Statements
t
t
6-36
L
Levels
l off Segmented
S
t d St
Statements
t
t
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$ 300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Di i i
Division
margin
i
$ 60,000
60 000
Contribution margin
is computed
p
by
y
taking sales minus
variable costs.
Segment
g
margin
g
is Television’s
contribution
to profits.
Sales
Variable costs
CM
Traceable FC
Division margin
C
Common
costs
t
Net operating
income
Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
Computer
$ 200,000
80,000
120,000
80,000
$ 40,000
6-37
Traceable Costs Can Become
Common Costs
L
Levels
l off Segmented
S
t d St
Statements
t
t
Sales
Variable costs
CM
Traceable FC
Division margin
C
Common
costs
t
Net operating
income
Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
25 000
25,000
$
75 000
75,000
6-38
Computer
$ 200,000
80,000
120,000
80,000
$ 40,000
As previously mentioned, fixed costs that
are traceable to one segment can become
p y is divided into
common if the company
smaller segments.
Common costs should not
be allocated to the
di i i
divisions.
These
Th
costs
t
would remain even if one
of the divisions were
eliminated.
Let’s see how this works
using the Webber, Inc.
example!
6-39
Traceable Costs Can Become
Common Costs
Webber’s Television Division
Television
Division
Regular
Big Screen
Product
Lines
6-40
Traceable Costs Can Become
Common Costs
Income Statement
Television
Di i i
Division
R
Regular
l
Sales
$ 200,000
Variable costs
95,000
,
CM
105,000
Traceable FC
45,000
Product line margin
$ 60,000
60 000
Common costs
Divisional margin
g
Big Screen
Bi
S
$ 100,000
55,000
,
45,000
35,000
$ 10,000
10 000
We obtained the following
g information from
the Regular and Big Screen segments.
6-41
Traceable Costs Can Become
Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
150,000
,
95,000
,
CM
150,000
105,000
Traceable FC
80,000
45,000
Product line margin
70 000
70,000
$ 60,000
60 000
Common costs
10,000
Divisional margin
g
$ 60,000
,
6-42
Segmented Income Statements and
Decision Making
5% increase in sales
Income Statement
Television
Di i i
Division
R
Regular
l
Sales
$ 315,000
$ 210,000
Variable costs
157,500
99,750
CM
157,500
110,250
Traceable FC
80,000
45,000
Product line margin
77,500
$ 65,250
Common costs
15,000
Divisional margin
$ 62,500
Big Screen
$ 100,000
55,000
,
45,000
35,000
$ 10,000
10 000
Fixed costs directly traced
to the Television Division
$80,000 + $10,000 = $90,000
$5,000 additional
advertising
Division margin
increases by
$2,500
Big Screen
Bi
S
$ 105,000
57,750
47,250
35,000
$ 12,250
Margin
increases
by $5,250
Margin
increases
by $2,250
6-43
O i i off Costs
Omission
C t
6-44
Inappropriate Methods of Allocating
Costs Among Segments
Costs assigned to a segment should include
all costs attributable to that segment
g
from the
company’s entire value chain.
chain
Failure to trace
costs directly
Inappropriate
allocation base
Business Functions
Making Up The
Value Chain
R&D
Product
Design
Customer
Manufacturing Marketing Distribution Service
Segment
1
Segment
2
Segment
3
Segment
4
6-45
C
Common
C
Costs
t and
d SSegments
t
6-46
Q i k Ch
Quick
Check
k
Income Statement
Common costs should not be arbitrarily allocated to segments
based on the rationale that “someone has to cover the
common costs” for two reasons:
1. This practice may make a profitable business segment appear
to be unprofitable.
Sales
Variable costs
CM
Traceable FC
S
Segment
t margin
i
Common costs
Profit
2. Allocating common fixed costs forces managers to be held
y cannot control.
accountable for costs they
Segment
1
Segment
2
Segment
3
Segment
4
Hoagland's
Lakeshore
$ 800,000
310,000
490,000
246,000
244 000
244,000
200,000
$ 44,000
,
Bar
$ 100,000
60,000
40,000
26,000
$ 14,000
14 000
Restaurant
$ 700,000
250,000
450,000
220,000
$ 230,000
230 000
Assume that Hoagland's Lakeshore prepared its
segmented
t d income
i
statement
t t
t as shown.
h
6-47
Q i k Ch
Quick
Check
k
How much of the common fixed cost of
$200,000 can be avoided by eliminating the
bar?
a. None of it.
b. Some of it.
c. All of it.
6-48
Q i k Ch
Quick
Check
k
Suppose square feet is used as the basis for
allocating the common fixed cost of $200,000.
How much would be allocated to the bar if the
bar occupies 1,000 square feet and the
restaurant 9,000 square feet?
a. $20,000
b. $30,000
c. $40,000
d. $50,000
6-49
Q i k Ch
Quick
Check
k
6-50
All
Allocations
ti
off Common
C
C
Costs
t
If Hoagland's
Hoagland s allocates its common
costs to the bar and the restaurant,
what would be the reported profit of
each segment?
Income Statement
Sales
Variable costs
CM
Traceable FC
S
Segment
t margin
i
Common costs
Profit
Hoagland's
Lakeshore
$ 800,000
310 000
310,000
490,000
246,000
244 000
244,000
200,000
$ 44,000
Bar
$ 100,000
60 000
60,000
40,000
26,000
14 000
14,000
20,000
$
((6,000))
Restaurant
$ 700,000
250 000
250,000
450,000
220,000
230 000
230,000
180,000
$ 50,000
Hurray now everything adds up!!!
Hurray,
6-51
Q i k Ch
Quick
Check
k
Should the bar be eliminated?
a. Yes
b. No
6-52
Companywide Income
Statements
Global View
Both U
U.S.
S GAAP and
IFRS require absorption costing
for external reports
reports.
Since absorption costing is required for
external reporting
reporting, most companies also use
it for internal reports rather than incurring the
additional cost of maintaining a separate
variable cost system for internal reporting.
6-53
Segmented Financial
Information
V i bl versus Ab
Variable
Absorption
ti C
Costing
ti
Fixed
Fi
d manufacturing
f t i
costs must be assigned
to products to properly
match revenues and
costs.
Absorption
p
Costing
Fixed manufacturing
costs are capacity costs
and will be incurred
even if nothing is
produced.
Global View
Both
B
th U
U.S.
S GAAP and
d IFRS require
i publically
bli ll
traded companies to include segmented
financial data in their annual reports.
reports
1. Companies must report segmented results to
shareholders using the same methods that are used
for internal segmented reports.
2 Thi
2.
This requirement
i
t motivates
ti t managers to
t avoid
id using
i
the contribution approach for internal reporting
purposes because if they did they would be required
to:
a. Share this sensitive data with the public.
b. Reconcile these reports with applicable
rules for consolidated reporting purposes.
Variable
Costing
6-55
E d off Chapter
End
Ch t 6
6-54