Managerial Accounting

Wild and Shaw

2010 Edition
McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All

Chapter 6
Variable Costing and
Performance Reporting

Conceptual Learning
Objectives
C1: Distinguish between absorption
costing and variable costing.
C2: Describe how absorption costing
can result in over-production.
C3: Explain the role of variable costing
in pricing special orders.

6-3

Analytical Learning Objectives

A1: Analyze income reporting for both
absorption and variable costing.
A2: Compute and interpret breakeven
volume in units.

6-4

Procedural Learning
Objectives
P1: Compute unit cost under both
absorption and variable costing.
P2: Prepare 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
Absorption costing
costing (also
(also called
called full
full
costing),
costing), assumes
assumes that
that products
products
absorb
absorb all
all costs
costs incurred
incurred to
to
produce
produce them.
them.

While
Whilewidely
widelyused
usedfor
for financial
financialreporting
reporting(GAAP),
(GAAP), this
this
costing
costing method
methodcan
canresult
resultin
inmisleading
misleading product
productcost
cost
information
informationfor
forbusiness
businessdecisions.
decisions.

6-6

C1

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

C1

Distinguishing Between Absorption Costing

and Variable Costing: Absorption Costing

Absorption Costing
Direct
Materials

Direct
Labor

Variable
Overhead

Fixed
Overhead

Product Cost
6-8

C1

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

6-10

P1

Difference Between Absorption Costing and Variable

Costing: Computing Unit Cost

6-11

A1

Analysis of Income Reporting for Both

Absorption and Variable Costing

6-12

A1
P2

Analysis of Income Reporting for Absorption

Costing: Units Produced Equal Units Sold

Notice that the net income is $580,000

6-13

A1
P2

Analysis of Income Reporting for Variable

Costing: Units Produced Equal Units Sold

6-14

A1
P2

Analysis of Income Reporting for Variable

Costing: Units Produced Equal Units Sold

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.

6-15

A1

Analysis of Income Reporting for Both

Absorption and Variable Costing: Units
Produced Equal Units Sold

6-16

A1
P2

Analysis of Income Reporting for Absorption

Costing: Units Produced Exceed Units Sold

6-17

A1
P2

Analysis of Income Reporting for Absorption

Costing: Units Produced Exceed Units Sold

Income for 2008 is $320,000

6-18

A1
P2

Analysis of Income Reporting for Variable

Costing: Units Produced Exceed Units Sold

6-19

A1
P2

Analysis of Income Reporting for Variable

Costing: Units Produced Exceed Units Sold

Under variable costing, the

net income is only $120,000

6-20

A1
P2

Analysis of Income Reporting for Variable

Costing: Units Produced Exceed Units Sold

Under absorption costing,

$200,000 of fixed overhead is
allocated to the 20,000 units in
ending inventory and is not
expensed until future periods.
Variable costing expenses the
entire $600,000 of fixed
overhead.

6-21

A1

Analysis of Income Reporting for Both

Absorption and Variable Costing: Units
Produced Exceed Units Sold

6-22

A1
P2

Analysis of Income Reporting for Absorption

Costing: Units Produced Are Less Than
Units Sold

Income is now $840,000

6-23

A1
P2

Analysis of Income Reporting for Variable

Costing: Units Produced Are Less Than
Units Sold

Income under variable

costing is $1,040,000

6-24

A1

Analysis of Income Reporting for Both

Absorption and Variable Costing: Units
Produced Are Less Than Units Sold

6-25

A1

Income Reporting Summarized

6-26

C2

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
6-27

C2

Planning Production

6-28

C2

Planning Production: Income Under Absorption

Costing for Different Production Levels
Exhibit 6.9

6-29

C2

Planning Production: Income Under Absorption

Costing for Different Production Levels
Exhibit 6.10

6-30

C2

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 for the two method.

6-31

C3

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

6-32

C3

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.
6-33

C3

Setting Prices

6-34

P3

Contribution Margin Report

Contribution margin contributes to

covering fixed costs and earning
income

Contribution
margin is the
excess of
sales over
total variable
expenses
6-35

P3

Contribution Margin Report

The
Contribution
Margin Ratio
is contribution
margin
divided by
sales
6-36

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.
6-37

P4

Converting Reports Under Variable

Costing to Absorption Costing

6-38

A2

Calculating Break-Even
We can use the data in the following contribution margin
format for IceAge to help us determine break-even point.

6-39

A2

Calculating Break-Even

Break-Even Volume in Units =

Total Fixed Costs
Contribution Margin per Unit
Where:
Contribution margin per unit =
Sales price per unit Variable cost per unit

6-40

A2

Calculating Break-Even
Precision Techs Break-Even Volume in Units
Total fixed costs
CM per unit

$800,000
=
=

$23 per unit

34,783 units

6-41

End of Chapter 6

6-42