Exercise 9 16 Variable and absorption costing explaining

Exercise 9 -16 Variable and absorption costing, explaining operatingincome differences Nascar Motors assembles and sells motor vehicles and uses standard costing. Actual data relating to April and May 2011 are: © 2012 Pearson Prentice Hall. All rights reserved. 9 -1

The following information is available: The selling price per vehicle is $24, 000. The budgeted level of production used to calculate the budgeted fixed manufacturing cost per unit is 500 units. There are no price, efficiency, or spending variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs. © 2012 Pearson Prentice Hall. All rights reserved. 9 -2

1. Prepare April and May 2011 income statements for Nascar Motors under: (a) variable

(a) variable costing © 2012 Pearson Prentice Hall. All rights reserved. 9 -4

(b) absorption costing © 2012 Pearson Prentice Hall. All rights reserved. 9 -5

2. Prepare a numerical reconciliation and explanation of the difference between operating income for each month under variable costing and absorption costing. The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May). © 2012 Pearson Prentice Hall. All rights reserved. 9 -6

Pr. 9 -17 Continued from 9 -16 1. April 2011 Revenuesa Direct material cost of goods sold Beginning inventory $ 0 b Direct materials in goods manufactured 3, 350, 000 Cost of goods available for sale Deduct ending inventoryc 3, 350, 000 (1, 005, 000) Total direct material cost of goods sold Throughput margin Other costs May 2011 $8, 400, 000 $12, 480, 000 $1, 005, 000 2, 680, 000 3, 685, 000 (201, 000) 2, 345, 000 6, 055, 000 3, 484, 000 8, 996, 000 Manufacturing costs 3, 650, 000 d 3, 320, 000 e Other operating costs 1, 650, 000 f 2, 160, 000 g 5, 300, 000 $ 755, 000 5, 480, 000 $ 3, 516, 000 Total other costs Operating income © 2012 Pearson Prentice Hall. All rights reserved. 9 -7

Pr. 9 -17 Concluded Variable costing Absorption costing Throughput costing April $1, 250, 000 1, 850, 000 755, 000 May $3, 120, 000 2, 640, 000 3, 516, 000 2. In April, throughput costing has the lower operating income, and in May throughput costing has the higher income. Throughput costing puts greater emphasis on sales as the source of operating income than does either absorption or variable costing. 3. Throughput costing penalizes production without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed in the period incurred, but under variable costing they would be capitalized. So, TP costing removes the incentive to build up inventory. © 2012 Pearson Prentice Hall. All rights reserved. 9 -8

Denominator Level Concepts © 2012 Pearson Prentice Hall. All rights reserved. 9 -9

9 -26 --Denominator Level Issues Denominator Level Capacity Concept Theoretical Budgeted Fixed Manufacturing Overhead per Period $ 6, 480, 000 Budgeted Capacity Level 5, 400 Budgeted Fixed Manufacturing Overhead Cost Rate $ 1, 200. 00 Practical $6, 480, 000 3, 840 $1, 687. 50 Normal $6, 480, 000 3, 240 $2, 000. 00 Master-budget $6, 480, 000 3, 600 $1, 800. 00 2. The variances that arise from use of theoretical or practical level concepts will signal that there is a divergence between the supply of capacity and the demand for capacity. This is useful input to managers. As a general rule, however, it is important not to place undue reliance on the production volume variance as a measure of the economic costs of unused capacity. © 2012 Pearson Prentice Hall. All rights reserved. 9 -10

Master Budget as Level? • Will lead to high prices when demand is low (more fixed costs allocated to the individual product level), further eroding demand; and to low prices when demand is high, forgoing profits. – This is the “downward demand spiral”—the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops, resulting in even higher unit costs and even more reluctance to meet the prices of competitors. • The positive aspects: – based on demand for the product and indicates the price at which all costs per unit would be recovered to enable the company to make a profit. – is also a good benchmark against which to evaluate performance. © 2012 Pearson Prentice Hall. All rights reserved. 9 -11

9 -32 Alternative denominator-level capacity concepts, effect on operating income Budgeted Fixed Days of Hours of Budgeted Manufacturing Denominator-Level Capacity Concept Manuf. Overhead per Period Production per Day Barrels per Hour Denominator Level (Barrels) Overhead Rate per Barrel (1) (2) (3) (4) (5) =2 x 3 x 4 (6) = (1)/ (5) Theoretical capacity $28, 000 360 24 540 4, 665, 600 $ 6. 00 Practical capacity 28, 000 350 20 500 3, 500, 000 8. 00 Normal capacity utilization 28, 000 350 20 400 2, 800, 000 10. 00 (a) January-June 2012 14, 000 175 20 320 1, 120, 000 12. 50 (b) July-December 2012 14, 000 175 20 480 1, 680, 000 8. 33 Master-budget utilization The theoretical and practical capacity concepts emphasize supply factors and are consequently higher, while normal capacity utilization and masterbudget utilization emphasize demand factors. The two separate six-month rates for the master-budget utilization concept differ because of seasonal differences in budgeted production. © 2012 Pearson Prentice Hall. All rights reserved. 9 -12

9 -32 Resulting Volume Variance Per Barrel Denominator-Level Capacity Concept Theoretical capacity Practical capacity Normal capacity utilization Budgeted Fixed Mfg. Overhead Rate per Barrel (6) $6. 00 8. 00 10. 00 Budgeted Variable Mfg. Cost Rate (7) $30. 20 a Budgeted Total Mfg Cost Rate (8) = (6) + (7) $36. 20 Fixed Mfg. Overhead Costs Allocated (9) = 2, 600, 000 (6) Fixed Mfg. Overhead Variance (10) = $27, 088, 000 – (9) $15, 600, 000 $11, 488, 000 U 30. 20 38. 20 20, 800, 000 6, 288, 000 U 30. 20 40. 20 26, 000 1, 088, 000 U © 2012 Pearson Prentice Hall. All rights reserved. 9 -13

9 -32 Resulting Income Revenues (2, 400, 000 bbls. $45 per bbl. ) Cost of goods sold Beginning inventory Variable mfg. costs Theoretical Capacity $108, 000 0 78, 520, 000 Practical Capacity $108, 000 0 78, 520, 000 Normal Capacity Utilization $108, 000 0 78, 520, 000 Fixed mfg. overhead costs allocated (2, 600, 000 units $6. 00; $8. 00; $10. 00 per unit) 15, 600, 000 20, 800, 000 26, 000 Cost of goods available for sale 94, 120, 000 99, 320, 000 104, 520, 000 Deduct ending inventory (200, 000 units $36. 20; $38. 20; $40. 20 per unit) (7, 240, 000) (7, 640, 000) (8, 040, 000) Adjustment for variances (add: all unfavorable) Cost of goods sold Gross margin Other costs Operating income 11, 488, 000 U 98, 368, 000 9, 632, 000 0 $ 9, 632, 000 6, 288, 000 U 97, 968, 000 10, 032, 000 0 $ 10, 032, 000 1, 088, 000 U 97, 568, 000 10, 432, 000 0 $ 10, 432, 000 Pr. 9 -33: Discuss Motivational Considerations © 2012 Pearson Prentice Hall. All rights reserved. 9 -14