Inventory Costing and Capacity Analysis Chapter 9 2003

Learning Objective 1 Identify what distinguishes variable costing from absorption costing. © 2003 Prentice

Inventory-Costing Methods The difference between variable costing and absorption costing is based on the

Variable Costing Direct Materials Variable Factory Labor Variable Overhead Work in Process Inventory ©

Variable Costing Work in Process Inventory Finished Goods Inventory Fixed Factory Labor Cost of

Learning Objective 2 Prepare income statements under absorption costing and variable costing. © 2003

Comparing Income Statements The following data pertain to Davenport Fixtures: Year 1 Beginning inventory

Comparing Income Statements The following information is on a per unit basis: Sales price:

Comparing Income Statements (Absorption Costing) Total fixed production costs are $54, 000 at a

Comparing Income Statements (Absorption Costing) Revenues Cost of goods sold Volume variance (U) Gross

Comparing Income Statements (Absorption Costing) Revenues for Year 1 are $568, 000. What is

Comparing Income Statements (Variable Costing) Revenues Cost of goods sold Variable nonmanufacturing costs Contribution

Learning Objective 3 Explain differences in operating income under absorption costing and variable costing.

Operating Income (Absorption Costing) What are revenues for Year 2? 13, 000 × $71

Operating Income (Absorption Costing) What is the gross margin? $923, 000 – ($695, 500

Operating Income (Absorption Costing) What is the operating income before taxes? $225, 250 –

Income Statements (Absorption Costing) Revenues Cost of goods sold Volume variance (U) Gross margin

Operating Income (Variable Costing) Revenues for Year 2 are $923, 000. What is the

Operating Income (Variable Costing) What is the net contribution margin? $286, 000 – $26,

Income Statements (Variable Costing) Revenues Cost of goods sold Mfg. contr. margin Variable nonmfg.

Income Statements (Variable Costing) Year 1 Net contr. margin $160, 000 Fixed mfg. costs

Comparison of Variable and Absorption Costing Variable costing operating income Year 1: $76, 000

Comparison of Variable and Absorption Costing Production exceeds sales in Year 1. The 2,

Comparison of Variable and Absorption Costing Variable costing operating income Year 2: $176, 000

Comparison of Variable and Absorption Costing Sales exceeded units produced in Year 2. 13,

Comparison of Variable and Absorption Costing Variable costing combined net income: $252, 000 Absorption

Comparison of Variable and Absorption Costing Absorption costing operating income Variable costing operating income

Learning Objective 4 Understand how absorption costing can provide undesirable incentives for managers to

Inventory Buildup Assume that Davenport Fixtures produced 4, 400 units in Year 1 and

Inventory Buildup Revenues (4, 100 × $71) Cost of goods sold (4, 100 ×

Inventory Buildup How many units are in ending inventory? 4, 400 – 4, 100

Inventory Buildup Suppose that management decides to produce 9, 000 units next year. Sales

Inventory Buildup How many units are in ending inventory? 300 + 9, 000 –

Learning Objective 5 Differentiate throughput costing from variable costing and absorption costing. © 2003

Throughput Costing Revenues Variable direct materials cost of goods sold Throughput contribution margin Manufacturing

Throughput Costing Manufacturing Costs: Labor $21. 00 × 10, 000 $210, 000 Indirect costs

Throughput Costing Nonmanufacturing Costs: Variable $2. 00 × 8, 000 $16, 000 Fixed 30,

Throughput Costing Variable costing operating income: $76, 000 Throughput costing operating loss: $14, 000

Throughput Costing The 2, 000 units in ending inventory are valued as follows: Variable

Throughput Costing Absorption costing operating income: $85, 000 Throughput costing operating loss: $14, 000

Throughput Costing The 2, 000 units in ending inventory are valued as follows: Absorption

Comparison of Inventory Costing Methods Actual Costing Variable Costing Absorption Costing Throughput Costing ©

Comparison of Inventory Costing Methods Normal Costing Variable Costing Absorption Costing Throughput Costing ©

Comparison of Inventory Costing Methods Standard Costing Variable Costing Absorption Costing Throughput Costing ©

Learning Objective 6 Describe the various capacity concepts that can be used in absorption

Alternative Denominator-Level Concepts Theoretical capacity Practical capacity Normal capacity Master-budget capacity © 2003 Prentice

Budgeted Fixed Manufacturing Overhead Rate Lloyd’s Bicycles produces bicycle parts for domestic and foreign

Budgeted Fixed Manufacturing Overhead Rate Assume that theoretical capacity is 10, 000 machine-hours, practical

Budgeted Fixed Manufacturing Overhead Rate Theoretical 100%: $200, 000 ÷ 10, 000 = $20.

Learning Objective 7 Understand the major factors management considers in choosing a capacity level

Choosing a Capacity Level What factors are considered in choosing a capacity level? Product

Decision Making Assume that Lloyd’s Bicycles’ standard hours are 2 hours per unit. What

Decision Making Theoretical capacity: $20 × 2 = $40. 00 Practical capacity: $23. 53

Learning Objective 8 Describe how attempts to recover fixed costs of capacity may lead

Downward Demand Spiral The downward demand spiral is the continuing reduction in demand that

Learning Objective 9 Explain how the capacity level chosen to calculate the budgeted fixed

Effect on Financial Statements Assume that Lloyd’s Bicycles actually used 8, 400 machine-hours during

Production Volume Variance Production volume variance = (Denominator level – Actual level) × Budgeted

Production Volume Variance Normal capacity: (7, 500 – 8, 400) × $26. 67 =

End of Chapter 9 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

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Inventory-Costing Methods The difference between variable costing and absorption costing is based on the treatment of fixed manufacturing overhead. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 -3

Variable Costing Work in Process Inventory Finished Goods Inventory Fixed Factory Labor Cost of Goods Sold Income Summary © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 -5

Comparing Income Statements The following data pertain to Davenport Fixtures: Year 1 Beginning inventory -0 Produced 10, 000 Sold 8, 000 Ending inventory 2, 000 Year 2 2, 000 11, 500 13, 000 500 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Total -021, 500 21, 000 500 9 -7

Comparing Income Statements The following information is on a per unit basis: Sales price: $71. 00 Variable manufacturing costs: Direct materials: Direct manufacturing labor: Indirect manufacturing costs: $ 4. 00 $21. 00 $24. 00 Fixed manufacturing costs: $ 4. 50 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 -8

Comparing Income Statements (Absorption Costing) Total fixed production costs are $54, 000 at a normal capacity of 12, 000 units. Fixed nonmanufacturing costs are $30, 000 per year. Variable nonmanufacturing costs are $2. 00 per unit sold. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 -9

Comparing Income Statements (Absorption Costing) Revenues Cost of goods sold Volume variance (U) Gross margin Nonmanufacturing costs Operating income $568, 000 428, 000 9, 000 $131, 000 46, 000 $ 85, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 10

Comparing Income Statements (Absorption Costing) Revenues for Year 1 are $568, 000. What is the cost of goods sold? 8, 000 × $49 = $392, 000 What is the manufacturing contribution margin? $568, 000 – $392, 000 = $176, 000 Net contribution margin = $160, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 11

Comparing Income Statements (Variable Costing) Revenues Cost of goods sold Variable nonmanufacturing costs Contribution margin Fixed manufacturing costs Fixed nonmanufacturing costs Operating income $568, 000 392, 000 16, 000 $160, 000 54, 000 30, 000 $ 76, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 12

Operating Income (Absorption Costing) What are revenues for Year 2? 13, 000 × $71 = $923, 000 What is the cost of goods sold? 13, 000 × $53. 50 = $695, 500 Is there a volume variance? (12, 000 – 11, 500) × $4. 50 = $2, 250 underallocated fixed manufacturing costs © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 14

Operating Income (Absorption Costing) What is the gross margin? $923, 000 – ($695, 500 + $2, 250) = $225, 250 What are the nonmanufacturing costs? 13, 000 units sold × $2. 00 = $26, 000 variable costs + $30, 000 fixed costs = $56, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 15

Operating Income (Absorption Costing) What is the operating income before taxes? $225, 250 – $56, 000 = $169, 250 What is the operating income for the two years combined? $85, 000 + $169, 250 = $254, 250 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 16

Income Statements (Absorption Costing) Revenues Cost of goods sold Volume variance (U) Gross margin Nonmfg. costs Operating income Year 1 Year 2 Combined $568, 000 $923, 000 $1, 491, 000 428, 000 695, 500 1, 123, 500 9, 000 2, 250 11, 250 $131, 000 $225, 250 $ 356, 250 46, 000 56, 000 102, 000 $ 85, 000 $169, 250 $ 254, 250 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 17

Operating Income (Variable Costing) Revenues for Year 2 are $923, 000. What is the cost of goods sold? 13, 000 × $49 = $637, 000 What is the manufacturing contribution margin? $923, 000 – $637, 000 = $286, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 18

Operating Income (Variable Costing) What is the net contribution margin? $286, 000 – $26, 000 variable nonmanufacturing costs = $260, 000 net contribution margin What is the operating income before taxes? $260, 000 – $54, 000 fixed manufacturing costs – $30, 000 fixed nonmanufacturing costs = $176, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 19

Income Statements (Variable Costing) Revenues Cost of goods sold Mfg. contr. margin Variable nonmfg. Net contr. margin Year 1 $568, 000 392, 000 $176, 000 16, 000 $160, 000 Year 2 $923, 000 637, 000 $286, 000 26, 000 $260, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Combined $1, 491, 000 1, 029, 000 $ 462, 000 42, 000 $ 420, 000 9 - 20

Income Statements (Variable Costing) Year 1 Net contr. margin $160, 000 Fixed mfg. costs 54, 000 Fixed nonmfg. costs 30, 000 Operating income $ 76, 000 Year 2 $260, 000 54, 000 30, 000 $176, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Combined $420, 000 108, 000 60, 000 $252, 000 9 - 21

Comparison of Variable and Absorption Costing Variable costing operating income Year 1: $76, 000 Absorption costing operating income Year 1: $85, 000 Absorption costing operating income is $9, 000 higher. Why? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 22

Comparison of Variable and Absorption Costing Production exceeds sales in Year 1. The 2, 000 units in ending inventory are valued as follows: Absorption costing: 2, 000 × $53. 50 = $107, 000 Variable costing: Difference: 2, 000 × $49. 00 = $ 98, 000 $ © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9, 000 9 - 23

Comparison of Variable and Absorption Costing Variable costing operating income Year 2: $176, 000 Absorption costing operating income Year 2: $169, 250 Variable costing operating income is $6, 750 higher. Why? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 24

Comparison of Variable and Absorption Costing Sales exceeded units produced in Year 2. 13, 000 – 11, 500 = 1, 500 decrease in inventory Absorption costing: 1, 500 × $53. 50 = $80, 250 Variable costing: 1, 500 × $49. 00 = $73, 500 Higher cost of goods sold under absorption costing: $ 6, 750 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 25

Comparison of Variable and Absorption Costing Variable costing combined net income: $252, 000 Absorption costing combined net income: $254, 250 Absorption costing is higher by $2, 250 500 units in inventory × $4. 50 = $2, 250 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 26

Comparison of Variable and Absorption Costing Absorption costing operating income Variable costing operating income – EQUALS Fixed manufacturing costs in ending inventory under absorption costing – Fixed manufacturing costs in beginning inventory under absorption costing © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 27

Learning Objective 4 Understand how absorption costing can provide undesirable incentives for managers to build up finished goods inventory. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 28

Inventory Buildup Assume that Davenport Fixtures produced 4, 400 units in Year 1 and sold 4, 100. What is the production volume variance? (12, 000 – 4, 400) × $4. 50 = $34, 200 U What is the net operating income or loss for the period? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 29

Inventory Buildup Revenues (4, 100 × $71) Cost of goods sold (4, 100 × $53. 50) Volume variance Gross margin Nonmanufacturing costs Net loss $291, 100 219, 350 34, 200 $ 37, 550 38, 200 $ 650 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 30

Inventory Buildup How many units are in ending inventory? 4, 400 – 4, 100 = 300 How much cost is in ending inventory? 300 × $53. 50 = $16, 050 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 31

Inventory Buildup Suppose that management decides to produce 9, 000 units next year. Sales remain the same (4, 100 units). What is the volume variance? (12, 000 – 9, 000) × $4. 50 = $13, 500 U What is the operating income or loss? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 32

Inventory Buildup Revenues (4, 100 × $71) Cost of goods sold (4, 100 × $53. 50) Volume variance Gross margin Nonmanufacturing costs Net income $291, 100 219, 350 13, 500 $ 58, 250 38, 200 $ 20, 050 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 33

Inventory Buildup How many units are in ending inventory? 300 + 9, 000 – 4, 100 = 5, 200 How much cost is in ending inventory? 5, 200 × $53. 50 = $278, 200 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 34

Throughput Costing Revenues Variable direct materials cost of goods sold Throughput contribution margin Manufacturing costs Nonmanufacturing costs Operating loss $568, 000 32, 000 $536, 000 504, 000 46, 000 $ 14, 000 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 36

Throughput Costing Manufacturing Costs: Labor $21. 00 × 10, 000 $210, 000 Indirect costs $24. 00 × 10, 000 240, 000 Fixed costs 54, 000 Total manufacturing costs $504, 000 What are other nonmanufacturing costs for the year? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 37

Throughput Costing Variable costing operating income: $76, 000 Throughput costing operating loss: $14, 000 Difference in operating income: $90, 000 How can this difference be explained? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 39

Throughput Costing The 2, 000 units in ending inventory are valued as follows: Variable 2, 000 × $49 = $98, 000 Throughput 2, 000 × $4 = $8, 000 $90, 000 difference © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 40

Throughput Costing Absorption costing operating income: $85, 000 Throughput costing operating loss: $14, 000 Difference in operating income: $99, 000 How can this difference be explained? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 41

Throughput Costing The 2, 000 units in ending inventory are valued as follows: Absorption 2, 000 × $53. 50 = $107, 000 Throughput 2, 000 × $4 = $8, 000 $99, 000 difference © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 42

Comparison of Inventory Costing Methods Actual Costing Variable Costing Absorption Costing Throughput Costing © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 43

Comparison of Inventory Costing Methods Normal Costing Variable Costing Absorption Costing Throughput Costing © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 44

Comparison of Inventory Costing Methods Standard Costing Variable Costing Absorption Costing Throughput Costing © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 45

Alternative Denominator-Level Concepts Theoretical capacity Practical capacity Normal capacity Master-budget capacity © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 47

Budgeted Fixed Manufacturing Overhead Rate Lloyd’s Bicycles produces bicycle parts for domestic and foreign markets. Fixed overhead costs are $200, 000 within the relevant range of the various capacity volume. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 48

Budgeted Fixed Manufacturing Overhead Rate Assume that theoretical capacity is 10, 000 machine-hours, practical capacity is 85%, normal capacity is 75%, and master-budget capacity is 60%. What is the budgeted fixed manufacturing overhead rate at the various capacity levels? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 49

Budgeted Fixed Manufacturing Overhead Rate Theoretical 100%: $200, 000 ÷ 10, 000 = $20. 00/machine-hour Practical 85%: $200, 000 ÷ 8, 500 = $23. 53/machine-hour Normal 75%: $200, 000 ÷ 7, 500 = $26. 67/machine-hour Master-budget 60%: $200, 000 ÷ 6, 000 = $33. 33/machine-hour © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 50

Learning Objective 7 Understand the major factors management considers in choosing a capacity level to compute the budgeted fixed overhead cost rate. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 51

Choosing a Capacity Level What factors are considered in choosing a capacity level? Product costing Pricing decision Performance evaluation Financial statements Regulatory requirements Difficulty © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 52

Decision Making Assume that Lloyd’s Bicycles’ standard hours are 2 hours per unit. What is the budgeted fixed manufacturing overhead cost per unit? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 53

Decision Making Theoretical capacity: $20 × 2 = $40. 00 Practical capacity: $23. 53 × 2 = $47. 06 Normal capacity: $26. 67 × 2 = $53. 34 Master-budget capacity: $33. 33 × 2 = $66. 66 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 54

Learning Objective 8 Describe how attempts to recover fixed costs of capacity may lead to price increases and lower demand. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 55

Downward Demand Spiral The downward demand spiral is the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 56

Learning Objective 9 Explain how the capacity level chosen to calculate the budgeted fixed overhead cost rate affects the production-volume variance. © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 57

Effect on Financial Statements Assume that Lloyd’s Bicycles actually used 8, 400 machine-hours during the year. What is the production volume variance? © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 58

Production Volume Variance Production volume variance = (Denominator level – Actual level) × Budgeted fixed manufacturing overhead rate Theoretical capacity: (10, 000 – 8, 400) × $20. 00 = $32, 000 U Practical capacity: (8, 500 – 8, 400) × $23. 53 = $2, 353 U © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 59

Production Volume Variance Normal capacity: (7, 500 – 8, 400) × $26. 67 = $24, 003 Master-budget capacity: (6, 000 – 8, 400) × $33. 33 = $79, 992 © 2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 9 - 60