Costing Final Ppt
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Absorption costing Group no-4 Apparel Production-6 National Institute Of Fashion Technology Mumbai
Absorption costing • Costing method which involves or “absorbs” all the costs necessary to produce the product into its saleable form.
The layman’s language The only cost of driving my car on a 200 mile trip today is $12 for gasoline.
Variable Costing
No! You must consider these costs too! Cost Car payment Insurance
Per month
Per day
$ 300.00
$ 10.00
60.00
2.00
Absorption Costing
Two Costing Methods Absorption Costing ✔ Used for external financial reporting ✔ Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost
Two Costing Methods Variable Costing ✔ Used for internal planning and decision making ✔ Does not include fixed factory overhead as a product cost
Absorption Costing Compared to Variable Costing Absorption Costing Cost of Goods Manufactured Direct Materials
Direct Labor
Variable Factory OH
Cost of Goods Manufactured
Variable Costing
Fixed Factory OH Period Expense
Overview of Absorption and Variable Costing Absorption Costing
Variable Costing Direct Materials
Product Costs
Direct Labor
Product Costs
Variable Manufacturing Overhead Fixed Manufacturing Overhead
Period Costs
Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses
Period Costs
• An example of income comparisons using variable and absorption costings
Unit Cost Computations ABC Co. produces a single product with the following information available: Number of units produced annually Variable costs per unit: Direct materials, direct labor, and variable mfg. overhead Selling & administrative expenses
25,000
$ $
Fixed costs per year: Manufacturing overhead Selling & administrative expenses
$ 150,000 $ 100,000
10 3
Unit Cost Computations Unit product cost is determined as follows: Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 ÷ 25,000 units) Unit product cost
Absorption Costing
Variable Costing
$
10
$
10
$
6 16
$
10
Selling and administrative expenses are always treated as period expenses and deducted from revenue.
Income Comparison of Absorption and Variable Costing ABC Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year. Absorption Costing Sales (20,000 × $30) Less cost of goods sold: Beginning inventory $ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 Gross margin Less selling & admin. exp. Variable Fixed Net operating income
$ 600,000
320,000 280,000
Income Comparison of Absorption and Variable Costing ABC Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year. Absorption Costing Sales (20,000 × $30) Less cost of goods sold: Beginning inventory $ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 Gross margin Less selling & admin. exp. Variable (20,000 × $3) $ 60,000 Fixed 100,000 Net operating income
$ 600,000
320,000 280,000
160,000 $ 120,000
Income Comparison of Absorption and Variable Costing Now let’s look at variable costing by ABC Co. Variable costs only.
Variable Costing
Sales (20,000 × $30) Less variable expenses: Beginning inventory $ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income
$ 600,000
All fixed manufacturing overhead is expensed. 260,000 340,000
250,000 $ 90,000
Income Comparison of Absorption and Variable Costing Let’s compare the methods. Cost of Goods Sold
Ending Inventory
Period Expense
Absorption costing Variable mfg. costs $ 200,000 Fixed mfg. costs 120,000 $ 320,000
$ 50,000 30,000 $ 80,000
$
Variable costing Variable mfg. costs $ 200,000 Fixed mfg. costs $ 200,000
$ 50,000 $ 50,000
$
$
-
150,000 $ 150,000
Total $ 250,000 150,000 $ 400,000
$ 250,000 150,000 $ 400,000
Reconciliation We can reconcile the difference between absorption and variable income as follows: Variable costing net operating income $ 90,000 Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net opearting income $ 120,000
Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000 units
Extending the Example Let’s look at the second year of operations for ABC Company.
ABC Co. Year 2 In its second year of operations, ABC Co. started with an inventory of 5,000 units, produced 25,000 units and sold 30,000 units. Number of units produced annually Variable costs per unit: Direct materials, direct labor variable mfg. overhead Selling & administrative expenses Fixed costs per year: Manufacturing overhead Selling & administrative expenses
25,000
$
10
$
3
$ 150,000 $ 100,000
ABC Co. Year 2 Unit product cost is determined as follows:
Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 ÷ 25,000 units) Unit product cost
Absorption Costing
Variable Costing
$
10
$
10
$
6 16
$
10
No change in ABC’s cost structure.
ABC Co. Year 2 Now let’s look at ABC’s income statement assuming absorption costing is used.
ABC Co. Year 2 Absorption Costing Sales (30,000 × $30) Less cost of goods sold: Beg. inventory (5,000 × $16) Add COGM (25,000 × $16) Goods available for sale Less ending inventory Gross margin Less selling & admin. exp. Variable (30,000 × $3) Fixed Net operating income
$ 900,000 $ 80,000 400,000 480,000 -
$ 90,000 100,000
These are the 25,000 units produced in the current period.
480,000 420,000
190,000 $ 230,000
ABC Co. Year 2 Next, we’ll look at ABC’s income statement assuming is used.
ABC Co. Year 2 Variable costs only.
Variable Costing
Sales (30,000 × $30) Less variable expenses: Beg. inventory (5,000 × $10) $ 50,000 Add COGM (25,000 × $10) 250,000 Goods available for sale 300,000 Less ending inventory Variable cost of goods sold 300,000 Variable selling & administrative expenses (30,000 × $3) 90,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income
$ 900,000
All fixed manufacturing overhead is expensed. 390,000 510,000
250,000 $ 260,000
Reconciliation We can reconcile the difference between absorption and variable income as follows: Variable costing net operating income $ 260,000 Deduct: Fixed manufacturing overhead costs released from inventory (5,000 units × $6 per unit) 30,000 Absorption costing net operating income $ 230,000
Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000 units
Summary Income Comparison Costing Method Absorption Variable
1st Period $ 120,000 90,000
2nd Period $ 230,000 260,000
Total $ 350,000 350,000
IF THEN
Units Sold < Units produced Variable Costing < Absorption Costing Income Income
IF THEN
Units Sold > Units produced Variable Costing > Absorption Costing Income Income
• when production > sales, absorption costing net income will be greater than variable costing net income due to the current period fixed costs held in inventory. • when production < sales, absorption costing net income will be less than variable costing net income due to the “old” fixed costs released from inventory. • when production = sales, absorption costing net income and variable costing net income will be equal.
Variable versus Absorption Costing
They are the numbers that appear on our external reports.
Absorption Costing
Absorption costing product costs are misleading for decision making.
Variable Costing
Absorption Costing Cost of goods sold decreases because production exceeds sales, leaving a portion of fixed manufacturing costs in inventory. Variable cost Fixed manufacturing overhead Units sold
Units Total Variable Produced Cost 10,000 $100,000 12,000 $120,000 14,000 $140,000 16,000 $160,000 18,000 $180,000 20,000 $200,000
$10 $100,000 10,000
Fixed Total Average Manufacturing Manufacturing Manufacturing Overhead Cost Cost $100,000 $200,000 $ 20.00 $100,000 $220,000 $ 18.33 $100,000 $240,000 $ 17.14 $100,000 $260,000 $ 16.25 $100,000 $280,000 $ 15.56 $100,000 $300,000 $ 15.00
Cost of Goods Sold $ 200,000 $ 183,333 $ 171,429 $ 162,500 $ 155,556 $ 150,000
Absorption Costing Cost of goods sold decreases because production exceeds sales, leaving a portion of fixed manufacturing costs in inventory.
COGS for 10,000 units
$150,000
0 0
3 4
,0
0 0
3 0
,0
0 0
2 6
,0
0 0
2 2
,0
0 0
1 8
,0
0 0 ,0
1 4
,0
0 0
$100,000 1 0
COGS
$200,000
Number of units produced
Impact of JIT Inventory Methods In a JIT inventory system . . . Production tends to equal sales . . .
So, the difference between variable and absorption income tends to disappear.
Management’s Use of Costing Methods Variable costing reports and absorption costing reports are useful in the following situations: 1. Controlling costs 2. Pricing products 3. Planning production 4. Analyzing market segments 5. Analyzing contribution margins
Accounting Reports and Management Decisions ACCOUNTING REPORTS Absorption Costing and Variable Costing
MANAGEMENT
MANAGEMENT
DECISIONS
Controlling Costs
Pricing
Planning Production
Analyzing Market Segments
Analyzing Contribution Margins ACTUAL
PLANNED
THANK YOU
Absorption costing • Costing method which involves or “absorbs” all the costs necessary to produce the product into its saleable form.
The layman’s language The only cost of driving my car on a 200 mile trip today is $12 for gasoline.
Variable Costing
No! You must consider these costs too! Cost Car payment Insurance
Per month
Per day
$ 300.00
$ 10.00
60.00
2.00
Absorption Costing
Two Costing Methods Absorption Costing ✔ Used for external financial reporting ✔ Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost
Two Costing Methods Variable Costing ✔ Used for internal planning and decision making ✔ Does not include fixed factory overhead as a product cost
Absorption Costing Compared to Variable Costing Absorption Costing Cost of Goods Manufactured Direct Materials
Direct Labor
Variable Factory OH
Cost of Goods Manufactured
Variable Costing
Fixed Factory OH Period Expense
Overview of Absorption and Variable Costing Absorption Costing
Variable Costing Direct Materials
Product Costs
Direct Labor
Product Costs
Variable Manufacturing Overhead Fixed Manufacturing Overhead
Period Costs
Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses
Period Costs
• An example of income comparisons using variable and absorption costings
Unit Cost Computations ABC Co. produces a single product with the following information available: Number of units produced annually Variable costs per unit: Direct materials, direct labor, and variable mfg. overhead Selling & administrative expenses
25,000
$ $
Fixed costs per year: Manufacturing overhead Selling & administrative expenses
$ 150,000 $ 100,000
10 3
Unit Cost Computations Unit product cost is determined as follows: Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 ÷ 25,000 units) Unit product cost
Absorption Costing
Variable Costing
$
10
$
10
$
6 16
$
10
Selling and administrative expenses are always treated as period expenses and deducted from revenue.
Income Comparison of Absorption and Variable Costing ABC Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year. Absorption Costing Sales (20,000 × $30) Less cost of goods sold: Beginning inventory $ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 Gross margin Less selling & admin. exp. Variable Fixed Net operating income
$ 600,000
320,000 280,000
Income Comparison of Absorption and Variable Costing ABC Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year. Absorption Costing Sales (20,000 × $30) Less cost of goods sold: Beginning inventory $ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 Gross margin Less selling & admin. exp. Variable (20,000 × $3) $ 60,000 Fixed 100,000 Net operating income
$ 600,000
320,000 280,000
160,000 $ 120,000
Income Comparison of Absorption and Variable Costing Now let’s look at variable costing by ABC Co. Variable costs only.
Variable Costing
Sales (20,000 × $30) Less variable expenses: Beginning inventory $ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income
$ 600,000
All fixed manufacturing overhead is expensed. 260,000 340,000
250,000 $ 90,000
Income Comparison of Absorption and Variable Costing Let’s compare the methods. Cost of Goods Sold
Ending Inventory
Period Expense
Absorption costing Variable mfg. costs $ 200,000 Fixed mfg. costs 120,000 $ 320,000
$ 50,000 30,000 $ 80,000
$
Variable costing Variable mfg. costs $ 200,000 Fixed mfg. costs $ 200,000
$ 50,000 $ 50,000
$
$
-
150,000 $ 150,000
Total $ 250,000 150,000 $ 400,000
$ 250,000 150,000 $ 400,000
Reconciliation We can reconcile the difference between absorption and variable income as follows: Variable costing net operating income $ 90,000 Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net opearting income $ 120,000
Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000 units
Extending the Example Let’s look at the second year of operations for ABC Company.
ABC Co. Year 2 In its second year of operations, ABC Co. started with an inventory of 5,000 units, produced 25,000 units and sold 30,000 units. Number of units produced annually Variable costs per unit: Direct materials, direct labor variable mfg. overhead Selling & administrative expenses Fixed costs per year: Manufacturing overhead Selling & administrative expenses
25,000
$
10
$
3
$ 150,000 $ 100,000
ABC Co. Year 2 Unit product cost is determined as follows:
Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 ÷ 25,000 units) Unit product cost
Absorption Costing
Variable Costing
$
10
$
10
$
6 16
$
10
No change in ABC’s cost structure.
ABC Co. Year 2 Now let’s look at ABC’s income statement assuming absorption costing is used.
ABC Co. Year 2 Absorption Costing Sales (30,000 × $30) Less cost of goods sold: Beg. inventory (5,000 × $16) Add COGM (25,000 × $16) Goods available for sale Less ending inventory Gross margin Less selling & admin. exp. Variable (30,000 × $3) Fixed Net operating income
$ 900,000 $ 80,000 400,000 480,000 -
$ 90,000 100,000
These are the 25,000 units produced in the current period.
480,000 420,000
190,000 $ 230,000
ABC Co. Year 2 Next, we’ll look at ABC’s income statement assuming is used.
ABC Co. Year 2 Variable costs only.
Variable Costing
Sales (30,000 × $30) Less variable expenses: Beg. inventory (5,000 × $10) $ 50,000 Add COGM (25,000 × $10) 250,000 Goods available for sale 300,000 Less ending inventory Variable cost of goods sold 300,000 Variable selling & administrative expenses (30,000 × $3) 90,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income
$ 900,000
All fixed manufacturing overhead is expensed. 390,000 510,000
250,000 $ 260,000
Reconciliation We can reconcile the difference between absorption and variable income as follows: Variable costing net operating income $ 260,000 Deduct: Fixed manufacturing overhead costs released from inventory (5,000 units × $6 per unit) 30,000 Absorption costing net operating income $ 230,000
Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000 units
Summary Income Comparison Costing Method Absorption Variable
1st Period $ 120,000 90,000
2nd Period $ 230,000 260,000
Total $ 350,000 350,000
IF THEN
Units Sold < Units produced Variable Costing < Absorption Costing Income Income
IF THEN
Units Sold > Units produced Variable Costing > Absorption Costing Income Income
• when production > sales, absorption costing net income will be greater than variable costing net income due to the current period fixed costs held in inventory. • when production < sales, absorption costing net income will be less than variable costing net income due to the “old” fixed costs released from inventory. • when production = sales, absorption costing net income and variable costing net income will be equal.
Variable versus Absorption Costing
They are the numbers that appear on our external reports.
Absorption Costing
Absorption costing product costs are misleading for decision making.
Variable Costing
Absorption Costing Cost of goods sold decreases because production exceeds sales, leaving a portion of fixed manufacturing costs in inventory. Variable cost Fixed manufacturing overhead Units sold
Units Total Variable Produced Cost 10,000 $100,000 12,000 $120,000 14,000 $140,000 16,000 $160,000 18,000 $180,000 20,000 $200,000
$10 $100,000 10,000
Fixed Total Average Manufacturing Manufacturing Manufacturing Overhead Cost Cost $100,000 $200,000 $ 20.00 $100,000 $220,000 $ 18.33 $100,000 $240,000 $ 17.14 $100,000 $260,000 $ 16.25 $100,000 $280,000 $ 15.56 $100,000 $300,000 $ 15.00
Cost of Goods Sold $ 200,000 $ 183,333 $ 171,429 $ 162,500 $ 155,556 $ 150,000
Absorption Costing Cost of goods sold decreases because production exceeds sales, leaving a portion of fixed manufacturing costs in inventory.
COGS for 10,000 units
$150,000
0 0
3 4
,0
0 0
3 0
,0
0 0
2 6
,0
0 0
2 2
,0
0 0
1 8
,0
0 0 ,0
1 4
,0
0 0
$100,000 1 0
COGS
$200,000
Number of units produced
Impact of JIT Inventory Methods In a JIT inventory system . . . Production tends to equal sales . . .
So, the difference between variable and absorption income tends to disappear.
Management’s Use of Costing Methods Variable costing reports and absorption costing reports are useful in the following situations: 1. Controlling costs 2. Pricing products 3. Planning production 4. Analyzing market segments 5. Analyzing contribution margins
Accounting Reports and Management Decisions ACCOUNTING REPORTS Absorption Costing and Variable Costing
MANAGEMENT
MANAGEMENT
DECISIONS
Controlling Costs
Pricing
Planning Production
Analyzing Market Segments
Analyzing Contribution Margins ACTUAL
PLANNED
THANK YOU
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