Notes And Summary In Product Costing With Quizzer.doc

PRODUCT COSTING ABSORPTION COSTING (also called full costing, conventional costing) Costing method that includes all manufacturing costs (direct materials, direct labor, and both variable and fixed manufacturing overhead) in the cost of a unit of product. It treats fixed manufacturing overhead as product cost.

VARIABLE COSTING (also called direct costing) Costing method that includes only variable manufacturing costs (direct materials, direct labor, and variable manufacturing overhead) in the cost of a unit of product. It treats fixed manufacturing overhead as a period cost.

DISTINCTIONS BETWEEN PERIOD COSTS AND PRODUCT COSTS: PERIOD COST

PRODUCT COST

Refers to an item charged against current revenue on the basis of time period regardless of the difference between production and sales volume.

Refers to an item included in product costing which is apportioned between the sold and unsold units.

Does not form part of the cost of inventory.

The portion of the cost, which has been allocated to the unsold units, becomes part of the inventory.

Diminishes income for the current period by its full amount.

Diminishes current income by the portion thereof identified with the sold units only with the remainder being deferred to the next accounting period as part of the cost of ending inventory.

PRINCIPAL DIFFERENCES BETWEEN VARIABLE AND CONVENTIONAL ABSORPTION COSTING: ABSORPTION COSTING

VARIABLE COSTING

Cost Segregation

Seldom segregates costs into variable and fixed costs

Costs are segregated into variable and fixed

Cost of inventory

Cost of inventory includes all the manufacturing costs: materials, labor, variable factory overhead, and fixed factory

Cost of inventory includes only the variable manufacturing costs: materials, labor and

ABSORPTION COSTING

VARIABLE COSTING

overhead

variable factory overhead

Treatment of fixed factory overhead

Fixed factory overhead is treated as product cost.

Fixed factory overhead is treated as period cost.

Income statement

Distinguished between production and other costs.

Distinguishes between variable and fixed costs.

Net income

Net income between the two methods may differ from each other because of the difference in the amount of fixed overhead costs recognized as expense during an accounting period. This is due to variations between sales and production. In the long run, however, both methods give substantially the same results since sales cannot continuously exceed production, noe production can continually exceed sales.

DIFFERENCE IN NET INCOME UNDER ABSORPTION AND VARIABLE COSTING: Variable and absorption costing methods of accounting for fixed manufacturing overhead result in different levels of net income in most cases. The differences are timing differences, i.e., when to recognize the fixed manufacturing overhead as an expense. In variable costing, it is expensed during the period when the fixed overhead is incurred, while in absorption costing, it is expensed in the period when the units to which such fixed overhead has been related are sold.

Production Equals Sales: When production is equal to sales, there is no change in inventory. Fixed overhead expensed under absorption costing equals fixed overhead expensed under variable costing. Therefore, absorption costing income equals variable costing income.

Production is Greater Than Sales: When production is greater than sales, there is an increase in inventory. Fixed overhead expensed under absorption costing is less than fixed overhead expensed under variable costing. Therefore, absorption income is greater than variable costing.

Production is less than Sales: When production is less than sales, there is decrease in inventory. Fixed expensed under absorption is greater than fixed overhead expensed under variable costing. Therefore, absorption income is greater variable costing income.

ARGUMENTS FOR THE USE OF VARIABLE COSTING Variable costing reports are simpler and more understandable. Date needed for break-even and cost-volume-profit analysis are readily available.

The problems involved in allocating fixed costs are eliminated. Variable costing is more compatible with the standard cost accounting system. Variable costing reports provide useful information for pricing decisions and other decision-making problems encountered by management.

ARGUMENTS AGAINST VARIABLE COSTING Segregation of costs into fixed and variable might be difficult, particularly in the case of mixed costs. The matching principle is violated by using variable costing which excludes fixed overhead from product costs and charges the same to period costs regardless of production and sales. With variable costing, inventory costs and other related accounts, such as working capital, current ratio, and acid-test ratio are understated because of the exclusion of fixed overhead in the computation of product cost.

THROUGHTPUT COSTING (or SUPER VARIABLE COSTING) An extreme form of variable costing in which only direct material costs are included as inventorable costs. All other costs are costs of the period in which they are incurred.

Throughout margin = Revenue – Direct material cost of the goods sold

EXERCISES: Jervick Company began business in 2015. Production for the year was 50,000 units of hairpin, and sales were 48,000 units. Selling price is P1.10 per unit. Costs incurred during the year were as follows: Materials Direct labor Variable overhead

P15,000 7,500 12,500

Fixed overhead

5,000

Variable selling expenses

5,760

Fixed selling and administrative expenses Total actual costs

10,000 P55,760

Compute the product cost per unit under absorption and variable costing. What was variable Cost of Goods Sold for 2015 under variable costing? What was the Cost of Goods Sold for 2015 under absorption costing? What was the value of ending inventory under variable costing? Under absorption costing?

What was income for 2015 under variable costing? Under absorption costing? How much fixed overhead was changed to expense in 2015 under variable costing? Under absorption costing?

Refer to Item 1. Compute the throughput margin and income under throughput costing. Leonor Corporation developed the following standards unit cost at 100% of its normal production capacity, which is 20,000 units per year: Materials

P5

Labor

20

Factory overhead (80% variable)

40

Unit product cost

P65

The product is sold for P100 per unit. Variable selling and administrative expenses are P6 per unit sold, and fixed non-manufacturing expenses total P92,000 for the period. During the year, 22,000 units were produced and 23,000 units were sold. There is not work if proves beginning or ending inventories, and finished goods inventory is maintained at standard costs, which has not changed from the preceding year. In the current year, there is a favourable prime cost variance of P8,000 and an unfavourable variable overhead variance of P12,000. All standard cost variances are written off to cost of goods sold at the end of the period.

REQUIRED:

1 Prepare an income statement on the absorption costing basis. 2. Prepare an income statement on the variable costing bases. 3. Compute and reconcile the difference in operating income for the current year under absorption costing a variable costing.

Kotsekotsehan Motors assembles and sells miniature toy motor vehicles and uses standard costing. Actual data relating to April and May 2015 are as follows:

Unit data: Beginning inventory

April

May 0

150

Production

500

400

Sales

350

520

P10,000

P10,000

Variable costs: Manufacturing cost per unit produced

Unit data:

April

Operating (marketing) cost per unit sold

May

3,000

3,000

P2,000,000

P10,000

600,000

600,000

Fixed costs: Manufacturing costs Operating (marketing) costs

The selling price per toy vehicle is P24,000. 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.

REQUIRED: Prepare April and May 2015 income statements for Kotsekotsehan Motors under (a) variable costing and (b) absorption costing. Prepare a numerical reconciliation and explanation of the difference between operating income for each month under variable costing and absorption costing. The variable manufacturing costs per unit of Kotsekotsehan Motors are as follows:

April Direct materials

May

P6,700

P6,700

Direct labor

1,500

1,500

Factory overhead

1,800

1,800

Prepare income statements for Kotsekotsehan Motors in April and May of 2015 under throughput costing.

The following information is available for Yamyam Company’s new product line:

Sale price per unit Variable manufacturing cost per unit of production Total annual fixed manufacturing cost Variable administrative cost per unit Total annual fixed and administrative expenses

P

15 8 25,000 3 15,000

Sale price per unit

P

15

There was no inventory at the beginning of the year. Normal capacity is 12,500 units. During the year, 12,500 units were produced and 10,000 units were sold.

REQUIRED: Ending inventory, assuming the use of direct costing. Ending inventory, assuming the use of absorption costing. Total variable cost charged to expense for the year, assuming the use of direct costing. Total fixed cost charged to expense for the year, assuming the use of absorption costing.

Lorrea Company was organized just a year ago. The results of the company’s first year of operations are shown below (absorption costing basis):

LORREA COMPANY Income Statement

Sales (2,000 units)

P135,000

Less: Cost of goods sold/variable cost: Beginning inventory Cost of goods manufactured Goods available for sale Ending inventory

P

-0105,000 P105,000 21,000

84,000

Gross margin

51,000

Less: Selling and administrative expenses

42,000

Net income

P 9,000

The company’s selling and administrative expenses consist of P32,000 per year in fixed expenses and P5 per unit sold in variable expenses. The company’s unit product cost is computed as follows:

Variable manufacturing cost Fixed manufacturing overhead (based on normal capacity of 2,500 units)

P32 10

Variable manufacturing cost

P32

Unit product cost

P42

REQUIRED:

1. Redo the company’s income statement in the contribution format using variable costing. 2. Reconcile any difference between the net income figure on your variable costing income statement and the net income figure on the absorption costing income statement above.

M. Raagas Company produces and sells a single product. The following costs relate to its production and sales:

Variable cost per unit: Materials

P9

Labor

10

Manufacturing overhead

5

Selling and administrative expenses

3

Fixed costs per year: Manufacturing overhead Selling and administrative expenses

P150,000 400,000

During the last year, 25,000 units were produced and 22,000 units were sold. The finished Goods Inventory account at the end of the year shows a balance of P72,000 for the 3,000 unsold units. REQUIRED: 1. Is the company using absorption costing or variable costing to cost units in the Finished Goods Inventory account? 2. Assume that the company wished to prepare financial statements for the year to issue to its stockholders. Is the P72,000 figure for Finished Goods Inventory the correct amount to use on these statements for external reporting purposes? At what peso amount should the 3,000 units be carried in the inventory for external reporting purposes?

During its first year of operations, Sugar Ray Company produced 55,000 jars of hand cream based on a formula containing 10 percent glycolic acid. Unit sales were 53,500 jars. Fixed overhead was applied at

P0.50 per unit produced. Fixed overhead was underapplied by P10,000. This fixed overhead variance was closed to Cost of Goods Sold. There was no variable overhead variance. The results of the year’s operations are as follows (on an absorption-costing basis):

Sales (53,500 units @ P8.50)

P454,750

Less: Cost of goods sold

(170,500)

Gross margin

P284,250

Less: Selling and administrative (all fixed)

(120,000)

Net income

P164,250

REQUIRED: 1. Give the cost of the firm’s ending inventory under absorption costing. What is the cost of the ending inventory under variable costing? 2. Compute the income under variable costing. Reconcile the difference between the two income figures.

Els Company had net income for the first 10 months of the current year of P200,000. They used a standard costing system, and there were no variances through October 31. One hundred thousand units were manufactured during the period, and 100,000 units were sold. Fixed manufacturing overhead was P2M over the 10 month period. There are no selling and administrative expenses for Els Company. All variances are disposed of at year-end by an adjustment to cost of goods sold. Both variable and fixed costs are expected to continue at the same rates for the balance of the year (i.e., fixed costs at P200,000 per month and variable costs at the same variable cost per unit). There were 10,000 units in inventory on October 31. Eighteen thousand units are to be produced and 22,000 units are to be sold in total over the last two months of the current year. Assume the standard unit variable cost is the same in the current year as in the previous year.

REQUIRED: 1. If operations proceed as described, will net income be higher under variable or absorption costing for the current year in total? 2. If operations proceed as described, what will net income for the year in total be under: a) variable costing; and b) absorption costing? Ignore income taxes.

“Now this doesn’t make any sense at all,” said Florence Gale, financial vice president for Warner Bros. Company. “Our sales have been steadily rising over the last several months, but profits have been going in the opposite direction. In September we finally hit P2,000,000 in sales, but the bottom line for that month drops off to a P100,000 loss. Why aren’t profit more closely correlated with sales?”

The statements to which Ms Gale was referring are shown below:

July

August

P1,750,000

P1,875,000

P2,000,000

80,000

320,000

400,000

Variable manufacturing cost

765,000

720,000

540,000

Fixed manufacturing overhead

595,000

560,000

420,000

Cost of goods manufactured

1,360,000

1,280,000

960,000

1,440,000

1,600,000

1,360,000

320,000

400,000

80,000

1,120,000

1,200,000

1,280,000

Sales (@P25)

September

Less cost of goods sold: Beginning inventory Cost applied to production:

Goods available for sale Less ending inventory Cost of goods sold

Underapplied or (overapplied) fixed Overhead cost

.

140,000

1,085,000

1,200,000

1,420,000

Gross margin

665,000

675,000

580,000

Less selling and administrative expenses

620,000

650,000

680,000

25,000

P (100,000)

Adjusted cost of goods sold

Net income (loss)

(35,000)

P

45,000

-0-

P

Harry Harp, a new graduate from Jose Rizal Memorial State University who has just been hired by Warner, has stated to Ms. Gale that the contribution approach, with variable costing, is a much better way to report profit data to management. Sales and production data for the last quarter follow:

July

August

September

Production in units

85,000

80,000

60,000

Sales in units

70,000

75,000

80,000

Additional information about the company’s operations is given below: Five thousand units were in inventory on July 1. Fixed manufacturing overhead costs total P1,680,000 per quarter and are incurred evenly throughout the quarter. This fixed manufacturing overhead cost is applied to

units of product on the basis of a budgeted production volume of 80,000 units per month. Variable selling and administrative expenses are P6 per unit sold. The remainder of the selling and administrative expenses on the statements above are fixed. The company uses a FIFO inventory flow assumption. Work in process inventories are insignificant and can be ignored.

“I know production is somewhat out of step with sales,” said Karla Cortes, the company’s controller. “But we had to build inventory early in the quarter in anticipation of a strike in September. Since the union settled without a strike, we then had to cut back production in September in order to work off the excess inventories. The income statements you have are completely accurate.”

REQUIRED: Without preparing income statements, compute the income for each month using variable costing. Compute the monthly breakeven point under variable costing Explain to Ms. Gale why profits have moved erratically over the three-month period shown in the absorption closing statements above and why profits have not been more closely related to changes in sales volume. Reconcile that the company had decided to introduce JIT inventory methods at the beginning of September. (Sales and production during July and August were as shown above) How many units would have been produced during September under JIT? Starting with next quarter (October-December) would you expect any difference between the income reported under absorption costing and under variable costing? Explain why there would or would not be any difference.

The following annual flexible budget has been prepared for use in making decisions relating to Product X.

100,000 Units Sales volume

150,000 Units

200,000 Units

P800,000

P1,200,000

P1,600,000

P300,000

P450,000

P600,000

200,000

200,000

200,000

P500,000

P650,000

P800,000

Manufacturing costs: Variable Fixed

100,000 Units

150,000 Units

200,000 Units

P 200,000

P 300,000

P 400,000

160,000

160,000

160,000

P360,000

P460,000

P560,000

(P60,000)

P90,000

P240,000

Selling and other expenses: Variable Fixed

Income (or loss)

The 200,000 unit budget has been adopted and will be used for allocating fixed manufacturing costs to units of Product X. at the end of the first six months the following information is available:

Units Production completed

120,000

Sales

60,000

All fixed costs are budgeted and incurred uniformly throughout year and all costs incurred coincide with budget.

Over- and underapplied fixed manufacturing costs are deferred until year-end. Annual sales have the following seasonal pattern:

Portion of Annual Sales First quarter

10%

Second quarter

20%

Third quarter

30%

Fourth quarter

40% 100%

REQUIRED: The amount of fixed factory costs applied to product during the first six months under absorption costing would be Overapplied by P20,000 Equal to the fixed costs incurred Underapplied by P40,000 Underapplied by P80,000

Reported net income (or loss) for the first six months under absorption costing Reported net income (or loss) for the first six months under direct costing.

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