9 - 1 ©2003 prentice hall business publishing, cost accounting 11/e, horngren/datar/foster...

9 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory Costingand Capacity

Analysis

Inventory Costingand Capacity

AnalysisChapter 9

9 - 2©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 1Learning Objective 1

Identify what distinguishesvariable costing from

absorption costing.

9 - 3©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory-Costing MethodsInventory-Costing Methods

The difference between variable costingand absorption costing is based on the

treatment of fixed manufacturing overhead.

9 - 4©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Variable CostingVariable Costing

DirectMaterials

VariableFactoryLabor

VariableOverhead

Work in Process Inventory

9 - 5©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Variable CostingVariable Costing

Work in ProcessInventory

Finished GoodsInventory

Cost of Goods Sold

Income Summary

Fixed FactoryLabor

9 - 6©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 2Learning Objective 2

Prepare income statementsunder absorption costing

and variable costing.

9 - 7©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparing Income StatementsComparing Income Statements

The following data pertain to Davenport Fixtures:

Year 1 Year 2 TotalBeginning inventory -0- 2,000 -0-Produced 10,000 11,500 21,500Sold 8,000 13,000 21,000Ending inventory 2,000 500 500

9 - 8©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparing Income StatementsComparing Income Statements

The following information is on a per unit basis:

Sales price: $71.00

Variable manufacturing costs:Direct materials: $ 4.00Direct manufacturing labor: $21.00Indirect manufacturing costs: $24.00

Fixed manufacturing costs: $ 4.50

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

Comparing Income Statements(Absorption Costing)

Comparing Income Statements(Absorption Costing)

Total fixed production costs are $54,000at a normal capacity of 12,000 units.

Fixed nonmanufacturing costs are$30,000 per year.

Variable nonmanufacturing costs are$2.00 per unit sold.

9 - 10©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparing Income Statements(Absorption Costing)

Comparing Income Statements(Absorption Costing)

Revenues $568,000Cost of goods sold 428,000Volume variance (U) 9,000Gross margin $131,000Nonmanufacturing costs 46,000Operating income $ 85,000

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

Comparing Income Statements(Absorption Costing)

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

9 - 12©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparing Income Statements (Variable Costing)

Comparing Income Statements (Variable Costing)

Revenues $568,000Cost of goods sold 392,000Variable nonmanufacturing costs 16,000Contribution margin $160,000Fixed manufacturing costs 54,000Fixed nonmanufacturing costs 30,000Operating income $ 76,000

9 - 13©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 3Learning Objective 3

Explain differences in operatingincome under absorption

costing and variable costing.

9 - 14©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Operating Income(Absorption Costing)

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 = $2,250underallocated fixed manufacturing costs

9 - 15©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Operating Income(Absorption Costing)

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 = $26,000variable costs + $30,000 fixed costs = $56,000

9 - 16©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Operating Income(Absorption Costing)

Operating Income(Absorption Costing)

What is the operating income before taxes?

$225,250 – $56,000 = $169,250

What is the operating income for thetwo years combined?

$85,000 + $169,250 = $254,250

9 - 17©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Income Statements (Absorption Costing)Income Statements (Absorption Costing)

Year 1 Year 2 CombinedRevenues $568,000 $923,000 $1,491,000Cost of goods sold 428,000 695,500 1,123,500Volume variance (U) 9,000 2,250 11,250Gross margin $131,000 $225,250 $ 356,250Nonmfg. costs 46,000 56,000 102,000Operating income $ 85,000 $169,250 $ 254,250

9 - 18©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Operating Income(Variable Costing)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

9 - 19©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Operating Income(Variable Costing)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

9 - 20©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Income Statements(Variable Costing)Income Statements(Variable Costing)

Year 1 Year 2 CombinedRevenues $568,000 $923,000 $1,491,000Cost of goods sold 392,000 637,000 1,029,000Mfg. contr. margin $176,000 $286,000 $ 462,000Variable nonmfg. 16,000 26,000 42,000Net contr. margin $160,000 $260,000 $ 420,000

9 - 21©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Income Statements(Variable Costing)Income Statements(Variable Costing)

Year 1 Year 2 CombinedNet contr. margin $160,000 $260,000 $420,000Fixed mfg. costs 54,000 54,000 108,000Fixed nonmfg. costs 30,000 30,000 60,000Operating income $ 76,000 $176,000 $252,000

9 - 22©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of Variableand Absorption CostingComparison of Variableand 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?

9 - 23©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of Variableand Absorption CostingComparison of Variableand Absorption Costing

Production exceeds sales in Year 1.

The 2,000 units in ending inventoryare valued as follows:

Absorption costing: 2,000 × $53.50 = $107,000

Variable costing: 2,000 × $49.00 = $ 98,000

Difference: $ 9,000

9 - 24©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of Variableand Absorption CostingComparison of Variableand 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?

9 - 25©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of Variableand Absorption CostingComparison of Variableand 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 underabsorption costing: $ 6,750

9 - 26©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of Variableand Absorption CostingComparison of Variableand 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

9 - 27©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of Variableand Absorption CostingComparison of Variableand Absorption Costing

Absorption costingoperating income

Variable costingoperating income

Fixed manufacturingcosts in endinginventory under

absorption costing

Fixed manufacturingcosts in beginninginventory under

absorption costing

–

EQUALS

–

9 - 28©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 4Learning Objective 4

Understand how absorptioncosting can provide undesirable

incentives for managers tobuild up finished goods inventory.

9 - 29©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory BuildupInventory Buildup

What is the production volume variance?

(12,000 – 4,400) × $4.50 = $34,200 U

What is the net operating income or lossfor the period?

Assume that Davenport Fixtures produced4,400 units in Year 1 and sold 4,100.

9 - 30©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory BuildupInventory Buildup

Revenues (4,100 × $71) $291,100Cost of goods sold (4,100 × $53.50) 219,350Volume variance 34,200Gross margin $ 37,550Nonmanufacturing costs 38,200Net loss $ 650

9 - 31©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory BuildupInventory Buildup

4,400 – 4,100 = 300

How much cost is in ending inventory?

300 × $53.50 = $16,050

How many units are in ending inventory?

9 - 32©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory BuildupInventory Buildup

Sales remain the same (4,100 units).

What is the volume variance?

(12,000 – 9,000) × $4.50 = $13,500 U

Suppose that management decides toproduce 9,000 units next year.

What is the operating income or loss?

9 - 33©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory BuildupInventory Buildup

Revenues (4,100 × $71) $291,100Cost of goods sold (4,100 × $53.50) 219,350Volume variance 13,500Gross margin $ 58,250Nonmanufacturing costs 38,200Net income $ 20,050

9 - 34©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory BuildupInventory Buildup

300 + 9,000 – 4,100 = 5,200

How much cost is in ending inventory?

5,200 × $53.50 = $278,200

How many units are in ending inventory?

9 - 35©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 5Learning Objective 5

Differentiate throughputcosting from variable costing

and absorption costing.

9 - 36©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

Revenues $568,000Variable direct materials cost of goods sold 32,000Throughput contribution margin $536,000Manufacturing costs 504,000Nonmanufacturing costs 46,000Operating loss $ 14,000

9 - 37©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

Manufacturing Costs:Labor $21.00 × 10,000 $210,000Indirect costs $24.00 × 10,000 240,000Fixed costs 54,000Total manufacturing costs $504,000

What are other nonmanufacturing costs for the year?

9 - 38©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

Nonmanufacturing Costs:Variable $2.00 × 8,000 $16,000Fixed 30,000Total $46,000

9 - 39©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

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

Difference in operating income: $90,000

How can this difference be explained?

9 - 40©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

The 2,000 units in ending inventoryare valued as follows:

Variable2,000 × $49 = $98,000

Throughput2,000 × $4 = $8,000

$90,000 difference

9 - 41©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

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

Difference in operating income: $99,000

How can this difference be explained?

9 - 42©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Throughput CostingThroughput Costing

The 2,000 units in ending inventoryare valued as follows:

Absorption2,000 × $53.50 =

$107,000

Throughput2,000 × $4= $8,000

$99,000 difference

9 - 43©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of InventoryCosting Methods

Actual CostingActual Costing

AbsorptionCosting

AbsorptionCosting

ThroughputCosting

ThroughputCosting

VariableCostingVariableCosting

9 - 44©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of InventoryCosting Methods

Normal CostingNormal Costing

AbsorptionCosting

AbsorptionCosting

ThroughputCosting

ThroughputCosting

VariableCostingVariableCosting

9 - 45©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Comparison of InventoryCosting Methods

Standard CostingStandard Costing

AbsorptionCosting

AbsorptionCosting

ThroughputCosting

ThroughputCosting

VariableCostingVariableCosting

9 - 46©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 6Learning Objective 6

Describe the variouscapacity concepts

that can be used inabsorption costing.

9 - 47©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Alternative Denominator-LevelConcepts

Alternative Denominator-LevelConcepts

Theoretical capacity

Practical capacity

Normal capacity

Master-budget capacity

9 - 48©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Budgeted Fixed ManufacturingOverhead Rate

Budgeted Fixed ManufacturingOverhead Rate

Lloyd’s Bicycles produces bicycle partsfor domestic and foreign markets.

Fixed overhead costs are $200,000 within therelevant range of the various capacity volume.

9 - 49©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Budgeted Fixed ManufacturingOverhead Rate

Budgeted Fixed ManufacturingOverhead Rate

Assume that the theoretical capacity is10,000 machine-hours, practical capacity

is 85%, normal capacity is 75%, andmaster-budget capacity is 60%.

What is the budgeted fixed manufacturingoverhead rate at the various capacity levels?

9 - 50©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Budgeted Fixed ManufacturingOverhead Rate

Budgeted Fixed ManufacturingOverhead 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

9 - 51©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 7Learning Objective 7

Understand the major factorsmanagement considers in choosing

a capacity level to compute thebudgeted fixed overhead cost rate.

9 - 52©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Choosing a Capacity Level Choosing a Capacity Level

What factors are consideredin choosing a capacity level?

Productcosting

Pricingdecision

Performanceevaluation

Financialstatements

Regulatoryrequirements

Difficulty

9 - 53©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Decision MakingDecision Making

Assume that Lloyd’s Bicycles’ standardhours are 2 hours per unit.

What is the budgeted fixed manufacturingoverhead cost per unit?

9 - 54©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Decision MakingDecision 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

9 - 55©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 8Learning Objective 8

Describe how attempts torecover fixed costs of capacity

may lead to price increasesand lower demand.

9 - 56©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Downward Demand Spiral

The downward demand spiral is the continuingreduction in demand that occurs when the pricesof competitors are not met and demand drops.

9 - 57©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 9Learning Objective 9

Explain how the capacitylevel chosen to calculate

the budgeted fixed overheadcost rate affects the

production-volume variance.

9 - 58©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Effect on Financial StatementsEffect on Financial Statements

Assume that Lloyd’s Bicycles actually used8,400 machine-hours during the year.

What is the production volume variance?

9 - 59©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Production Volume VarianceProduction 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

9 - 60©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Production Volume VarianceProduction Volume Variance

Normal capacity:(7,500 – 8,400) × $26.67 = $24,003

Master-budget capacity:(6,000 – 8,400) × $33.33 = $79,992

9 - 61©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

End of Chapter 9End of Chapter 9