Variable Costing for Management Analysis

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Variable Costing for Management Analysis
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Variable Costing for Management Analysis
After studying this chapter, you should be able
to
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20-2
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Variable Costing for Management Analysis
(continued)
20-3
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Describe and illustrate reporting income from
operations under absorption and variable costing.
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Absorption Costing
Absorption costing is required under generally
accepted accounting principles for financial
statements distributed to external users.
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Variable Costing
For internal use in decision making, managers
often use variable costing.
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Costs of Goods Manufactured Comparison
Absorption Costing
Cost of Goods Manufactured
Cost of Goods Manufactured
Variable Costing
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Assume that 15,000 units are manufactured and
sold at a price 50.
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Exhibit 1
Absorption Costing Income Statement
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Contribution Margin
Note in Exhibit 2 that the variable selling and
administrative expenses are deducted from the
manufacturing margin to yield the contribution
margin.
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Exhibit 2
Variable Costing Income Statement
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Example Exercise 20-1
Variable Costing Leone Company has the following
information for March
Sales 450,000 Variable cost of goods
sold 220,000 Fixed manufacturing
costs 80,000 Variable selling and administrative
expenses 50,000 Fixed selling and administrative
expenses 35,000
Determine the March (a) manufacturing margin, (b)
contribution margin, and (c) income from
operations for Leone Company.
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Example Exercise 20-1 (continued)

1. 230,000 (450,000 220,000)
2. 180,000 (230,000 50,000)
3. 65,000 (180,000 80,000 35,000)

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Income from Operations When Units Manufactured
Exceed Units Sold
Assume that in the preceding example only 12,000
units of the 15,000 units manufactured were sold.
Examine Exhibit 3 and you will see that income
from operations using variable costing is 40,000
while absorption costing provides an income of
70,000.
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Units Manufactured Exceed Units Sold
Exhibit 5
Exhibit 3
(continued)
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Exhibit 5
Units Manufactured Exceed Units Sold
Exhibit 3
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Why is absorption costing income higher when
units manufactured exceed units sold?
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Example Exercise 20-2
Variable CostingProduction Exceeds Sales
Fixed manufacturing costs are 40 per unit, and
variable manufacturing costs are 120 per unit.
Production was 125,000 units, while sales were
120,000 units. Determine (a) whether variable
costing income from operations is less than or
greater than absorption costing income from
operations, and (b) the difference in variable
costing and absorption costing income from
operations.
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Example Exercise 20-2 (continued)
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1. Variable costing income from operations is less
   than absorption costing income from operations.
2. 200,000 (40 per unit 5,000 units)

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Income from Operations When Units Manufactured
Are Less than Units Sold
Assume that 5,000 units of inventory were on hand
at the beginning of a period, 10,000 units were
manufactured during the period, and 15,000 units
were sold at 50 per unit.
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Exhibit 5
Units Manufactured Are Less Than Units Sold
Exhibit 4
(continued)
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Exhibit 5
Units Manufactured Are Less Than Units Sold
Exhibit 4
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Example Exercise 20-3
Variable CostingSales Exceeds Production
The beginning inventory is 8,000 units. All of
the units were manufactured during the period and
6,000 units of the beginning inventory were sold.
The beginning inventory fixed manufacturing costs
are 60 per unit, and variable manufacturing
costs are 300 per unit. Determine (a) whether
variable costing income from operations is less
than or greater than absorption costing income
from operations, and (b) the difference in
variable costing and absorption costing income
from operations.
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Example Exercise 20-3 (continued)
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1. Variable costing income from operations is
   greater than absorption costing income from
   operations.

1. 360,000 (60 per unit 6,000 units)

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Comparing Income from Operations Under the Two
Concepts
IF
Units Manufactured Units Sold
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Comparing Income from Operations Under the Two
Concepts
IF
Units Manufactured gt Units Sold
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Comparing Income from Operations Under the Two
Concepts
IF
Units Manufactured lt Units Sold
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Describe and illustrate the effects of absorption
and variable costing on analyzing income from
operations.
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Frand Manufacturing Company
Frand Manufacturing Company has no beginning
inventory and sales are estimated to be 20,000
units at 75 per unit, regardless of production
levels.
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Proposal 1 20,000 Units to be Manufactured and
Sold
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Proposal 2 25,000 Units to be Manufactured and
20,000 Units to be Sold
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Exhibit 5
Absorption Costing Income Statements for Two
Production Levels
Exhibit 5
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Frand Manufacturing Company
Now, assume that Frand Manufacturing uses
variable costing and has sales of 20,000 units.
Exhibit 6 illustrates that net income remains a
constant 200,000 at the three levels of
production.
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Variable Income Statements for Three Production
Levels
Exhibit 6
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Example Exercise 20-4
Analyzing Income Under Absorption and Variable
Costing

• Variable manufacturing costs are 100 per unit,
  and fixed manufacturing costs are 50,000. Sales
  are estimated to be 4,000 units.
• a. How much would absorption costing income from
  operations differ between a plan to produce
  4,000 units and a plan to produce 5,000 units?
• How much would variable costing income from
  operations differ between the two production
  plans?

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Example Exercise 20-4 (continued)
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1. 10,000 greater in producing 5,000 units. 4,000
   units (12.50¹ 10.00²), or 1,000 units
   (50,000/5,000 units).
2. There would be no difference in variable costing
   income from operations between the two plans.

¹50,000/4,000 units ²50,000/5,000 units
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Describe managements use of absorption and
variable costing.
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Accounting Reports and Management Decisions
Exhibit 7
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Controllable and Noncontrollable Costs
For a specific level of management, controllable
costs are costs that can be influenced by
management at that level, and noncontrollable
costs are costs that another level of management
controls.
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Pricing Products
Many factors enter into determining the selling
price of a product. However, the cost of making
the product is significant in all pricing
decisions. In the short run, fixed costs cannot
be avoided.
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Pricing Products
In the long run, a company must set its selling
price high enough to cover all costs and expenses
(variable and fixed) and generate income.
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Planning Production
In the short run, planning production is limited
to existing capacity. In the long run, planning
production can consider expanding capacity.
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Analyzing Contribution Margins
Managers often plan and control operations by
evaluating the differences between planned and
actual contribution margin.
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Analyzing Market Segments
A market segment is a portion of a business that
can be analyzed using sales, costs, and expenses
to determine its profitability.
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Use variable costing for analyzing market
segments, including product, territories, and
salespersons segments.
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Analyzing Market Segments
Camelot Fragrance Company manufactures and sells
the Gwenevere perfume for women and the Lancelot
cologne line for men. The inventories are
negligible.
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Sales Territory Profitability Analysis
Sales territory profitability analysis may lead
management to

1. Reduce costs in lower-profit sales territories

1. Increase sales efforts in higher-profit
   territories

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Sales Territory Profitability Analysis
To illustrate the analysis of profit differences
by sales territory, Exhibit 8 shows the variable
costing income statements by sales territories
for Camelot Fragrance Company.
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Contribution Margin by Sales Territory Report
Exhibit 8
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Sales Territory Profitability Analysis
Contribution Margin Ratio
Contribution Margin Sales

Northern territory 43 (34,400/80,000) Southern
territory 50.5 (40,400/80,000)
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Sales mix, sometimes referred to as product mix,
is defined as the relative distribution of sales
among the various products sold.
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Product Profitability Analysis
A company should focus its sales efforts on
products that will provide the maximum total
contribution margin. Exhibit 9 illustrates the
contribution margin for each product line.
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Contribution Margin by Product Line Report
Exhibit 9
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Salesperson Profitability Analysis
Sales managers may wish to evaluate the
performance of salespersons. This may be done
with a report that shows contribution margin by
salesperson. Such a report is shown in Exhibit 10
for the Northern Territory salespersons.
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Contribution Margin by Salesperson Report
Exhibit 10
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Example Exercise 20-5
Contribution Margin by Segment
The following data are for Moss Creek Apparel
East West
Sales volume (units) Shirts 6,000 5,000 Shorts
4,000 8,000 Sales price Shirts 12
13 Shorts 16 18 Variable cost per
unit Shirts 7 7 Shorts 10
10
Determine the contribution margin for (a) Shorts
and (b) the West Region.
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Example Exercise 20-5 (continued)
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1. 88,000 4,000 units (16 10) 8,000
   units (18 10)
2. 94,000 5,000 units (13 7) 8,000
   units (18 10)

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Use variable costing for analyzing and explaining
changes in contribution margin as a result of
quantity and price factors.
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Contribution Margin Analysis
Contribution margin analysis focuses on
explaining the difference between planned and
actual contribution margins.
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Contribution Margin Analysis
A difference between the planned and actual
contribution margin may be caused by an increase
or decrease in
1. Sales
2. Variable costs
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Contribution Margin Analysis
An increase or decrease in sales or variable
costs may in turn be due to an increase or
decrease in the
1. Number of units sold
2. Unit sales price or unit cost
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Quantity factor is the effect of a difference in
the number of units sold, assuming no change in
unit sales price or unit cost.
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Unit price factor or unit cost factor is the
effect of a difference in unit sales price or
unit cost on the number of units sold.
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Contribution Margin Analysis
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Exhibit 11
Contribution Margin Analysis
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Exhibit 12
Contribution Margin Analysis Report
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Example Exercise 20-6
Contribution Margin Analysis
The actual price for a product was 48 per unit,
while the planned price was 40 per unit. The
volume increased by 5,000 units to 60,000 actual
total units. Determine (a) the quantity factor
and (b) the price factor for sales.
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Example Exercise 20-6 (continued)
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1. 200,000 increase (5,000 units 40 per unit)

1. 480,000 increase (48 40) 60,000 units

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Describe and illustrate the use of variable
costing for service firms.
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Reporting Income from Operations Using Variable
Costing for a Service Company
Unlike a manufacturing firm, a service firm does
not make a product for sale. As a result, service
firms do not have inventory and thus do not
allocate fixed costs to inventory using
absorption costing concepts.
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Service firms can, however, report and analyze
contribution margin as the difference between
revenues and variable costs. To analyze a service
firm, we will use Blues Skies Airlines. The
fixed and and variable costs associated with
operating Blue Skies are shown in Exhibit 13.
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Exhibit 13
Costs of Blue Skies Airlines, Inc.
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The variable costing income statement for Blue
Skies is shown in Exhibit 14. Notice that there
are no cost of goods sold, inventory, or
manufacturing margin. Contribution margin is
reported separately from income from operations.
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Variable Costing Income Statement
Exhibit 14
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Market Segment Analysis for Service Company
Service Industry Market Segments
Electric power Regions, customer types
(industrial, consumer) Banking Customer types
(commercial, retail), products (loans, savings
accounts) Airlines Products (passengers, cargo),
routes Railroads Products (commodity type),
routes Hotels Hotel properties Telecommunications
Customer type (commercial, retail), service type
(voice, data) Health care Procedure, payment type
(Medicare, insured)
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Blue Skies Airlines
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Contribution Margin by Segment ReportService Firm
Exhibit 15
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Blue Skies Airlines
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Contribution Margin Analysis ReportService
Company
Exhibit 16


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