Variable Costing: A Tool for Management

1
Variable Costing ATool for Management

• Chapter Seven

2
Overview of Absorptionand Variable Costing
VariableCosting
AbsorptionCosting
3
Unit Cost Computations

• Harvey Company produces a single productwith the
  following information available

4
Income Comparison ofAbsorption and Variable
Costing

• Lets assume the following additional
  information for Harvey Company.
• 20,000 units were sold during the year at a price
  of 30 each.
• There were no units in beginning inventory.
• Now, lets compute net operatingincome using
  both absorptionand variable costing.

5
Extended Comparison of Income Data Harvey Company
Year Two
6
Income Comparison
7
Summary
8
Effect of Changes in ProductionHarvey Company
Year One
9
Effect of Changes in ProductionHarvey Company
Year Two
10
Income Comparison
11
Impact on the Manager
Opponents of absorption costing argue that
shiftingfixed manufacturing overhead costs
between periodscan lead to misinterpretations
and faulty decisions.
Those who favor variable costing argue that the
incomestatements are easier to understand
because net operatingincome is only affected by
changes in unit sales. Theresulting income
amounts are more consistent withmanagers
expectations.
12
CVP Analysis, Decision Makingand Absorption
costing

• Absorption costing does not support CVP
  analysis because it essentially treats fixed
  manufacturing overhead as a variable cost by
  assigning a per unit amount of the fixed overhead
  to each unit of production.

• Treating fixed manufacturing overhead as a
  variable cost can
• Lead to faulty pricing decisions and keep/drop
  decisions.
• Produce positive net operating income even
  when the number of units sold is less than the
  breakeven point.

13
External Reporting and Income Taxes
To conform toGAAP requirements,absorption
costing must be used forexternal financial
reports in the United States.
Under the TaxReform Act of 1986,absorption
costing must beused when filing income tax
returns.
14
Advantages of Variable Costingand the
Contribution Approach
Advantages
15
Variable versus Absorption Costing
16
Impact of JIT Inventory Methods
In a JIT inventory system . . .
Productiontends to equalsales . . .
So, the difference between variable
and absorption income tends to disappear.