Chapter 6: Variable Costing: A tool for management.pptx

Chapter:6 variable costing: A tool for management

1. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 1 5/4/2024 Managerial Accounting Chapter 6 Seventeenth edition Variable Costing: A Tool for Management Instructor: Madam Nadia Anjum By Iram Shahnawaz Kanrani

2. Learning Objective 1 Explain how variable costing differs from absorption costing and compute unit product costs under each method. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 2 5/4/2024

3. Overview of Absorption and Variable Costing Product Costs Period Costs Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Product Costs Period Costs Absorption Costing Variable Costing SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 3 5/4/2024

4. Unit Cost Computations Unit product cost is determined as follows: Under absorption costing, all production costs, variable and fixed, are included when determining unit product cost. Under variable costing, only the variable production costs are included in product costs. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 4 5/4/2024

5. Learning Objective 2 Prepare income statements using both variable and absorption costing. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 5 5/4/2024

6. Absorption Costing Fixed manufacturing overhead deferred in inventory is 5,000 units × $6 = $30,000. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 6 5/4/2024

7. Variable Costing SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 7 5/4/2024

8. Learning Objective 3 Reconcile variable costing and absorption costing net operating incomes and explain why the two amounts differ. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 8 5/4/2024

9. Comparing the Two Methods We can reconcile the difference between absorption and variable income as follows: Fixed mfg. overhead $150,000 Units produced 25,000 units = = $6 per unit SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 9 5/4/2024

10. Unit Cost Computations ince the variable costs per unit, total fixed costs, and the number of units produced remained unchanged, the unit cost computations also remain unchanged. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 10 5/4/2024

11. Comparing the Two Methods SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 11 5/4/2024

12. Summary of Key Insights SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 12 5/4/2024

13. Learning Objective 4 Understand the advantages and disadvantages of both variable and absorption costing. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 13 5/4/2024

14. Impact on the Manager Opponents of absorption costing argue that shifting fixed manufacturing overhead costs between periods can lead to faulty decisions. These opponents argue that variable costing income statements are easier to understand because net operating income is only affected by changes in unit sales. This produces net operating income figures that are consistent with managers’ expectations. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 14 5/4/2024

15. CVP Analysis, Decision Making and Absorption costing Absorption costing does not dovetail with CVP analysis, nor does it support decision making. It treats fixed manufacturing overhead as a variable cost. It assigns per unit fixed manufacturing overhead costs to production. Treating fixed manufacturing overhead as a variable cost can: Lead to faulty pricing decisions and faulty keep-or-drop decisions. Assigning per unit fixed manufacturing overhead costs to production can: Potentially produce positive net operating income even when the number of units sold is less than the breakeven point. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 15 5/4/2024

16. External Reporting and Income Taxes To conform to GAAP requirements, absorption costing must be used for external financial reports in the United States. Under the Tax Reform Act of 1986, absorption costing must be used when filling out income tax returns. Since top executives are typically evaluated based on earnings reported to shareholders in external reports, they may feel that decisions should be based on absorption costing data. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 16 5/4/2024

17. Advantages of Variable Costing and the Contribution Approach Management finds it more useful. Impact of fixed costs on profits emphasized . Profit is not affected by changes in inventories. Easier to estimate profitability of products and segments . Consistent with standard costs and flexible budgeting. Net operating income is closer to net cash flow. Consistent with CVP analysis. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 17 5/4/2024

18. Variable Costing Variable versus Absorption Costing Absorption Costing Fixed manufacturing costs must be assigned to products to properly match revenues and costs. Fixed manufacturing costs are capacity costs and will be incurred even if nothing is produced. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 18 5/4/2024

19. Variable Costing and the Theory of Constraints (TOC) Companies involved in TOC use a form of variable costing. However, one difference of the TOC approach is that it treats direct labor as a fixed cost for three reasons: Many companies have a commitment to guarantee workers a minimum number of paid hours. Direct labor is usually not the constraint. TOC emphasizes the role direct laborers play in driving continuous improvement. Since layoffs often devastate morale, managers involved in TOC are extremely reluctant to lay off employees. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 19 5/4/2024

20. Impact of Lean Production When companies use Lean Production . . . Production tends to equal sales . . . So, the difference between variable and absorption income tends to disappear. SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 20 5/4/2024

21. ABOUT US I BA University Kandhkot Campus 5/4/2024 SUKKUR IBA UNIVERSITY KANDH KOT CAMPUS 21 The establishment of Sukkur IBA University has been a ray of hope for those who cannot afford quality education. Ranked as one of the best educational institutions in Pakistan, the university has been successfully transforming the students' lives and uplifting their careers. Sukkur IBA University has emerged as a beacon of light forth underprivileged talented youth with small pockets. Having national accreditation and collaboration all around the world, Sukkur IBA University is now considered one of the best educational institutes in Pakistan.

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