chapter eight absorption and variable costing, and inventory management copyright © 2012 nelson...

Chapter EightAbsorption and Variable Costing,

and Inventory Management

Chapter EightAbsorption and Variable Costing,

and Inventory Management

COPYRIGHT © 2012 Nelson Education Ltd.

COPYRIGHT © 2012 Nelson Education Ltd.COPYRIGHT © 2012 Nelson Education Ltd.

Learning ObjectivesLearning Objectives

1. Explain the difference between absorption and variable costing

2. Prepare segmented income statements

3. Discuss inventory management under the economic order quantity and just-in-time (JIT) models

8-2

OBJECTIVE OBJECTIVE 11

Explain the difference between absorption and variable costing


Absorption Costing Income StatementAbsorption Costing Income Statement

• Assigns all manufacturing costs to the product– direct materials– direct labour– variable overhead– fixed overhead

• Fixed overhead is applied to the product using a predetermined overhead rate

• Required by generally accepted accounting principles (GAAP) for external reporting

8-4


Variable Costing Income StatementVariable Costing Income Statement

• Assigns only variable manufacturing costs to the product– direct materials– direct labour– variable overhead

• Fixed overhead is treated as a period expense

8-5


Example: Cornerstone 8-1Example: Cornerstone 8-1

Information:

8-6

Units in beginning inventoryUnits produced

Units sold ($300 per unit)Variable costs per unit:

Direct materialsDirect labourVariable overhead

Fixed costs:Fixed overhead per unit producedFixed selling and administrative

----10,000

8,000

$50$100

$50

$25$100,000

How to Compute Inventory Cost under Absorption Costing


ExampleExample

Required:

1. How many units are in ending inventory?

2. Using absorption costing, calculate the per-unit product cost

3. What is the value of ending inventory?

8-7


ExampleExample

Units ending inventory

Units beginning inventory

Units produced

Units sold

= + –

0 + 10,000 – 8,000=

= 2,000

8-8


Absorption CostingAbsorption Costing

Direct materials $ 50

Direct labour

Variable overhead

Fixed overheadUnit product cost

100

50

$22525

Value of ending inventory = 2,000 × $225 = $450,000

Per unit

8-9



Information:Units in beginning inventoryUnits produced




----10,000

8,000

$50$100

$50

$25$100,000

How to Compute Inventory Cost under Variable Costing

8-10


ExampleExample

Required:

1. How many units are in ending inventory?

2. Using variable costing, calculate the per-unit product cost

3. What is the value of ending inventory?

8-11


ExampleExample

Units ending inventory

Units beginning inventory

Units produced

Units sold

= + –

0 + 10,000 – 8,000=

= 2,000

8-12


Variable CostingVariable Costing

Direct materials

Direct labour

Variable overheadUnit product cost

$ 50

100

50$200

Value of ending inventory = 2,000 × $200 = $400,000

When inventory on hand exists, variable costing results in lower ending inventory than absorption costing

Only variable costs

8-13


Absorption and Variable CostingAbsorption and Variable Costing

DM

DL

Var OH

Fixed OH

DM

DL

Var OH

Variable Costing

Unit Cost

Absorption Costing

Unit Cost

Absorption Costing includes Fixed Overhead in Unit Cost, Variable Costing does not

8-14







----10,000

8,000

$50$100

$50

$25$100,000

How to Prepare an Absorption-Costing Income Statement

8-15


ExampleExample

Required:

1. Calculate the cost of goods sold under absorption costing

2. Prepare an income statement using absorption costing

8-16


ExampleExample

Cost of goods sold

Absorption unit product

costUnits sold= ×

$225= × 8,000

= $1,800,000

$50 + $100 + $50 + $25

8-17


Fairchild CompanyAbsorption-Costing Income Statement

Fairchild CompanyAbsorption-Costing Income Statement

Sales ($300 × 8,000)

Less: Cost of goods sold

Gross Margin

Less: Selling and administrative expenses

$2,400,000

1,800,000

$ 600,000

100,000

Net Income $ 500,000

Fixed selling and administrative costs

8-18







----10,000

8,000

$50$100

$50

$25$100,000

How to Prepare a Variable-Costing Income Statement

8-19


ExampleExample

Required:

8-20

1. Calculate the cost of goods sold under variable costing

2. Prepare an income statement using variable costing


ExampleExample

Cost of goods sold

Variable unit product cost

Units sold= ×

$200= × 8,000

= $1,600,000

$50 + $100 + $50

8-21


Fairchild CompanyVariable-Costing Income Statement

Fairchild CompanyVariable-Costing Income Statement

Sales ($300 × 8,000)

Less variable expenses:

Variable cost of goods sold

$2,400,000

1,600,000

Contribution margin $ 800,000

Less fixed expenses:

Fixed overhead $250,000

350,000Fixed selling and administrative 100,000

$ 450,000Net Income

8-22


Production, Sales, and Income RelationshipsProduction, Sales, and Income Relationships

1.

2.

3.

IfProduction > Sales

Production < Sales

Production = Sales

ThenAbsorption Income > Variable Income

Absorption Income < Variable Income

Absorption Income = Variable Income

8-23


Prepare segmented income statements


Segmented Income StatementsSegmented Income Statements

• Segment is a subunit of a company– divisions– departments– product lines– customer classes

• Fixed expenses are broken down into two categories:– direct fixed expenses

• directly traceable to a segment– common fixed expenses

• jointly caused by two or more segments

25


Segment MarginSegment Margin

Sales

– Variable Cost of Goods Sold

– Variable Selling Expense

Contribution Margin– Direct fixed overhead

– Direct selling and administrative

Segment Margin

8-26



Information:Sales Variable cost of goods sold Direct fixed overhead

• Sales commissions, 5% of sales• Direct fixed selling and administrative expense

estimated:◦ $10,000 for the MP3 line◦ $15,000 for the DVD line

• Common fixed overhead est., $100,000• Common selling and administrative est., $20,000

150,00020,000

MP3 Players DVD Players$400,000 $290,000

200,00030,000

How to Prepare a Segmented Income Statement

8-27


ExampleExample

Required:

28

Prepare a segmented income statement for Audiomatronics Inc. for the coming year, using variable costing


Audiomatronics Inc.Segmented Income Statement

For the Coming Year


For the Coming Year

Sales Variable cost of goods sold Variable selling expense

(150,000)

MP3 Players DVD Players$400,000 $290,000(200,000)(20,000)

Total$690,000(350,000)

5% × $290,000

(14,500)

8-29

Sales commissions = 5% of Sales5% × $400,000



For the Coming Year


For the Coming Year


(150,000)


Total$690,000(350,000)

(14,500)Contribution Margin

Less direct fixed expenses:Direct fixed overheadDirect selling & admin.

(34,500)$180,000 $125,500 $305,500

(30,000) (20,000) (50,000)(10,000) (15,000) (25,000)

$140,000 $ 90,500 $230,500Segment margin

Segment margin reflects only those costs directly related to the operation of the segment. Common costs are not included in the

segment margin

8-30



For the Coming Year


For the Coming Year


(150,000)


Total$690,000(350,000)

(14,500)Contribution Margin

Less direct fixed expenses:Direct fixed overheadDirect selling & admin.

(34,500)$180,000 $125,500 $305,500

(30,000) (20,000) (50,000)(10,000) (15,000) (25,000)

$140,000 $ 90,500 $230,500Segment margin

Common fixed overheadCommon selling & admin.

Operating Income

(100,000)(20,000)

Less common fixed expenses:

$110,5008-31


Discuss inventory management under the

economic order quantity and just-in-time (JIT) models


Ordering CostsOrdering Costs

• Costs of placing and receiving an order• Examples:

– order processing costs– cost of insurance for shipment– unloading costs

8-33


Carrying CostsCarrying Costs

• Costs of carrying inventory• Examples:

– insurance– inventory taxes– obsolescence– opportunity cost of funds ties up in inventory,

handling costs, and storage space

8-34


Stockout CostsStockout Costs

• Occur when demand is not known• Costs of not having:

– product available when demanded by a customer– raw materials available when needed for production

• Examples:– lost sales– costs of expediting– costs of interrupted production

8-35


Traditional Reasons for Carrying InventoryTraditional Reasons for Carrying Inventory

• To balance ordering or setup costs and carrying costs• To satisfy customer demand • To avoid shutting down manufacturing facilities because

of:– Machine failure– Defective parts– Unavailable parts– Late delivery of parts

• To buffer against unreliable production processes• To take advantage of discounts• To hedge against future price increases

8-36


How to Calculate Ordering Cost, and Total Inventory-Related Cost


• Mall-o-Cars Inc. uses part X7B to repair water pumps– 10,000 units of part X7B are used each year– currently purchased in lots of 1,000 units– cost of $25 to place an order– carrying cost is $2 per part per year

Information:

8-37


ExampleExample

1. How many orders for Part X7B does Mall-o-Cars place per year?

2. What is the total ordering cost of Part X7B per year?

3. What is the total carrying cost of Part X7B per year?

4. What is the total cost of Mall-o-Car’s inventory policy for Part X7B per year?

Required:

8-38


ExampleExample

1. Number of orders

= Annual number of units used ÷ Number of units in an order

= 10,000 / 1,000

= 10 orders per year

8-39


ExampleExample

2. Total ordering cost

= Number of orders × Cost per order

= 10 orders × $25

= $250

8-40


ExampleExample

3. Total carrying cost

Average number of units in inventory

= (1,000/2) × $2

= $1,000

= × Cost of carrying

one unit in inventory

8-41


ExampleExample

4. Total inventory-related cost

Total ordering cost

= $250 + $1,000

= $1,250

= + Total carrying cost

8-42


Economic Order Quantity (EOQ):The Traditional Inventory ModelEconomic Order Quantity (EOQ):The Traditional Inventory Model

• Number of units in the optimal size order• Minimizes total inventory-related costs• Formula:

2 × CO × D/CC

Cost of placing one order

Annual demand in units

Cost of carrying one unit in inventory

8-43



• Mall-o-Cars Inc. uses Part X7B to repair water pumps– 10,000 units of Part X7B are used each year– Currently purchased in lots of 1,000 units– Cost of $25 to place an order– Carrying cost is $2 per part per year

Information:

How to Calculate the EOQ

8-44


ExampleExample

1. What is the EOQ for Part X7B?

2. How many orders per year for Part X7B will Mall-o-Cars place under the EOQ policy?

3. What is the total annual ordering cost of Part X7B for a year under the EOQ policy?

4. What is the total annual carrying cost of Part X7B per year under the EOQ policy?

5. What is the total annual inventory-related cost for Part X7B under the EOQ?

Required:

8-45


ExampleExample

1. Economic Order Quantity (EOQ)

(2 × $25 × 10,000) /$2=

= 500,000/2

= 500 units

8-46


ExampleExample

2. Number of orders

= Annual number of units used / Number of units in an order

= 10,000 / 500

= 20 orders per year

8-47


ExampleExample

3. Total ordering cost

= Number of orders × Cost per order

= 20 orders × $25

= $500

8-48


ExampleExample

4. Total carrying cost

= (500/2) × $2

= $500

Average number of units in inventory

= × Cost of carrying

one unit in inventory

8-49


ExampleExample

5. Total inventory-related cost

= $500 + $500

= $1,000

Total ordering cost= + Total carrying cost

8-50


Reorder PointReorder Point

• Point in time when a new order should be placed

• Function of:– EOQ– Lead time– Rate at which inventory is used

Reorder point = Rate of usage × Lead time

8-51



Mall-o-Cars Inc. uses Part X7B to repair water pumps– 10,000 units of Part X7B are used each year– Used at a rate of 40 parts per day– Takes 5 days from time of order to arrival of order

Information:

HOW TO Calculate the Reorder Point

Required:Calculate the reorder point

8-52


ExampleExample

Reorder point = Daily usage × Lead time

Reorder point = 40 × 5 days

Reorder point = 200

8-53



• Mall-o-Cars Inc. uses Part X7B to repair water pumps– 10,000 units of Part X7B are used each year– Used at an average rate of 40 parts per day

• But some days as many as 50 parts are used

– Takes 5 days from the time of order to the arrival of the order

Information:

How to Calculate Safety Stock and the Reorder Point with Safety Stock

8-54


ExampleExample

1. Calculate the amount of safety stock

2. Calculate the reorder point with safety stock

Required:

8-55


ExampleExample

1. Safety stock

= (Maximum daily usage – Average daily usage) × lead time

= (50 – 40) × 5 days

= 50

8-56


ExampleExample

2. Reorder point= Maximum daily usage × lead time

= 50 × 5 days

= 250

= (Average daily usage × lead time) + Safety stock

= (40 × 5 days) + 50

= 250

OR

8-57


Just-in-Time (JIT) ApproachJust-in-Time (JIT) Approach

• Goods pushed through the system by present demand rather than being pushed through on a fixed schedule based on anticipated demand

• Each operation produces only what is necessary to satisfy the demand of the succeeding operation

• Reduces all inventories to very low levels• Reduces inventory carrying costs

8-58

chapter eight absorption and variable costing, and inventory management copyright © 2012 nelson...

Documents

inventory units

variable costing slide

unit variable costs

nelson education

inventory cost

fixed overhead fixed

absorption costing slide

example units