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CSULB ACCT 310 - CHAPTER 7

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11CHAPTER 72Variable Costing VsAbsorption Costing3• Two systems are used to produce ISs:–Absorption Costing–Variable Costing24• Absorption Costing– All we have used so far– Cost of units• All factory costs– Factory costs expensed when inventory sold• COGS5• Absorption Costing– Inventory costs: • DL• DM• MO/H– Both FO/H & VO/H• Required by GAAP6• Variable Costing– Alternative to Absorption Costing– Not GAAP– Separates VCs & FCs37• Variable Costing– Problem with COGS• Both FC & VC– Need to change Inventory cost:• DL• DM• VO/H– Not FO/H8• FO/H (Variable Costing)– Not inventory cost• “product cost”– Expensed• “period cost”– COGS is now a VC9Different IS Formats410• Different IS formats:ABSORPTION VARIABLESales Sales-COGS -VCGM CM-SG&A -FCOP OP11• Assume:Units Produced: 10KUnits Sold: 10KPrice Per Unit: $25DM: $50KDL: $30KVO/H: $20KFO/H: $50KVariable SG&A: $30KFixed SG&A: $30K12• With These Problems:– 1stcalculate cost of 1 unit• ALWAYS!!!!!!!!!!513• Absorption Costing: • 1st Calculate cost of 1 unit DM: $50KDL: $30KVO/H: $20KFO/H: $50KTotal Costs $150K÷ Units Produced ÷10KCost Per Unit $1514• Variable Costing• 1st Calculate Cost of 1 unit:DM: $50KDL: $30KVO/H: $20KTotal Costs $100K÷ Units Produced ÷10KCost Per Unit $1015• Difference in cost– Absorption Costing ($15)– Variable Costing Method ($10)•  FO/H per unit – $50K/10K units =$5616Absorption Costing ISSales: $250K (25x10K)COGS: -150K ((10+5)x10K)GM: $100K-SG&A: -60K (30K+30K)OP: $40K17Variable Costing ISSales: $250K (25x10K)Less VC:V COGS: -100K (10x10K)V SG&A: -30KCM: $120KLess FC:FO/H: -50KF SG&A: -30KOP: $40K18• OP was same for both methods– # units sold = # units produced• OP will be different if:– # units sold ≠ # units produced• Same e.g. but assume:– 5K units sold– ½ of production719Absorption Costing ISSales: $125K (25x5K)COGS: -75K ((10+5)x5K)GM: $50K- SG&A: -45K (30K+ ½ 30K)OP: $5K20Variable Costing ISSales: $125K (25x5K)Less VC:V COGS: -50K (10x5K)V SG&A: -15K ½ (30K)CM: $60KLess FC:FO/H: -50KF SG&A: -30KOP: -$20K21Reason For Different OP822• Difference due to FO/H–Variable Costing • FO/H Cost expensed ($50K)–Absorption Costing • FO/H divided into per unit cost ($5)• Part of cost of each unit• Expensed when unit sold• ½ of units sold – ½ of FO/H expensed ($25K)23• Difference in OP– [$5K – (-$20K) = $25K]– Due to difference in treatmentof FO/H of unsold units:FO/H Per Unit x Unsold Units$5 x 5K = $25K24• Absorption Costing –Inventory Cost = $15 per unit–Cost of 5K unsold units is $75K• Variable Costing–Inventory Cost = $10 per unit–Cost of the 5K unsold units is $50K• Cost not expensed added to Inv– Nothing disappears925Cooking The Books26• Let’s Review Cost Behavior27• VC per unit doesn’t change as production increases–V=Vx↑/x↑• Total VC go up• Total units go up• VC per unit (V) stays the same1028• FC per unit drops as you produce more units– (FC per unit)↓=F/(x↑)• Total FC stays the same• Total units goes up• FC per unit drops– Spreading FC over greater # of units29• Because of these relationships– You can artificially inflate GAAP OP30• With Absorption Costing  If you produce more units:• FC per unit drops• Cost of each unit drops• You end up with• Lower COGS• Higher OP• You can artificially inflate OP1131• Assume– TC = $5K + $1/unit produced– Sales Price = $1.9032• Production: 10K units– TC = $15K = [$5K + ($1x10K)]– Unit cost = $1.50– Profit: 40¢/unit ($1.90 - $1.50)33• Production: 50K units– TC = $55K = [$5K + ($1x50K)]– Unit cost = $1.10– Profit: 80¢/unit ($1.90 - $1.10)• Co. doubled its OP – without selling more units1234Produce & Sell 10K UnitsSales: $19K ($1.90x10K)COGS: -15K ($1.50x10K)GM: $4K35Produce 50K Units & Sell 10K UnitsSales: $19K ($1.90x10K)COGS: -11K ($1.10x10K)GM: $8K36• Co made 40¢ of cost disappear – 10K units  FC per unit 50¢ ($5K/10K units)– 50K units  FC per unit 10¢ ($5K/50K units)40¢1337• The $5K FC is still there• But only $1K was expensed (with 10K units sold)• $4K is part of cost of unsold units– It is part of the cost of the unsold Inventory• It is an asset• Not an expense38• Manipulation of OP is not possible with Variable Costing– All FO/H is expensed currently – Cost of inventory  solely VCs– Can’t shift FO/H cost to Inv39• Production: 10K units–TC = $10K = ($1 x 10K)–Unit cost = $1• Production: 50K units–TC = $50K = ($1 x 50K)–Unit cost = $11440• With Variable Costing – Co has $4K of OP regardless of # of units produced41Produce & Sell 10K UnitsSales: $19K ($1.90x10K)VCOGS: -10K ($1x10K)CM: $9KFO/H: -5KOP: $4K42Produce 50K Units & Sell 10K UnitsSales: $19K ($1.90x10K)VCOGS: -10K ($1x10K)CM: $9KFO/H: -5KOP: $4K1543• Both Methods give same OP when:– Units produced = Units sold44• That is why we like Variable Costing OP– Tells you what Absorption Costing OP would have been if no over-production– It exposes OP manipulation by making unneeded units45• Over-production may improve Absorption OP• But it is detrimental to Co1646• If units sold > units producedVariable Costing OP > Absorption Costing OP47• Continue with same E.g.:Units:Produced Sold1stYear 50K 10K2ndYear 10K 50KCost Fn: $5,000 + $1/unitProduced Absorption Variable1stYear 50K $1.10/unit $1/unit2ndYear 10K $1.50/unit $1/unit48• 1stYear:Absorption CostingSales: $19K (1.90x10K)COGS: -11K ($1.10x10K)OP: $8K (80¢x10K)1749• 1stYear:Variable CostingRevenue: $19K (1.90x10K)VCOGS: -10K ($1x10K)CM: $9KFO/H: -5KOP: $4K50• Difference in OP • FO/H / unit = 10¢ •($5,000/50,000)FO/H/Unit X Unsold Units = Difference10¢ X 40,000 = $4,00051• 2ndYearAbsorption CostingSales: $95K (1.9x50K)COGS: -59K($1.10x40K)+($1.5 x 10K)OP: $36K1852• 2ndYearVariable CostingSales: $95K (1.90x50K)VCOGS: -50K ($1x50K)CM: $45KFO/H: -5KOP: $40K53• What happened?– 1stYear  Shifted $4K of FC into inventory– 2ndYear • Sold all the units produced in 2ndYear –This included all of FC for 2ndYear• Sold unsold units from 1stYear–This included $4K of FC from 1stYear– There is an extra $4K of FC in COGS in 2ndYear54• 1stYear– Units produced > Units sold– Absorption OP > Variable OP– $4K of FC put into Inv• 2ndYear– Units produced < Units sold– Absorption OP <


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CSULB ACCT 310 - CHAPTER 7

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