Lecture 5 Inventory Costing and Capacity Analysis PDF

Dr./ Mostafa I. El-Feky Lecturer of Accounting Faculty of commerce - Mansoura University Manager of University Services Marketing Center Manager of Measurement and Assessment Unit Dr/Mostafa I. EL-Feky  Chapter 03...

Dr./ Mostafa I. El-Feky Lecturer of Accounting Faculty of commerce - Mansoura University Manager of University Services Marketing Center Manager of Measurement and Assessment Unit Dr/Mostafa I. EL-Feky  Chapter 03 Inventory Costing and Capacity Analysis Lecture 05 Dr/Mostafa I. EL-Feky  Learning Objective 1 Identify what distinguishes variable costing from absorption costing. Dr/Mostafa I. EL-Feky 3  Difference between Variable & Absorption Costing The two most common methods of costing inventories in manufacturing companies are variable costing and absorption costing. (1)Variable costing (also known as direct costing) is a method of inventory costing in which all variable manufacturing costs (direct and indirect) are included as inventoriable costs. All fixed manufacturing costs are excluded from inventoriable costs and are treated as costs of the period in which they are incurred. (2) Absorption costing is a method of inventory costing in which all variable manufacturing costs and all fixed manufacturing costs are included as inventoriable costs. Thus, inventory "absorbs" all manufacturing costs. Absorption costing is the method required for Generally Accepted Accounting Principles for external financial reporting. Dr/Mostafa I. EL-Feky 4  Overview of Absorption and Variable Costing Absorption Variable Costing Costing Direct Materials Product Product Direct Labor Costs Costs Variable Manufacturing Overhead Fixed Manufacturing Overhead Period Period Variable Selling & Administrative Exp. Costs Costs Fixed Selling & Administrative Exp. Dr/Mostafa I. EL-Feky 5  Learning Objective 2 Prepare income statements under absorption costing and variable costing. Dr/Mostafa I. EL-Feky 6  Overview of Absorption and Variable Costing El-Feky’s management wants to prepare an income statement for 2020 to evaluate the performance of the telescope product line. The operating information for the year is:- Actual price and cost data for 2020 are: - Units Selling price $ 1,000 Beginning Inventory -0- Variable manufacturing cost per unit Production 8,000 Direct material cost per unit $ 110 Sales 6,000 Direct manufacturing labor cost per unit 40 Ending Inventory 2,000 Manufacturing overhead cost per unit 50 Required Total variable manufacturing cost per unit $ 200 Variable marketing cost per unit sold $ 185 a) Compute product cost per unit under variable Fixed manufacturing cost (All indirect) 1,080,000 and absorption costing. Fixed marketing (All indirect) 1,380,000 b) Compute Operating Income under variable and absorption costing. Dr/Mostafa I. EL-Feky 7  Overview of Absorption and Variable Costing Product cost per unit under variable and absorption costing. Variable Absorption costing Costing Variable manufacturing cost per unit produced:- Direct material $110 $110 Direct manufacturing labor 40 40 Manufacturing overhead 50 50 Fixed manufacturing cost per unit produced ‫ــــــــــــ‬ 135 Total inventoriable cost per unit produced $200 $335 Dr/Mostafa I. EL-Feky 8  Overview of Absorption and Variable Costing Variable Costing Sales revenue; $1,000× 6,000 units sold $ 6,000,000 Variable cost of goods sold: Beginning Inventory $ -0- Add; Variable manufacturing cost; $200 × 8,000 units 1,600,000 Cost of Goods Available for Sale 1,600,000 Less; Ending Inventory; $200 × 2,000 units (400,000) Variable Cost of Goods Sold (1,200,000) Variable marketing cost; $185 × 6,000 units sold (1,110,000) Contribution margin 3,690,000 Less; Fixed manufacturing cost (1,080,000) Fixed marketing cost (1,380,000) Net Operating Income $1,230,000 Dr/Mostafa I. EL-Feky 9  Overview of Absorption and Variable Costing Absorption Costing Sales revenue; $1,000× 6,000 units sold $ 6,000,000 Cost of goods sold: Beginning Inventory $ -0- Add; Variable manufacturing cost; $200 × 8,000 units 1,600,000 Allocated fixed manufacturing cost $135 × 8,000 units 1,080,000 Cost of Goods Available for Sale 2,680,000 Less; Ending Inventory; $335 × 2,000 units (670,000) Cost of Goods Sold (2,010,000) Gross margin 3,990,000 Variable marketing cost; $185 × 6,000 units sold (1,110,000) Fixed marketing cost (1,380,000) Net Operating Income $1,500,000 Dr/Mostafa I. EL-Feky 10  Comparative Income Statements – Two Years El-Feky’s management wants to prepare an income statement for 2020, and 2021 to evaluate the performance of the telescope product line. The operating information is as follows:- Actual price and cost data for 2020, and 2021 are: - 2020 2021 Selling price/ unit sold $ 1,000 Beginning Inventory -0- 2,000 Variable manufacturing cost per unit Production 8,000 5,000 Direct material cost per unit $ 110 Sales 6,000 6,500 Direct manufacturing labor cost per unit 40 Ending Inventory 2,000 500 Manufacturing overhead cost per unit 50 Total variable manufacturing cost per unit $ 200 Required Variable marketing cost per unit sold $ 185 a) Compute product cost per unit Fixed manufacturing cost (All indirect) 1,080,000 under variable and absorption Fixed marketing (All indirect) 1,380,000 costing. b) Compute Operating Income under variable and absorption costing. Dr/Mostafa I. EL-Feky 11  Comparative Income Statements – Two Years Product cost per unit under variable and absorption costing. Variable Absorption costing Costing Variable manufacturing cost per unit produced:- Direct material $110 $110 Direct manufacturing labor 40 40 Manufacturing overhead 50 50 Fixed manufacturing cost per unit produced (1,080,000 ÷ 8,000) ‫ــــــــــــ‬ 135 Total inventoriable cost per unit produced $200 $335 Dr/Mostafa I. EL-Feky 12  Comparative Income Statements – Two Years Variable Costing 2020 2021 Sales Revenue $1,000 × 6,000; 6,500 units $ 6,000,000 $6,500,000 Variable cost of goods sold: Beginning Inventory $ -0- $ 400,000 $200 × 0; 2,000 units Add; Variable manufacturing cost $200 × 8,000; 5,000 unit 1,600,000 1,000,000 Cost of Goods Available for Sale 1,600,000 1,400,000 Less; Ending Inventory $200 × 2,000; 500units (400,000) (100,000) Variable Cost of Goods Sold (1,200,000) 1,300,000 Variable marketing cost $185 × 6,000; 6,500 units (1,110,000) (1,202,500) Contribution margin 3,690,000 3,997,500 Less; Fixed manufacturing cost (1,080,000) (1080,000) Fixed marketing cost (1,380,000) (1,380,000) Net Operating Income $1,230,000 $1,537,500 Dr/Mostafa I. EL-Feky 13  Comparative Income Statements – Two Years Absorption Costing 2020 2021 Sales Revenue $1,000 × 6,000; 6,500 units $ 6,000,000 $6,500,000 Cost of goods sold: Beginning Inventory $335 × 0; 2,000 units $ -0- 670,000 Add; Variable manufacturing cost $200 × 8,000; 5,000 units 1,600,000 1,000,000 Allocated fixed manufacturing cost $135 × 8,000; 5,000 units 1,080,000 675,000 Cost of Goods Available for Sale 2,680,000 2,345,000 Less; Ending Inventory $335 × 2,000; 500 units (670,000) (167,500) Cost of Goods Sold (2,010,000) (2,582,500) Gross margin 3,990,000 3,917,500 Variable marketing cost (1,110,000) (1,202,500) $185 × 6,000; 6,500 units Fixed marketing cost (1,380,000) (1,380,000) Net Operating Income $1,500,000 $1,335,000 Dr/Mostafa I. EL-Feky 14  Summary of Key Insights Dr/Mostafa I. EL-Feky 15  Comparative Income Statements – Two Years 2020 2021 2022 The difference between operating income Beginning Inventory -0- 2,000 500 under absorption costing and variable costing Production 8,000 5,000 10,000 can be computed by formula 1, which focuses Sales 6,000 6,500 7,500 on fixed manufacturing costs in beginning Ending Inventory 2,000 500 3,000 inventory and ending inventory:- 1. O.I. (Absorption – Variable) = F.OH (Ending inv. – Beg.inv) under Absorption. 2020 (1,500,000 – 1,230,000) = ($135 ×"2,000 – 0") $ 270,000 = $ 270,000 2021 (1,335,000 – 1,537,500) = ($135 ×"500 – 2,000") ($ 202,500) = ($ 202,500) 2022 (2,490,000 – 2,152,500) = ($135 ×"3,000 – 500") $ 337,500 = $ 337,500 Dr/Mostafa I. EL-Feky 16  Comparative Income Statements – Two Years 2020 2021 2022 The difference between operating income under Beginning Inventory -0- 2,000 500 absorption costing and variable costing can be Production 8,000 5,000 10,000 computed by formula 2, which focuses on fixed Sales 6,000 6,500 7,500 manufacturing costs in units produced and cost Ending Inventory 2,000 500 3,000 of goods sold under absorption costing:- 2. O.I. (Absorption – Variable) = F.OH (Production – C.O.G.S) under Absorption. 2020 (1,500,000 – 1,230,000) = ($135 ×"8,000 – 6,000") $ 270,000 = $ 270,000 2021 (1,335,000 – 1,537,500) = ($135 ×"5,000 – 6,500") ($ 202,500) = ($ 202,500) 2022 (2,490,000 – 2,152,500) = ($135 ×"10,000 – 7,500") $ 337,500 = $ 337,500 Dr/Mostafa I. EL-Feky 17  End of Lecture 05 Dr/Mostafa I. EL-Feky