Overview
Class Example
Relevance of Fixed Costs?
production capacity
= 10,000 units
selling price
= $20 per unit
variable mfg costs (relevant range = 5,000 to 10,000 units):
direct materials
= $4 per unit
direct labour
= $3 per unit
variable manufacturing overhead
= $1 per unit
fixed manufacturing overhead
= $50,000
variable selling and administrative costs
= $2 per unit
fixed selling and administrative costs
= $15,000
Class Example
Relevance of Fixed Costs?
Current Production = 8,000 units
Current Sales
= 8,000 units
Decision Problem:
Assuming that there are no additional
selling and administrative costs, should
a special order for 1,500 units at a price
of $12 be accepted?
5
Differences Between
Absorption and Direct Costing
Class Example
Absorption vs Direct Costing
production capacity
= 10,000 units
selling price
= $20 per unit
variable mfg costs (relevant range = 5,000 to 10,000 units):
direct materials
= $4 per unit
direct labour
= $3 per unit
variable manufacturing overhead
= $1 per unit
fixed manufacturing overhead
= $50,000
variable selling and administrative costs
= $2 per unit
fixed selling and administrative costs
= $15,000
Class Example
Absorption vs Direct Costing
Current production = 8,000 units
Current sales
= 7,600 units
Product cost??
Accounting for fixed OH??
Operating income??
10
Direct Costing
product cost = DM + DL + var OH
11
Direct
Costing
Product cost
Manufacturing CGS
Inventory
12
product costs
inventory in B/S,
if unsold
cost of goods
sold in I/S, if sold
Direct Costing
fixed OH
period costs
expensed in I/S
in period incurred
13
Direct Costing
Fixed OH deducted as expense
Fixed OH in inventory
14
Operating Income
Absorption Costing
Traditional Approach
Costs/Expenses classified on the basis of Cost
Function (manufacturing vs. non-manufacturing)
Direct Costing
Contribution Approach
Costs/Expenses classified on the basis of Cost
Behaviour (variable vs. fixed)
15
16
17
Contribution margin
= sales variable costs
Contribution margin ratio
= contribution margin / sales
Variable cost ratio
= variable cost / sales
18
Income Statement
Sales
Direct Costing
(Contribution Approach)
Sales
CGS
Gross profits
SG&A expenses
Variable costs
Contribution margin
Fixed costs
Operating income
Operating income
Absorption Costing
(Traditional Approach)
19
Direct Costing
Sales
Variable costs
Variable mfg CGS
Variable SG&A
Total variable costs
Contribution margin
Fixed costs
Fixed mfg costs
Fixed SG&A
Total fixed costs
Operating income
20
21
22
Timing Difference
The difference between absorption and direct
costing income is temporary as it will
reverse from period to period depending on
the relationship between production and
sales units.
24
Reconciliation of Absorption
and Direct Costing Income
Absorption Costing
Direct Costing
Fixed OH
Fixed OH
Beg. Inv.
Current
Production
charged to
I/S as cost of
goods sold
charged to
I/S as cost of
goods sold
deferred in
end. inv. in
B/S
Current
Production
expensed
in I/S
25
= DCI + Y + Z
(Absorption Costing)
(Direct Costing)
ACI + X = DCI + Z
ACI = DCI + Z - X
DCI = ACI + X - Z
27
Reconciliation of Absorption
and Direct Costing Income
Absorption Costing Income
=
Fixed OH
Direct
Fixed OH
in
Costing + in ending beginning
Income
inventory
inventory
28