ACT 5733 Advanced

Managerial Accounting

Chapter 9 Inventory
Costing and Capacity

ACT 5733 - Chapter 9 - Felo

Session Outline
Review HW 8
Absorption vs. Variable costing
Impact of production
Denominator choice (capacity)
Throughput costing

ACT 5733 - Chapter 9 - Felo

Absorption vs Variable Costing
Absorption (GAAP) All manufacturing

costs are inventoriable

Variable Only variable manufacturing

costs are inventoriable; fixed are period;

also called direct costing (misleading)

ACT 5733 - Chapter 9 - Felo

Absorption vs Variable Example
Year 1 Year 2 Year 3
Budgeted production 25,000 25,000 25,000
Units produced 25,000 25,000 25,000
Units sold 25,000 20,000 30,000
DM per unit $6 $6 $6
DL per unit $5 $5 $5
VMOH per unit $10 $10 $10
Fixed man costs $100,000 $100,000 $100,000
Var mktg costs $4 $4 $4
Fixed mktg costs $50,000 $50,000 $50,000
Selling price $50 $50 $50

ACT 5733 - Chapter 9 - Felo

Variable COGS Calculation
Year 1 Year 2 Year 3
Inventory, Beg $0 $0 $105,000
DM $150,000 $150,000 $150,000
DL $125,000 $125,000 $125,000
VMOH $250,000 $250,000 $250,000
Man costs to account for $525,000 $525,000 $630,000
Inventory, End ($21/unit) $0 $105,000 $0
Var COGS $525,000 $420,000 $630,000

ACT 5733 - Chapter 9 - Felo

Variable Income
Year 1 Year 2 Year 3
Revenue $1,250,000 $1,000,000 $1,500,000
Variable COGS $525,000 $420,000 $630,000
Var mktg costs $100,000 $80,000 $120,000
Contribution margin $625,000 $500,000 $750,000
Fixed man costs $100,000 $100,000 $100,000
Fixed mktg costs $50,000 $50,000 $50,000
Operating income $475,000 $350,000 $600,000

Inventory ($21/unit) $0 $105,000 $0

Man Costs Incurred $625,000 $625,000 $625,000

ACT 5733 - Chapter 9 - Felo

Absorption COGS Calculation
Year 1 Year 2 Year 3
Inventory, Beg $0 $0 $125,000
DM $150,000 $150,000 $150,000
DL $125,000 $125,000 $125,000
VMOH $250,000 $250,000 $250,000
Fixed man costs allocated $100,000 $100,000 $100,000
Man costs to account for $625,000 $625,000 $750,000
Inventory, End ($25/unit) $0 $125,000 $0
COGS $625,000 $500,000 $750,000

Fixed man costs incurred $100,000 $100,000 $100,000

Production volume variance $0 $0 $0

ACT 5733 - Chapter 9 - Felo

Absorption Income
Year 1 Year 2 Year 3
Revenue $1,250,000 $1,000,000 $1,500,000
COGS $625,000 $500,000 $750,000
Gross margin $625,000 $500,000 $750,000
Var mktg costs $100,000 $80,000 $120,000
Fixed mktg costs $50,000 $50,000 $50,000
Operating income $475,000 $370,000 $580,000

Inventory ($25/unit) $0 $125,000 $0

Man Costs Incurred $625,000 $625,000 $625,000

ACT 5733 - Chapter 9 - Felo

Comparison
Year 1 Year 2 Year 3
Production 25,000 25,000 25,000
Sales 25,000 20,000 30,000

COGS (Var + Fixed) $625,000 $520,000 $730,000

Operating income $475,000 $350,000 $600,000
Inventory $0 $105,000 $0

COGS $625,000 $500,000 $750,000

Operating income $475,000 $370,000 $580,000
Inventory $0 $125,000 $0

ACT 5733 - Chapter 9 - Felo

Summary of Differences
Assume costs remain the same from one
period to the next
When production = sales, no difference in
income
When production > sales, absorption income
> variable income
When production < sales, variable income >
absorption income

ACT 5733 - Chapter 9 - Felo

Two Additional Factors
Increase in production
Denominator used for allocation rate

ACT 5733 - Chapter 9 - Felo

Impact of Production
Under absorption, income can be increased
simply by producing more units
Variable income is not impacted by
increased production

ACT 5733 - Chapter 9 - Felo

Impact of Production
Year 1
Units produced 50,000
Units sold 25,000
DM per unit $6
DL per unit $5
VMOH per unit $10
Fixed man costs $100,000
Var mktg costs $4
Fixed mktg costs $50,000
Selling price $50

ACT 5733 - Chapter 9 - Felo

COGS Calculation
Variable Absorption
Inventory, Beg $0 $0
DM $300,000 $300,000
DL $250,000 $250,000
VMOH $500,000 $500,000
Fixed man costs allocated N/A $100,000
Man costs to account for $1,050,000 $1,150,000
Inventory, End $525,000 $575,000
COGS $525,000 $575,000

Fixed man costs incurred $100,000 $100,000

Production volume variance N/A $0

ACT 5733 - Chapter 9 - Felo

Results Production Impact
Variable Absorption
Revenue $1,250,000 $1,250,000
COGS (Var + Fixed) $625,000 $575,000
Gross margin $625,000 $675,000
Var mktg costs $100,000 $100,000
Fixed mktg costs $50,000 $50,000
Operating income $475,000 $525,000

Fixed man costs expensed $100,000 $50,000

ACT 5733 - Chapter 9 - Felo

Comparison - Production
Original Revised
Production 25,000 50,000
Sales 25,000 25,000

COGS (Var + Fixed) $625,000 $625,000

Operating income $475,000 $475,000
Inventory $0 $525,000

COGS $625,000 $575,000

Operating income $475,000 $525,000
Inventory $0 $575,000

ACT 5733 - Chapter 9 - Felo

Production Implications
If using absorption costing, need to include
performance measures to reduce incentive
to increase production to increase income
Examples
1. Inventory levels
2. Charge back for inventory
3. Days in inventory

ACT 5733 - Chapter 9 - Felo

Denominator Choice
This impacts allocation rate used for FMOH

Only an issue for absorption costing

PVV - Difference between flexible budget

FMOH and FMOH allocated to output

Theoretical capacity, practical capacity,

master budget capacity, normal capacity

ACT 5733 - Chapter 9 - Felo

Impact of Denominator Used
Alt 1 Alt 2
Budgeted production 25,000 50,000
Units produced 25,000 25,000
Units sold 20,000 20,000
DM per unit $6 $6
DL per unit $5 $5
VMOH per unit $10 $10
Fixed man costs $100,000 $100,000
Var mktg costs $4 $4
Fixed mktg costs $50,000 $50,000
Selling price $50 $50

ACT 5733 - Chapter 9 - Felo

COGS Calculation
Alt 1 Alt 2
Inventory, Beg $0 $0
DM $150,000 $150,000
DL $125,000 $125,000
VMOH $250,000 $250,000
Fixed man costs allocated $100,000 $50,000
Man costs to account for $625,000 $575,000
Inventory, End $125,000 $115,000
Preliminary COGS $500,000 $460,000
Adjustment for PVV $0 $50,000
Final COGS $500,000 $510,000

Fixed man costs incurred $100,000 $100,000

Production volume variance $0 $50,000
ACT 5733 - Chapter 9 - Felo
Impact of PVV
Alt 1 Alt 2 Var
Revenue $1,000,000 $1,000,000 $1,000,000
COGS $500,000 $510,000 $520,000
Gross margin $500,000 $490,000 $480,000
Var mktg costs $80,000 $80,000 $80,000
Fixed mktg costs $50,000 $50,000 $50,000
Operating income $370,000 $360,000 $350,000
Inventory $125,000 $115,000 $105,000

ACT 5733 - Chapter 9 - Felo

Denominator Implications
As denominator used increases, absorption

results approach variable results

IRS allows practical capacity for tax

purposes (larger tax deduction)

ACT 5733 - Chapter 9 - Felo

Throughput Costing
Only DM inventoriable

Sometimes called Super-variable costing

ACT 5733 - Chapter 9 - Felo