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Chapter 19

Profit Reporting for Management Analysis


Financial and Managerial Accounting 8th Edition

Warren Reeve Fess


PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting Pepperdine University Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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Objectives
1. Describe and illustrate income reporting After studying absorption costing. this under variable costing and chapter, you should 2. Describe and illustrate income analysis under variable costing be able to: and absorption costing. 3. Describe and illustrate managements use of variable costing and absorption costing for controlling costs, pricing products, planning production, analyzing market segments, and analyzing contribution margins.

Objectives
4. Illustrate contribution margin reporting for products, territories, and salespersons. 5. Explain changes in contribution margin as a result of quantity and price factors. 6. Describe and illustrate contribution margin reporting and analysis for service firms.

Two Costing Methods Absorption Costing Used for external financial reporting Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost

Two Costing Methods Variable Costing

Used for internal planning and decision making Does not include fixed factory overhead as a product cost

Absorption Costing Compared to Variable Costing


Absorption Costing
Cost of Goods Manufactured Direct Materials Direct Labor Variable Factory OH Fixed Factory OH Period Expense

Cost of Goods Manufactured

Variable Costing

Units Manufactured Equal Units Sold


Variable Costing Income Statement
Sales (15,000 x $50) Variable cost of goods sold: Variable cost of goods mfg. (15,000 x $25) Less ending inventory Variable cost of goods sold Manufacturing margin Variable selling and administrative expenses (15,000 x $5) Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Income from operations $750,000

$375,000 0 375,000 $375,000 75,000 $300,000

$150,000
50,000 200,000 $100,000

Units Manufactured Equal Units Sold


Absorption Costing Income Statement
Sales (15,000 x $50) Cost of goods sold: Cost of goods manufactured (15,000 x $35) Less ending inventory Cost of goods sold Gross profit Selling and administrative expenses ($75,000 + $50,000) Income from operations $750,000

$525,000 0
525,000 $225,000 125,000 $100,000

When the number of units manufactured equals the number of units sold, income from operations will be the same under both methods.

Units Manufactured Exceed Units Sold


Variable Costing Income Statement Sales (12,000 x $50) $600,000 Variable cost of goods sold: Variable cost of goods manufactured (15,000 x $25) $375,000 Less ending inventory (3,000 x $25) 75,000 Variable cost of goods sold 300,000 Manufacturing margin $300,000 Variable selling and admin. expenses 60,000 Contribution margin $240,000 Fixed costs: Fixed manufacturing costs $150,000 Fixed selling and admin. expenses 50,000 200,000 Income from operations $ 40,000

Units Manufactured Exceed Units Sold


Absorption Costing Income Statement Sales (12,000 x $50) $600,000 Cost of goods sold: Cost of goods manufactured (15,000 x $35) $525,000 Less ending inventory (3,000 x $35) 105,000 Cost of goods sold 420,000 Gross profit $180,000 Selling and administrative expenses [(12,000 x $5) + $50,000] 110,000 Income from operations $ 70,000

Units Manufactured Exceed Units Sold


Operating Income: Absorption costing Variable costing Difference

$70,000 40,000 $30,000

Why is absorption costing income higher when units manufactured exceed units sold?

Units Manufactured Exceed Units Sold


Operating Income: Absorption costing Variable costing Difference Analysis: Units manufactured Units sold Ending inventory units Fixed cost per unit Difference

$70,000 40,000 $30,000 15,000 12,000 3,000 x $10 $30,000

Units Manufactured Are Less Than Units Sold


Variable Costing Income Statement
Sales (15,000 x $50) Variable cost of goods sold: Beginning inventory (5,000 x $25) Variable cost of goods manufactured (10,000 x $25) Manufacturing margin Variable selling and admin. expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and admin. expenses Income from operations $750,000 $125,000 250,000 375,000 $375,000 75,000 $300,000

$150,000 50,000

200,000 $100,000

Units Manufactured Are Less Than Units Sold


Variable Costing Income Statement
Sales (15,000 x $50) Variable cost of goods sold: Beginning inventory (5,000 x $25) Variable cost of goods manufactured (10,000 x $25) Manufacturing margin Variable selling and admin. expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and admin. expenses Income from operations $750,000 $125,000 250,000 375,000 $375,000 75,000 $300,000

$150,000 50,000

200,000 $100,000

Units Manufactured Are Less Than Units Sold


Absorption Costing Income Statement
Sales (15,000 x $50) Cost of goods sold: Beginning inventory (5,000 x $35) Cost of good manufactured (10,000 x $45) Cost of goods sold Gross profit Selling and administrative expenses ($75,000 + $50,000) Income from operations $750,000 $175,000 400,000 575,000 $175,000 125,000 $ 50,000

Units Manufactured Are Less Than Units Sold


Operating Income: Variable costing Absorption costing Difference $100,000 50,000 $ 50,000

Why is variable costing income higher when units manufactured are less than units sold?

Units Manufactured Are Less Than Units Sold


Operating Income: Variable costing Absorption costing Difference $100,000 50,000 $ 50,000

Analysis: Units sold Units manufactured Ending inventory units Fixed cost per unit Difference

15,000 10,000 5,000 x $10 $50,000

IF THEN

Units Sold < Units produced

Variable Costing < Absorption Costing Income Income

IF THEN

Units Sold > Units produced

Variable Costing > Absorption Costing Income Income

Income Analysis Under Variable Costing and Absorption Costing


Frand Manufacturing Company has no beginning inventory and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels.

Income Analysis Under Variable Costing and Absorption Costing


Proposal 1: 20,000 Units to Be Manufactured and Sold Total Cost Manufacturing costs: Variable $ 700,000 Fixed 400,000 Total costs $1,100,000 Selling and administrative exp. Variable ($5 per unit sold) $ 100,000 Fixed 100,000 Total expenses $ 200,000 Unit Cost $35 20 $55

Income Analysis Under Variable Costing and Absorption Costing


Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold

Total Cost Manufacturing costs: Variable $ 875,000 Fixed 400,000 Total costs $1,275,000 Selling and administrative exp. Variable ($5 per unit sold) $ 100,000 Fixed 100,000 Total expenses $ 200,000

Unit Cost $35 16 $51

Frand Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55)

$1,100,000

$35 + ($400,000 20,000)

Frand Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55) (25,000 units x $51)

$1,100,000

$1,275,000

$35 + ($400,000 25,000)

Frand Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55) (25,000 units x $51) Less ending inventory: (5,000 units x $51) Cost of goods sold Gross profit Selling and administrative expenses ($100,000 + $100,000) Income from operations

$1,100,000

$1,275,000
255,000 $1,020,000 $ 480,000 200,000 $ 280,000

$1,100,000 $ 400,000 200,000 $ 200,000

Now, assume that Frand Manufacturing uses variable costing.

Frand Manufacturing Company Variable Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35) $ 700,000 (25,000 units x $35)

$ 875,000

Direct materials, direct labor, and variable manufacturing overhead only.

Frand Manufacturing Company Variable Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35) $ 700,000 (25,000 units x $35) Less ending inventory: (0 units x $35) 0 (5,000 units x $35) Variable cost of goods sold $ 700,000 Manufacturing margin $ 800,000
Continued

$ 875,000

175,000 $ 700,000 $ 800,000

Frand Manufacturing Company Variable Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured

Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Income from operations

$ 800,000
100,000 $ 700,000 $ 400,000 100,000 $ 500,000 $ 200,000

$ 800,000
100,000 $ 700,000 $ 400,000 100,000 $ 500,000 $ 200,000

What would be the income from operations if the firm manufactured 30,000 units?

Frand Manufacturing Company Variable Costing Income Statements 30,000 Units Manufactured

Sales Variable cost of goods sold: Variable cost of goods manufactured: (30,000 units x $35) Less ending inventory: (10,000 units x $35) Variable cost of goods sold Manufacturing margin
Continued

$1,500,000

$1,050,000 350,000 $ 700,000 $ 800,000

Frand Manufacturing Company Variable Costing Income Statements 30,000 Units Manufactured

Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Income from operations

$ 800,000
100,000 $ 700,000 $ 400,000

100,000 $ 500,000 $ 200,000

Managements Use of Costing Methods


Variable costing reports and absorption costing reports are useful in the following situations: 1. Controlling costs 2. Pricing products 3. Planning production 4. Analyzing market segments

5. Analyzing contribution margins

Accounting Reports and Management Decisions


ACCOUNTING REPORTS
Absorption Costing and Variable Costing

MANAGEMENT

MANAGEMENT

DECISIONS

Controlling Costs

Pricing

Planning Production

Analyzing Market Segments

Analyzing Contribution Margins


ACTUAL PLANNED

Pricing Products

In the short run, we are committed to our existing manufacturing facilities.

Pricing Products
That is correct. The pricing decision should be based upon making the best use of our existing capacity.

Pricing Products
Even in the long-run where plant capacity can be changed, the selling prices of our products must cover all costs and provide a reasonable income.

Analyzing Market Segment


A market segment is a portion of business that can be assigned to a manager for profit responsibility.

Contribution Margin Reporting for Market Segments


Camelot Fragrance Company manufactures and sells the Gwenevere perfume for women and the Lancelot cologne line for men. The inventories are negligible.

Northern Southern Territory Territory Sales: Gwenevere Lancelot Total territory sales Variable production costs: Gwenevere (12% of sales) Lancelot (12% of sales) Total variable production cost by territory $60,000 20,000 $80,000 $ 7,200 2,400 $ 9,600 $30,000 50,000 $80,000 $ 3,600 6,000 $ 9,600

Total $ 90,000 70,000 $160,000 $ 10,800 8,400 $ 19,200

Continued

Northern Southern Territory Territory Promotion costs: Gwenevere (30% of sales) Lancelot(20% of sales) Total variable production cost by territory Sales commissions: Gwenevere (20% of sales) Lancelot (12% of sales) Total sales commission by territory $18,000 4,000 $22,000 $12,000 2,000 $14,000 $ 9,000 10,000 $19,000 $ 6,000 5,000 $11,000

Total $ 27,000 14,000 $ 41,000 $ 18,000 7,000 $ 25,000

Camelot Fragrance Company Contribution Margin by Sales Territory For the Month Ended March 31, 2006
Northern Territory Southern Territory

Sales Variable cost of goods sold Manufacturing margin Variable selling expenses: Promotion costs Sales commissions Total Contribution margin
Contribution margin ratio

$80,000 9,600 $70,400


$22,000 14,000 $36,000 $34,400 43%

$80,000 9,600 $70,400


$19,000 11,000 $30,000 $40,400 50.5%

Camelot Fragrance Company Contribution Margin by Product Line For the Month Ended March 31, 2006 Gwenevere Lancelot

Sales Variable cost of goods sold Manufacturing margin Variable selling expenses: Promotion costs Sales commissions Total Contribution margin
Contribution margin ratio

$90,000 10,800 $79,200


$ 27,000 18,000 $45,000 $34,200 38%

$70,000 8,400 $61,600


$14,000 7,000 $21,000 $40,600 58%

Camelot Fragrance Company Contribution Margin by SalespersonNorthern Territory For the Month Ended March 31, 2003
Inez Rodriquez Sales Variable cost of goods sold Manufacturing margin Variable selling expenses: Promotion costs Sales commissions Contribution margin Contribution margin ratio Sales mix (% Lancelot sales) $20,000 2,400 $17,600 $ 5,000 3,000 $ 8,000 $ 9,600 48% 50% Tom Ginger $20,000 2,400 $17,600 $ 5,000 3,000 $ 8,000 $ 9,600 48% 50% Beth Williams $40,000 4,800 $35,200 $12,000 8,000 $20,000 $15,200 38% 0% Total $80,000 9,600 $70,400 $22,000 14,000 $36,000 $34,400 43% 25%

Contribution Margin Analysis


Planned Contribution Margin

Actual Contribution Margin

Sales

Variable Cost of Goods Sold


Continued

Variable Selling and Administrative Expenses

Contribution Margin Analysis


Sales Variable Cost of Goods Sold

Variable Selling and Administrative Expenses


Quantity Factor +/ Unit Cost Factor

Quantity Factor +/ Price Factor

Quantity Factor +/ Unit Cost Factor

Changes in Contribution Margin as a Result of Quantity and Price Factors


Quantity factor The difference between the actual quantity sold and the planned quantity sold, multiplied by the planned unit sales price or unit cost. Unit price or unit cost factor The difference between the actual unit price or unit cost and the planned unit price or unit cost, multiplied by the actual quantity sold.

Noble Inc. for Year Ended December 31, 2006


Actual
Sales Less: Variable cost of goods sold Variable selling and administrative exp. Total Contribution margin Increase or Planned (Decrease)

$937,500 $800,000 $137,500 $425,000 $350,000 $ 75,000 162,500 125,000 37,500 $587,500 $475,000 $112,500 $350,000 $325,000 $ 25,000

Continued

Noble Inc. for Year Ended December 31, 2006


Actual
Number of units sold 125,000 Per unit: Sales price $7.50 Variable cost of goods sold $3.40 Variable selling and administrative exp. $1.30

Planned
100,000 $8.00 $3.50 $1.25

Contribution Margin Report

Blue Skies Airlines Inc. operates a small commercial airline.

Blue Skies Airlines Inc. Contribution Margin and Income from Operations Report for the Month Ended April 30, 2006

Revenue Variable costs: Fuel expense Wages expense Food and beverage service exp. Selling expenses Contribution margin Fixed costs: Depreciation expense Rental expense Income from operations

$19,238,000 $4,080,000 6,120,000 444,000 3,256,000

13,900,000 $ 5,338,000

$3,600,000 800,000

4,400,000 $ 938,000

Blue Skies Airlines Inc. Contribution Margin by Route ReportChicago/Atlanta for the Month Ended April 30, 2006

Revenue Variable costs: Fuel expense Wages expense Food and beverage service exp. Selling expenses Contribution margin

$6,400,000 $1,120,000 1,680,000 240,000 1,760,000

4,800,000 $1,600,000

Contribution Margin Ratio = 0.25

Blue Skies Airlines Inc. Contribution Margin by Route ReportAtlanta/Los Angeles for the Month Ended April 30, 2006

Revenue Variable costs: Fuel expense Wages expense Food and beverage service exp. Selling expenses Contribution margin

$7,525,000 $1,760,000 2,640,000 105,000 770,000

5,275,000 $2,250,000

Contribution Margin Ratio = 0.30

Blue Skies Airlines Inc. Contribution Margin by Route ReportLos Angeles/Chicago for the Month Ended April 30, 2006

Revenue Variable costs: Fuel expense Wages expense Food and beverage service exp. Selling expenses Contribution margin

$5,313,000 $1,200,000 1,800,000 99,000 726,000

3,825,000 $1,488,000

Contribution Margin Ratio = 0.28

Blue Skies Airlines Inc. Contribution MarginChicago/Atlanta ActualMay PlannedMay Revenue Less variable expenses: Fuel expense Wages expense Food and beverage service exp. Selling expenses and commiss. Total Contribution margin Contribution Margin Ratio
Continued

$7,600,000 $1,232,000 1,680,000 300,000 2,200,000 $5,412,000 $2,188,000 0.29

$6,400,000 $1,120,000 1,680,000 240,000 1,760,000 $4,800,000 $1,600,000 0.25

Blue Skies Airlines Inc. Contribution MarginChicago/Atlanta ActualMay PlannedMay Number of miles flown Number of passengers flown Per unit: Ticket price Fuel expense Wages expense Food and beverage service exp. Selling expenses 56,000 20,000 $380 22 30 15 110 56,000 16,000 $400 20 30 15 110

Contribution Margin Analysis ReportService Company


Blue Skies Airlines Inc. Contribution Margin Analysis For the Month Ended May 31, 2006

Increase in revenue attributed to: Quantity factor: Increase in the number of tickets sold in May (4,000 x $400) $1,600,000 Price factor: Decrease in the ticket price in May ($20 x 20,000) (400,000) Net increase in revenue $1,200,000
Continued

Contribution Margin Analysis ReportService Company


Blue Skies Airlines Inc. Contribution Margin Analysis For the Month Ended May 31, 2006

Increase in fuel costs attributed to: Unit cost factor: Increase in unit cost in May times number of miles flown ($2 x 56,000)

$112,000

Continued

Contribution Margin Analysis ReportService Company


Blue Skies Airlines Inc. Contribution Margin Analysis For the Month Ended May 31, 2006

Increase in food and beverage service costs attributed to: Quantity factor: Increase in number of tickets sold in May times planned unit cost in May (4,000 x $15.00)
Continued

$60,000

Contribution Margin Analysis ReportService Company


Blue Skies Airlines Inc. Contribution Margin Analysis For the Month Ended May 31, 2006

Increase in selling costs and commissions attributed to: Quantity factor: Increase in number of tickets sold in May times planned unit cost in May (4,000 x $110)
Continued

$440,000

Contribution Margin Analysis ReportService Company


Blue Skies Airlines Inc. Contribution Margin Analysis For the Month Ended May 31, 2006

Summary: Net increase in revenue Net increase in fuel cost Net increase in food and beverage service costs Net increase in selling costs Increase in contribution margin

$1,200,000 (112,000) (60,000) (440,000) $ 588,000

Chapter 19

The End