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Chapter 19 Variable Costing and Performance Reporting
Chapter 19
Variable Costing and
Performance Reporting
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems**
(A & B set)
Beyond the
Numbers
Conceptual objectives:
C1. Describe how absorption
costing can result in over
production.
2, 3, 4, 5, 8
19-1
19-10
19-5
CIP
C2. Explain the role of variable
costing in pricing special
orders.
1, 4, 6, 7, 9,
10, 14
19-10
19-7
19-4
HTR
Analytical objectives:
A1. Compute and interpret
breakeven volume in units.
19-11
19-4
19-2
Procedural objectives:
P1. Compute unit cost under both
absorption and variable costing.
12
19-4, 19-5
19-1, 19-9
P2. Prepare and analyze an income
statement using absorption
costing and using variable
costing.
3
19-6, 19-7,
19-9
19-2, 19-3,
19-5, 19-6,
19-9, 19-12
19-1, 19-3,
19-5
RIA, CA,
EC, TTN,
TIA, GD
P3. Prepare a contribution margin
report.
9, 11
19-2, 19-3,
19-8
19-8, 11
P4. Convert income under variable
costing to the absorption cost
basis.
19-12, 19-13,
19-14
19-3, 19-5,
19-6
19-1, 19-3
ED
Notes appear on next page.
Chapter 19 Variable Costing and Performance Reporting
* Assignment materials that can be completed by students using:
Sage 50 and QuickBooks Pro 2013 templates – None.
Excel templates – None.
** The Serial Problem for Success Systems, which covers numerous learning objectives, can be
of the chapters. Even if previous segments are not assigned, students can begin the problem in any
chapter. It is most readily solved if students use the Working Papers that accompany the book.)
Synopsis of Chapter Revisions
• Guy Brown: NEW opener with new entrepreneurial assignment
• New Global View with reference to McDonald's international operations
• Revised section on limitations of variable costing
• New discussion of absorption costing and IFRS
• Revised several exhibits for better learning
• Enhanced examples of absorption and variable costing and their differences
• Added new assignments for better learning
Chapter 19 Variable Costing and Performance Reporting
Chapter Outline
Notes
I. Introducing Variable Costing and Absorption Costing – under the
traditional costing approach, absorption costing, or full costing,
products absorb all costs incurred to product them which can result in
misleading product cost information for decision-making. Under
variable costing only costs that change in total with changes in
production level are included in product costs.
A. Under both methods direct materials, direct labor and variable
overhead are included in product costs.
B. Key difference is in treatment of fixed overhead.
C. Fixed overhead is included in product costs under absorption costs
and included in period expenses under variable costing.
D. Computing Unit Cost
1. For absorption costing, the product unit cost consists of direct
labor, direct materials, variable overhead, and fixed overhead.
2. For variable costing, the product units cost consists of direct
labor, direct materials and variable overhead. Fixed overhead
costs are treated as period costs and recorded as expense in the
period incurred.
3. The difference between the two costing methods is the
exclusion of fixed overhead from product cost for variable
costing.
II. Performance Reporting (Income) Implications
A. Units Produced Equal Units Sold
1. The income statement under variable costing is referred to as
2. Contribution Margin Report is a performance report that
excludes fixed expenses and net income and focuses on
revenue minus variable costs.
4. When quantity produced equals quantity sold, there is no
difference in total costs assigned, but there is a difference in
B. Units Produced Exceed Units Sold
1. Under variable costing, the entire fixed overhead is treated as
2. Under absorption costing, the fixed overhead cost is allocated
to each unit.
3. When production exceeds sales, the fixed overhead cost
allocated to these units is carried as part of the cost of ending
Chapter 19 Variable Costing and Performance Reporting
Chapter Outline
reported in cost of goods sold when the products are sold.
4. Income under absorption costing is higher than income
under variable costing when units produced exceed units
sold because of the greater fixed overhead cost allocated
to ending inventory.
Notes
C. Units Produced are Less Than Units Sold
1. Ending inventory under absorption costing is higher than
under variable costing.
2. Income under absorption costing is less than income under
variable costing.
3. Cost differences extend to both cost of goods sold and period
costs.
D. Summarizing Income Reporting
2. Income will be different whenever the quantity produced and
quantity sold are different.
3. Income under absorption costing is higher when more units
are produced relative to sales and is lower when fewer units
are produced than sold.
normally see differences in income for these two methods
extending over several years.
5. Converting Reports Under Variable Costing to Absorption
Costing - an income statement using the variable costing
method is restated under absorption costing by adding the
E. Converting Income Under Variable Costing to Absorption
cost in ending inventory and subtracting the fixed overhead cost in
beginning inventory.
III. Comparing Variable Costing and Absorption Costing
A. Planning Production
1. Production levels should be based on reliable sales forecasts.
Over-production and inventory build-up can occur because
many companies link manager bonuses to income computed
under absorption costing since this is how income is reported
to shareholders per GAAP.
2. Inventory build-up leads to increased costs in storage,
financing, and obsolescence. If excess inventory is never sold,
it will be disposed of at a loss.
Chapter 19 Variable Costing and Performance Reporting
Chapter Outline
Notes
3. Managers cannot increase income under variable costing by
merely increasing production without increasing sales.
4. Under absorption costing, fixed overhead per unit is lower
when more units are produced so fixed overhead cost is
allocated to more units. If these excess units are not sold, the
fixed overhead cost allocated to these units is not expensed
until a future period when these units are sold.
5. Reported income under variable costing is not affected by
production level changes because all fixed production costs
are expensed in the year incurred. Under this method,
companies increase income by selling more units since it is
not possible to increase income just by producing more units
and creating excess inventory.
B. Setting Prices
1. Cost information is a crucial factor in setting prices.
2. Over the long run, the selling price must be high enough to
cover all costs and still provide an acceptable return to
shareholders.
3. Absorption cost information is useful since it reflects the full
costs that sales must exceed for the company to be profitable.
4. Managers should accept special orders provided the special
change in the short run regardless of rejecting or accepting the
order. Using variable costing reveals the special orders
C. Controlling Costs
1. A cost is controllable if a manager has the power to determine
or at least markedly affect the amount incurred. An effective
cost control practice is to hold managers responsible only for
their controllable costs.
controlled at different levels of management.
4. Variable selling and administrative costs are usually controlled
5. Higher-level managers usually make fixed costs decisions.
6. Lower-level managers usually make most variable cost
decisions.
7. An income statement prepared in the contribution format
highlights the impact of each cost element for income which
makes it easier to identify problem areas and take cost control
Chapter 19 Variable Costing and Performance Reporting
Chapter Outline
measures by appropriate levels of management. This approach is
also useful in evaluating the performance of managers of different
segments within a company.
D. Limitations of Reports Using Variable Costing – Absorption
costing is the only acceptable basis for external reporting under
both U.S. GAAP and IFRS. For income tax purposes, absorption
costing is the only acceptable basis for filings with the IRS under
the Tax Reform Act of 1986.
Notes
IV. Variable Costing for Service Firms – variable costing also applies to
service companies. Service companies do not have inventory but a
focus on variable costs is still useful for managerial decisions.
V. Global View – U.S. multination companies must change their business
processes when moving their operations to international locations.
McDonald’s and Yum Brands offer delivery services in heavily
populated cities which discourage the building of drive-through
facilities which would increase fixed overhead costs. As fixed
overhead costs decrease, the difference in net income that would result
from applying variable costing versus absorption costing also
decreases.
VI. Decision Analysis – Break-Even Analysis
A. If the income statement is prepared under absorption costing, the
data needed for CVP analysis are not readily available.
Substantial effort is required to go back and reclassify the cost
data to obtain information necessary for conducting CVP analysis.
B. If the income statement is prepared using the contribution format,
the data needed for CVP analysis are readily available.
C. Contribution margin per unit = sales price per unit – variable cost
per unit.
website, in whole or part. 19-7
Chapter 19 Alternative Demonstration Problem
Major Company began operations on January 1, 2013. Cost and sales information
for its first two calendar years are summarized below:
Manufacturing costs:
Direct materials $50 per unit
Direct labor $25 per unit
Factory overhead costs for the year:
Variable overhead $10 per unit
Fixed overhead $1,000,000
Nonmanufacturing costs:
Variable selling and administrative $10 per unit
Fixed selling and administrative $5,000,000
Production and sales data:
Units produced, 2013 100,000 units
Units sold, 2013 80,000 units
Units in ending inventory, 2013 20,000 units
Units produced, 2014 60,000 units
Units sold, 2014 80,000 units
Units in ending inventory, 2014 0 units
Sales price per unit $500 per unit
Required:
1. Prepare an income statement for the company for 2013 under absorption
costing.
2. Prepare an income statement for the company for 2013 under variable
costing.
3. Prepare an income statement for the company for 2014 under absorption
costing.
4. Prepare an income statement for the company for 2014 under variable
costing.
5. Prepare a schedule to convert variable costing income to absorption
costing income for the years 2013 and 2014.
Chapter 19 Variable Costing and Performance Reporting
website, in whole or part. 19-8
Solution: Chapter 19 Alternative Demonstration Problem #1
Compute unit costs for 2013 under the two costing methods as follows:
Absorption Costing
Variable Costing
Direct materials per unit
$50
$50
Direct labor per unit
25
25
Overhead per unit
Variable overhead per
unit
10
10
Fixed overhead per unit *
10
--
Total production cost per
unit
$95
$85
*Fixed overhead per unit = $5,000,000 / 100,000 units = $10
1. Absorption costing income statement for 2013:
Major Corporation
Income Statement
For Year Ended December 31, 2013
Sales (80,000 x $500)
$40,000,000
Cost of goods sold (80,000 x $95)
7,600,000
Gross margin
32,400,000
Selling and administrative expenses (10 x 80,000) +
5,000,000
5,800,000
Net income
$26,600,000
2. Variable costing income statement for 2013:
Major Corporation
Income Statement (Contribution Format)
For Year Ended December 31, 2013
Sales (80,000 x $500)
$40,000,000
Variable expenses
Variable production costs (80,000 x $85) $6,800,000
Variable selling and administrative costs
(80,000 x $10) 800,000
$7,600,000
Gross margin
32,400,000
Fixed expenses
Fixed overhead 1,000,000
Fixed selling and administrative 5,000,000
6,000,000
Net income
$26,400,000
Chapter 19 Variable Costing and Performance Reporting
website, in whole or part. 19-9
Solution: Chapter 19 Alternative Demonstration Problem #1, Continued
Compute unit costs for 2014 under the two costing methods as follows:
Absorption Costing
Variable Costing
Direct materials per unit
$50
$50
Direct labor per unit
25
25
Overhead per unit
Variable overhead per
unit
10
10
Fixed overhead per unit *
17
--
Total production cost per
unit
$101.67
$85
*Fixed overhead per unit = $1,000,000 / 60,000 = 16.67 rounded.
3. Absorption costing income statement for 2014:
Major Corporation
Income Statement
For Year Ended December 31, 2014
Sales (80,000 x $500)
$40,000,000
Cost of goods sold
From beginning inventory (20,000 x $95) $1,900,000
Produced during the year (60,000 x $101.67) 6,100,200
8,000,200
Gross margin
31,999,800
Selling and administrative expenses (10 x 80,000) +
5,000,000
5,800,000
Net income
$26,199,800
Chapter 19 Variable Costing and Performance Reporting
website, in whole or part. 19-10
Solution: Chapter 19 Alternative Demonstration Problem #1 Continued
4. Variable costing income statement for 2014:
Major Corporation
Income Statement (Contribution Format)
For Year Ended December 31, 2014
Sales (80,000 x $500)
$40,000,000
Variable expenses
Variable production costs (80,000 x $85) $6,800,000
Variable selling and administrative costs
(80,000 x $10) 800,000
$7,600,000
Gross margin
32,400,000
Fixed expenses
Fixed overhead 1,000,000
Fixed selling and administrative 5,000,000
6,000,000
Net income
$26,400,000
5. Conversion of variable costing income to absorption costing income:
2012
2013
Variable costing income
$26,400,000
$26,400,000
Add: Fixed overhead cost deferred in
ending inventory (20,000 x $10)
200,000
0
Less: Fixed overhead cost recognized
from beginning inventory (20,000 x $10)
0
(200,000)
Absorption costing income
$26,600,000
$26,200,000
