ACT5733
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ACT5733FeloWinter2020Chat7slides.pptACT 5733 – Advanced Managerial Accounting
Chat # 7 – Inventory Costing & Capacity
ACT 5733 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
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Chat Outline
- Absorption vs. Variable costing
- Throughput costing
ACT 5733 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
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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 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
Absorption vs Variable Example
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Variable COGS Calculation
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Variable Income
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Absorption COGS Calculation
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Absorption Income
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Comparison
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - 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 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
Two Additional Factors
- Increase in production
- Denominator used for allocation rate
ACT 5733 - Chat 7 - Felo
ACT 5733 - Chat 7 - 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 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
Impact of Production
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
COGS Calculation
ACT 5733 - Chat 7 - Felo
| 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 |
ACT 5733 - Chat 7 - Felo
Results – Production Impact
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Comparison - Production
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Production Implications
- If using absorption costing, need to include performance measures to reduce incentive to increase production to increase income (remove goal incongruence)
- Examples
Inventory levels
“Charge back” for inventory
Days in inventory
ACT 5733 - Chat 7 - Felo
ACT 5733 - Chat 7 - 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 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
Impact of Denominator Used
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
COGS Calculation
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Impact of PVV
ACT 5733 - Chat 7 - Felo
| 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 - Chat 7 - Felo
Denominator Implications
- As denominator used increases, absorption results approach variable results
- IRS allows practical capacity for tax purposes (larger tax deduction)
ACT 5733 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
Throughput Costing
- Only DM inventoriable
- Sometimes called “Super-variable costing”
ACT 5733 - Chat 7 - Felo
ACT 5733 - Chat 7 - Felo
