1. No category

18-1
18
Customer Profitability Analysis,
Sales Performance Evaluation,
and Income Reporting
Student Tutorial
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-2
Chapter Organization
This chapter has been subdivided into three
independent sections.
Click the section below that you wish to study,
or press “Enter” to proceed linearly through
the chapter.
!Customer Profitability Analysis
"Sales Variance Analysis
#Income Reporting Effects of Alternative
Product-Costing Approaches
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-3
Customer Profitability Analysis
Using
Using ABC
ABC to
to determine
determine the
the activities,
activities, costs,
costs,
and
and profit
profit associated
associated with
with serving
serving particular
particular
customers.
customers.
For
Forvarious
various
reasons,
reasons,some
some
customers
customerssimply
simply
are
areless
lessprofitable
profitable
than
thanothers.
others.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-4
Customer Profitability Analysis
For
Forvarious
various
reasons,
reasons,some
some
customers
customerssimply
simply
are
areless
lessprofitable
profitable
than
thanothers.
others.
Irwin/McGraw-Hill Ryerson
For Example
Using
Using ABC
ABC to
to determine
determine the
the activities,
activities, costs,
costs,
and
and profit
profit associated
associated with
with serving
serving particular
particular
customers.
customers.
Customer makes frequent
order changes.
Customer needs special
parts.
Customer is difficult to
please.
©McGraw-Hill Ryerson Limited, 2001
18-5
Customer Profitability Analysis
Once
Once we
we know
know which
which customers
customers are
are the
the least
least
profitable,
profitable, we
we can
can modify
modify our
our relationship
relationship to
to
improve
improve profitability.
profitability.
Examples:
e
w
ut ing
b
,
o
s
i
h ue d .
t
o tin
u
d
o
o
y
n
t
o i th
e
c
t
t
a
’
I h can ess w
t
s
in
u
s
j
bu
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-6
Customer Profitability Analysis
Once
Once we
we know
know which
which customers
customers are
are the
the least
least
profitable,
profitable, we
we can
can modify
modify our
our relationship
relationship to
to
improve
improve profitability.
profitability.
Examples:
Irwin/McGraw-Hill Ryerson
We’ll send a team to your plant
next week and help you set up an
ordering system that gives us
more lead time.
©McGraw-Hill Ryerson Limited, 2001
18-7
Customer Profitability Analysis
Once
Once we
we know
know which
which customers
customers are
are the
the least
least
profitable,
profitable, we
we can
can modify
modify our
our relationship
relationship to
to
improve
improve profitability.
profitability.
Examples:
If you ask for
fewer changes,
we can charge
you less!
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-8
Customer Profitability Analysis
To
To determine
determine customer
customer profitability,
profitability, Use
Use ABC
ABC
based
based on
on the
the customer-related
customer-related activity
activity units
units
used
used by
by each
each customer
customer in
in question.
question.
Typical Customer-Related Activities Include:
$
$
$
$
Processing Orders
Sales Contacts
Sales Visits
Processing Shipments
Irwin/McGraw-Hill Ryerson
$ Billing
$ Engineering/Design
Changes
$ Special Packaging
$ Special Handling
©McGraw-Hill Ryerson Limited, 2001
18-9
Customer Profitability Analysis
Example
Recall
Recall from
from the
the example
example in
in your
your text,
text, Koala
Koala
Camp
Camp Gear
Gear looked
looked at
at 55 customers.
customers.
Customer Profitability
$200,000
Bar graphs
are
common
analytical
tools.
$150,000
$100,000
$50,000
$0
-$50,000
Customer #
-$100,000
107
Irwin/McGraw-Hill Ryerson
108
101
102
114
©McGraw-Hill Ryerson Limited, 2001
18-10
Customer Profitability Analysis
Example
Customer Profitability
Note
Note that
that attention
attention should
should be
be focused
focused on
on
customer
customer #102
#102 and
and #114.
#114.
$200,000
Question:
$150,000
Why are
customers
#102 and
#114 not
profitable?
$100,000
$50,000
$0
-$50,000
Customer #
-$100,000
107
Irwin/McGraw-Hill Ryerson
108
101
102
114
©McGraw-Hill Ryerson Limited, 2001
18-11
Customer Profitability Analysis
Example
Comparing
Comparing the
the customer-related
customer-related costs
costs for
for each
each
customer
customer to
to established
established “norms”
“norms” should
should reveal
reveal
helpful
helpful insights.
insights.
For Customer #102, costs
of order processing,
engineering/design
changes, and special
handling are above
normal.
Irwin/McGraw-Hill Ryerson
For Customer #114,
the cost of special
packaging is 4× the
norm. The cost for
special handling is
6× the norm.
©McGraw-Hill Ryerson Limited, 2001
18-12
Product Life-Cycle Costs
Product
Product Life-Cycle
Life-Cycle Costs
Costs include
include all
all costs
costs
incurred
incurred over
over all
all phases
phases of
of aa product’s
product’s life
life
cycle.
cycle.
!Product planning and
concept design.
"Preliminary design.
#Detailed design and testing.
%Production.
&Marketing, distribution, and
customer service.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-13
Let’s Look
at Sales
Variances.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-14
Sales Variance Analysis
The
The company’s
company’s overall
overall sales
sales performance
performance can
can
be
be analyzed
analyzed two
two ways:
ways:
1.
1. Focus
Focus on
on sales
sales revenue
revenue by
by analyzing
analyzing the
the
variance
variance between
between actual
actual and
and budgeted
budgeted sales
sales
revenue.
revenue.
Or
Or
2.
2. Focus
Focus on
on contribution
contribution margin.
margin.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-15
Sales Revenue Variance Analysis
Revenue Budget Variance
Sales price
variance
Sales
volume variance
Sales mix
variance
Sales quantity
variance
Revenue m arket
size variance
Irwin/McGraw-Hill Ryerson
Revenue M arket
Share Variance
©McGraw-Hill Ryerson Limited, 2001
18-16
Revenue Budget Variance
Revenue
budget
variance for
product x
=
(
Budgeted
Actual sales
sales
revenue for –
revenue for
product x
product x
)
Example
Example
Elf,
Elf, Inc.
Inc. sells
sells artificial
artificial trees.
trees. Budgeted
Budgeted sales
sales for
for
2001
2001 are
are 65,000
65,000 units
units @
@ $120.
$120. Koala
Koala actually
actually
sold
sold 69,000
69,000 trees
trees at
at an
an average
average sales
sales price
price of
of
$110.
$110.
Compute
Compute the
the Revenue
Revenue Budget
Budget Variance.
Variance.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-17
Revenue Budget Variance
Example
Budgeted
Revenue
budget
variance for
product x
$210,000 U
=
=
(
Actual sales
sales
revenue for –
revenue for
product x
product x
)
(
$7,590,000 – $7,800,000
)
Because
Because actual
actual revenue
revenue << budgeted
budgeted revenue,
revenue,
the
the variance
variance is
is UNFAVOURABLE.
UNFAVOURABLE.
Next,
Next, compute
compute the
the sales
sales price
price variance
variance and
and the
the
sales
sales volume
volume variance
variance for
for the
the Tree
Tree Line
Line Tents.
Tents.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-18
Sales Price Variance
Model
Sales
price
variance =
for
product x
(
Actual
Budgeted
sales
sales
–
price for
price for
product x
product x
)
Actual
sales
× volume
for
product x
The
TheSales
SalesPrice
PriceVariance
Varianceis
isaameasure
measure
of
ofhow
howmuch
muchof
of the
thetotal
total variance
variance
results
resultsfrom
fromthe
thedifference
differencebetween
betweenthe
the
BUDGETED
BUDGETEDsales
salesprice
priceand
andthe
the
ACTUAL
ACTUALsales
salesprice.
price.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-19
Sales Price Variance
Example
Elf’s budgeted sales for 2001 are 65,000 units
@ $120. Koala actually sold 69,000 trees at
an average sales price of $110. What is Elf’s
Sales Price Variance.
A. $ 10 Unfavourable
B. $ 650,000 Unfavourable
C. $ 480,000 Unfavourable
D. $ 690,000 Unfavourable
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-20
Sales Price Variance
Example
Elf’s budgeted sales for 2001 are 65,000 units
@ $120. Koala actually sold 69,000 trees at
an average sales price of $110. What is Elf’s
Sales Price Variance.
A. $ 10 Unfavourable
You are on
B. $ 650,000 Unfavourable
the right
C. $ 480,000 Unfavourable track, but you
need to try
D. $ 690,000 Unfavourable
again!
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-21
Sales Price Variance
Example
Elf’s budgeted sales for 2001 are 65,000 units
@ $120. Koala actually sold 69,000 trees at
an average sales price of $110. What is Elf’s
Sales Price Variance.
A. $ 10 Unfavourable
Try
Tryagain.
again.
Askyourself
yourself
B. $ 650,000 Unfavourable Ask
ififyou
you should
should
C. $ 480,000 Unfavourable multiply
multiplyby
by
D. $ 690,000 Unfavourable actual
actualsales
sales
or
orbudgeted
budgeted
sales.
sales.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-22
Sales Price Variance
Example
Elf’s budgeted sales for 2001 are 65,000 units
@ $120. Koala actually sold 69,000 trees at
an average sales price of $110. What is Elf’s
Sales Price Variance.
A. $ 10 Unfavourable
You
Youare
areWAY
WAY
off
B. $ 650,000 Unfavourable
offbase!
base!
Lookat
at the
the
C. $ 480,000 Unfavourable Look
model
modeland
and
D. $ 690,000 Unfavourable
then
thentry
try
again.
again.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-23
Sales Price Variance
Example
Elf’s budgeted sales for 2001 are 65,000 units
@ $120. Koala actually sold 69,000 trees at
an average sales price of $110. What is Elf’s
Sales Price Variance.
A. $ 10 Unfavourable
B. $ 650,000 Unfavourable
C. $ 480,000 Unfavourable
D. $ 690,000 Unfavourable
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-24
Sales Price Variance
Model
Sales
price
variance =
for
product x
Irwin/McGraw-Hill Ryerson
(
Actual
Budgeted
sales
sales
–
price for
price for
product x
product x
)
Actual
sales
× volume
for
product x
©McGraw-Hill Ryerson Limited, 2001
18-25
Sales Volume Variance
Model
Sales
Volume
Variance
=
(
Actual
Budgeted
unit sales
unit sales
volume – volume
for
for
product x
product x
)
Budgeted
sales
×
price for
product x
This variance measures how
much of the total revenue
variance is due to unit sales
differing from budgeted unit
sales.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-26
Sales Volume Variance
Example
Elf’s
Elf’s budgeted
budgeted sales
sales for
for 2001
2001 are
are 65,000
65,000 units
units
@
@ $120.
$120. Koala
Koala actually
actually sold
sold 69,000
69,000 trees
trees at
at
an
an average
average sales
sales price
price of
of $110.
$110. What
What is
is Elf’s
Elf’s
Sales
Sales Volume
Volume Variance.
Variance.
A.
favourable
A. $$ 4,000
4,000 favourable
B.
B. $$ 440,000
440,000 favourable
favourable
C.
C. $$ 480,000
480,000 favourable
favourable
D.
D. $$ 690,000
690,000 Unfavourable
Unfavourable
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-27
Sales Volume Variance
Example
Elf’s
Elf’s budgeted
budgeted sales
sales for
for 2001
2001 are
are 65,000
65,000 units
units
@
@ $120.
$120. Koala
Koala actually
actually sold
sold 69,000
69,000 trees
trees at
at
an
an average
average sales
sales price
price of
of $110.
$110. What
What is
is Elf’s
Elf’s
Sales
Sales Volume
Volume Variance.
Variance.
A.
favourable
A. $$ 4,000
4,000 favourable
You are on
B.
the right
B. $$ 440,000
440,000 favourable
favourable
track, but you
C.
$
480,000
favourable
C. $ 480,000 favourable
need to try
D.
again!
D. $$ 690,000
690,000 Unfavourable
Unfavourable
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-28
Sales Volume Variance
Example
Elf’s
Elf’s budgeted
budgeted sales
sales for
for 2001
2001 are
are 65,000
65,000 units
units
@
@ $120.
$120. Koala
Koala actually
actually sold
sold 69,000
69,000 trees
trees at
at
an
an average
average sales
sales price
price of
of $110.
$110. What
What is
is Elf’s
Elf’s
Sales
Sales Volume
Volume Variance.
Variance.
A.
Try
favourable
A. $$ 4,000
4,000 favourable
Tryagain.
again. Ask
Ask
yourself ififyou
you should
should
B.
B. $$ 440,000
440,000 favourable
favourable yourself
multiply
multiplyby
byactual
actual
C.
$
480,000
favourable
C. $ 480,000 favourable
price
priceor
orbudgeted
budgeted
price.
D.
price.
D. $$ 690,000
690,000 Unfavourable
Unfavourable
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-29
Sales Volume Variance
Example
Elf’s
Elf’s budgeted
budgeted sales
sales for
for 2001
2001 are
are 65,000
65,000 units
units
@
@ $120.
$120. Koala
Koala actually
actually sold
sold 69,000
69,000 trees
trees at
at
an
an average
average sales
sales price
price of
of $110.
$110. What
What is
is Elf’s
Elf’s
Sales
Sales Volume
Volume Variance.
Variance.
A.
You
favourable
A. $$ 4,000
4,000 favourable
Youare
areWAY
WAY
off
offbase!
base!
B.
B. $$ 440,000
440,000 favourable
favourable
Look
Lookat
at the
the
C.
$
480,000
favourable
C. $ 480,000 favourable
model
modeland
and
then
D.
thentry
try
D. $$ 690,000
690,000 Unfavourable
Unfavourable
again.
again.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-30
Sales Volume Variance
Example
Elf’s
Elf’s budgeted
budgeted sales
sales for
for 2001
2001 are
are 65,000
65,000 units
units
@
@ $120.
$120. Koala
Koala actually
actually sold
sold 69,000
69,000 trees
trees at
at
an
an average
average sales
sales price
price of
of $110.
$110. What
What is
is Elf’s
Elf’s
Sales
Sales Volume
Volume Variance.
Variance.
A.
favourable
A. $$ 4,000
4,000 favourable
B.
B. $$ 440,000
440,000 favourable
favourable
C.
C. $$ 480,000
480,000 favourable
favourable
D.
D. $$ 690,000
690,000 Unfavourable
Unfavourable
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-31
Sales Volume Variance
Model
Sales
Volume
Variance
Irwin/McGraw-Hill Ryerson
=
(
Actual
Budgeted
unit sales
unit sales
volume – volume
for
for
product x
product x
)
Budgeted
sales
×
price for
product x
©McGraw-Hill Ryerson Limited, 2001
18-32
Sales Mix Variance
For
For the
the Sales
Sales Mix
Mix Variance,
Variance, sum
sum the
the sales
sales mix
mix
variances
variances for
for each
each product.
product.
Sales
Mix
Variance
Budget
=
sales
price
×
(
Actual
sales
mix %
Budget
–
sales
mix %
)
Actual
× total unit
sales
Example
Example -- Refer
Refer to
to the
the text
text
Koala
Koalaoriginally
originallybudgeted
budgeted for
forTree
TreeLine
LineTents
Tentsto
to
comprise
comprise60%
60%of
ofsales.
sales. By
Bythe
theend
end of
of the
theperiod,
period,
Tree
TreeLine
LineTents
Tentsrepresented
representedonly
only55%
55%of
of sales.
sales.
Total
Totalunit
unitsales
salesfor
forthe
theperiod
periodwas
was55,000
55,000units.
units.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-33
Sales Mix Variance
For
For the
the Sales
Sales Mix
Mix Variance,
Variance, sum
sum the
the sales
sales mix
mix
variances
variances for
for each
each product.
product.
Sales
Mix
Variance
Budget
=
sales
price
$495,000 U =
×
$180
(
×
Budget
–
sales
mix %
)
Actual
× total unit
sales
55% – 60%
)
×
Actual
sales
mix %
(
55,000
The
Thevariance
varianceis
isUNFAVOURABLE,
UNFAVOURABLE,
because
becauseTree
TreeLine
LineTents
Tentswere
wereaasmaller
smaller
portion
portionof
oftotal
total sales
salesthan
than originally
originally
planned.
planned.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-34
Sales Quantity Variance
For
For the
the Sales
Sales Quantity
Quantity Variance,
Variance, sum
sum the
the sales
sales
quantity
quantity variances
variances for
for each
each product.
product.
Sales
Quantity
Variance
Budget
= sales ×
price
(
Actual
Budget
unit –
unit
sales
sales
)
Budget
×
Sales %
Example
Example
Koala
Koalaoriginally
originallybudgeted
budgeted for
forTree
TreeLine
LineTents
Tentsto
to
comprise
comprise60%
60%of
ofsales.
sales. Koala
Koalaplanned
plannedto
tosell
sell
50,000
50,000Tree
TreeLine
LineTents,
Tents, but
but actually
actuallysold
sold55,000
55,000
Tree
TreeLine
LineTents.
Tents. Budgeted
BudgetedSales
SalesPrice
Priceis
is$180.
$180.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-35
Sales Quantity Variance
For
For the
the Sales
Sales Quantity
Quantity Variance,
Variance, sum
sum the
the sales
sales
quantity
quantity variances
variances for
for each
each product.
product.
Sales
Quantity
Variance
Budget
= sales ×
price
$540,000 F =
$180
Actual
Budget
unit –
unit
sales
sales
(
×
(
55,000 – 50,000
)
Budget
×
Sales %
)
× 60%
The
Thevariance
varianceis
isFAVOURABLE,
FAVOURABLE,because
because
Tree
TreeLine
LineTents
Tentssold
soldmore
moreunits
unitsthat
that
originally
originallyplanned.
planned.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-36
Revenue Market Size
Variance
Base
Base the
the Revenue
Revenue Market
Market Size
Size Variance
Variance on
on
total
total production
production and
and budgeted
budgeted market
market share.
share.
Budget
Revenue
weighted
market
= avg. unit ×
size
sales
variance
price
(
Actual
total
market
unit
sales
Budget
total
– market
unit
sales
)
Budget
× market
share %
The
The resulting
resulting variance
variance is
is favourable,
favourable, or
or
unfavourable,
unfavourable, simply
simply as
as aa function
function of
of how
how
the
the industry,
industry, as
as aa whole,
whole, did
did compared
compared to
to
expectations.
expectations.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-37
Revenue Market Share Variance
Budget
Revenue
weighted
market
= avg. unit ×
share
sales
variance
price
(
Actual
Budget
market – market
share %
share %
)
Actual
total
× market
unit
sales
Example
Example
Koala’s
Koala’sbudgeted
budgeted market
market share
shareis
is5%.
5%.
However,
However,Koala
Koalaonly
onlyachieved
achieved aamarket
market
share
shareof
of 4%.
4%. Weighted
Weightedaverage
averageunit
unitsales
sales
price
pricefor
forKoala’s
Koala’sthree
threetypes
typesof
of tents
tentsis
is
$199.
$199. Total
Totalindustry
industrysales
saleswere
were1,375,000
1,375,000
units.
units.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-38
Revenue Market Share Variance
Example
Budget
Revenue
weighted
market
= avg. unit ×
share
sales
variance
price
=
$199
×
= $2,736,250 U
Irwin/McGraw-Hill Ryerson
(
(
Actual
Budget
market – market
share %
share %
4% – 5%
)
×
)
Actual
total
× market
unit
sales
1,375,000
Koala’s market share is
down. This particular
variance is likely to be of
great concern to
management.
©McGraw-Hill Ryerson Limited, 2001
18-39
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-40
CM Variance Analysis
CM Budget Variance
CM variance
CM sales volume variance
Each
Eachof
ofthese
thesevariances
variancesis
is
computed
computedthe
thesame
sameway
wayas
asits
its
revenue
revenuecounterpart.
counterpart.
Use
UseCM
CMinstead
insteadof
ofsales
salesprice.
price.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-41
CM Variance Analysis
CM Budget Variance
CM variance
CM sales volume variance
CM sales mix
variance
CM Sales quantity
variance
Each
Eachof
ofthese
thesevariances
variancesis
is
computed
computedthe
thesame
sameway
wayas
asits
its
revenue
revenuecounterpart.
counterpart.
Use
UseCM
CMinstead
insteadof
ofsales
salesprice.
price.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-42
CM Variance Analysis
CM Budget Variance
CM variance
CM sales volume variance
CM sales mix
variance
Each
Eachof
ofthese
thesevariances
variancesis
is
computed
computedthe
thesame
sameway
wayas
asits
its
revenue
revenuecounterpart.
counterpart.
Use
UseCM
CMinstead
insteadof
ofsales
salesprice.
price.
Irwin/McGraw-Hill Ryerson
CM Sales quantity
variance
CM market
size variance
CM Market
Share Variance
©McGraw-Hill Ryerson Limited, 2001
Income Reporting Effects of
Alternative Product-Costing
Approaches
Absorption
Costing
Irwin/McGraw-Hill Ryerson
Vs.
18-43
Variable
Costing
©McGraw-Hill Ryerson Limited, 2001
18-44
Absorption Costing
Product
Product cost
cost includes
includes both
both variable
variable and
and fixed
fixed
manufacturing
manufacturing overhead,
overhead, in
in addition
addition to
to direct
direct
materials
materials (variable)
(variable) and
and direct
direct labour
labour (variable).
(variable).
Direct
DirectMaterial
Material
Costs
incurred
Direct
Directlabour
labour
ALL
ALLMfg.
Mfg.O/H
O/H
Irwin/McGraw-Hill Ryerson
WIP
WIP
Inventory
Inventory
on
onBal.
Bal.
Sheet
Sheet
COGS
COGSon
on Income
Income
Statement
Statement
Goods
completed
Finished
Finished
Goods
Goods
Inventory
Inventory
on
onBal.
Bal.
Sheet
Sheet
Goods sold
©McGraw-Hill Ryerson Limited, 2001
18-45
Variable Costing
Variable
Variable costing
costing uses
uses only
only the
the variable
variable portion
portion
of
of manufacturing
manufacturing overhead
overhead when
when computing
computing
product
product cost.
cost.
Direct
DirectMaterial
Material
Direct
Directlabour
labour
Variable
VariableMfg.
Mfg.
O/H
O/H
Irwin/McGraw-Hill Ryerson
Costs
incurred
WIP
WIP
Inventory
Inventory
on
onBal.
Bal.
Sheet
Sheet
COGS
COGSon
on Income
Income
Statement
Statement
Goods
completed
Finished
Finished
Goods
Goods
Inventory
Inventory
on
onBal.
Bal.
Sheet
Sheet
Goods sold
©McGraw-Hill Ryerson Limited, 2001
18-46
Variable Costing
With
With Variable
Variable Costing,
Costing, the
the Fixed
Fixed manufacturing
manufacturing
overhead
overhead is
is charged
charged directly
directly to
to expenses
expenses on
on
the
the income
income statement.
statement.
Fixed
Fixed
Manufacturing
Manufacturing
Overhead
Overhead
Irwin/McGraw-Hill Ryerson
Costs
incurred
Expenses
Expenseson
on Income
Income
Stmt.
Stmt.
©McGraw-Hill Ryerson Limited, 2001
18-47
Alternative Product-Costing
Absorption costing will often result
in different net income than variable
costing. Remember, the only
difference is in how we treat FIXED
manufacturing overhead.
Koala
Koala Cooking
Cooking Gear
Gear needs
needs to
to know
know how
how net
net
income
income would
would differ
differ under
under absorption
absorption costing
costing
and
and variable
variable costing.
costing. Use
Use the
the information
information in
in the
the
following
following table
table to
to prepare
prepare income
income statements
statements for
for
both
both absorption
absorption costing
costing and
and variable
variable costing.
costing.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-48
Alternative Product-Costing
Example
Production and Inventory data:
Beginning Inventory
Units Produced
Units Sold
Ending Inventory
0
18,000
13,500
4,500
Revenue and Cost data:
Sales Price per Unit
Direct Material Cost per Unit
Direct Labour Cost per Unit
Variable Manufacturing Overhead per Unit
Variable SG&A
Fixed Manufacturing Overhead
Fixed SG&A
Irwin/McGraw-Hill Ryerson
$34
$12
$4
$7
$3
$81,000
$45,000
©McGraw-Hill Ryerson Limited, 2001
18-49
Absorption Costing
Example
Step 1: Compute Fixed Overhead Rate
per Unit of Production
Budgeted
Planned
Fixed
annual
÷ annual
= Overhead
fixed
production
Rate
overhead
$81,000
Irwin/McGraw-Hill Ryerson
÷
18,000
=
$4.50
©McGraw-Hill Ryerson Limited, 2001
18-50
Absorption Costing
Example
Step 2: Compute Absorption Cost per Unit
Direct Materials Cost per Unit
Direct Labour Cost per Unit
Variable Overhead Cost per Unit
Fixed Overhead Cost per Unit*
TOTAL COST PER UNIT**
$12.00
4.00
7.00
4.50
$27.50
* Com pute d in Ste p 1
** Us e to prepare Incom e Statem ent
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-51
Absorption Costing
Example
Koala Cooking Gear
Absorption Costing Income Statement
Revenue
( 13,500 × $34.00 ) $ 459,000
COGS
( 13,500 × $27.50 ) (371,250)
Gross Margin
$ 87,750
SG& A Expenses
Variable
( 13,500 × $3.00 )
(40,500)
Fixed
(45,000)
NET INCOME
$ 2,250
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-52
Absorption Costing
Example
Koala Cooking Gear
Absorption Costing Income Statement
Revenue
( 13,500 × $34.00 ) $ 459,000
COGS
( 13,500 × $27.50 ) (371,250)
Gross Margin
$ 87,750
SG& A Expenses
Variable
( 13,500 × $3.00 )
(40,500)
Fixed
(45,000)
NET INCOME
$ 2,250
Irwin/McGraw-Hill Ryerson
COGS includes only part of
the fixed overhead incurred
during the period. ©McGraw-Hill Ryerson Limited, 2001
18-53
Variable Costing
Example
Koala Cooking Gear
Variable Costing Income Statement
Revenue
( 13,500 × $34.00 ) $ 459,000
COGS
( 13,500 × $23.00 ) $(310,500)
Variable SG&A
( 13,500 × $3.00 )
(40,500)
Contribution Margin
$ 108,000
Fixed Expenses
SG&A
(45,000)
Mfg. Overhead
(81,000)
NET INCOME
$ (18,000)
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-54
Variable Costing
Example
Koala Cooking Gear
Variable Costing Income Statement
Revenue
( 13,500 × $34.00 ) $ 459,000
COGS
( 13,500 × $23.00 ) $(310,500)
Variable SG&A
( 13,500 × $3.00 )
(40,500)
Contribution Margin
$ 108,000
Fixed Expenses
SG&A
(45,000)
Mfg. Overhead
(81,000)
Includes direct
NET INCOME
material ($12), direct $ (18,000)
labour ($4) and
variable overhead ($7)
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-55
Variable Costing
Example
Koala Cooking Gear
Variable Costing Income Statement
Revenue
( 13,500 × $34.00 ) $ 459,000
COGS
( 13,500 × $23.00 ) $(310,500)
Variable SG&A
( 13,500 × $3.00 )
(40,500)
Contribution Margin
$ 108,000
Fixed Expenses
SG&A
(45,000)
This includes
Mfg. Overhead ALL the fixed
(81,000)
NET INCOME
$ (18,000)
overhead for the
period.
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001
18-56
Absorption vs. Variable Costing
Reconciling Income
Period-to-Period
Income Comparison
Income Comparison
No Change in Inventory
Increase in Inventory
Decrease in Inventory
Absorption = Variable
Absorption > Variable
Absorption < Variable
Difference in Fixed
Overhead Expensed
Under Absorption and =
Variable Costing
Methods
Irwin/McGraw-Hill Ryerson
Change in
Inventory
Units
Predetermined
× Fixed-Overhead
Rate Per Unit
©McGraw-Hill Ryerson Limited, 2001
18-57
End of Chapter 18
I can’t stand
it anymore!
Please make
it stop!
Irwin/McGraw-Hill Ryerson
©McGraw-Hill Ryerson Limited, 2001