Income Comparison of Variable  and Absorption Costing:

Learning Objectives:

1. Prepare income statements using variable costing and absorption costing.
2. Why net operating income usually different under variable and absorption costing methods?

The income statements prepared under absorption costing and variable costing usually produce different net operating income figures. This difference can be quite large. Here we will explain the basic reason of this difference in income. The explanation for this difference needs two separate income statements one under absorption costing and other under variable costing. We will prepare two income statements that will produce different income figures and then explain the reasons of difference. Consider the following example:

Example:

Following data relates to a manufacturing company:

Number of units produced each year 6,000 Variable cost per unit: Direct materials $2 Direct labor $4 Variable Manufacturing Overhead $1 Variable selling and Administrative expenses $3     Fixed costs per year:   Fixed manufacturing overhead $30,000 Fixed selling and administrative expenses $10,000     Units in beginning inventory 0 Units produced 6,000 Units Sold 5,000 Units in ending inventory 1,000 Selling price per unit $20 Selling and administrative expenses: Variable per unit $3 Fixed per year $10,000

Required:

1. Prepare income statements using:
   a. Absorption costing system
   b. Variable costing system
2. Prepare a reconciliation schedule

Absorption Costing Income Statement   Sales (5,000 units×$20 per unit) $100,000   ---------- Less cost of goods sold: Beginning inventory $0 Add Cost of goods manufactured (6,000 units×$12per unit) $72,000   ---------- Goods available for sale $72,000 Less ending inventory $12,000   ---------- Cost of goods sold $60,000   ---------- Gross Margin ($100,000 – $60,000) $40,000 ---------- Less selling and administrative expenses Variable selling and administrative expenses (5,000 × 3) $15,000 Fixed selling and administrative expenses $10,000   ---------   $25,000   ---------- Net operating income ($40,000 – $25,000) $15,000   ========     Variable Costing Income Statement   Sales ($5,000units×$20 per unit) $100,000 ------------ Less variable expenses: Variable cost of goods sold:   Beginning inventory $0 Add variable manufacturing costs (6,000 units×$7 per unit) $42,000   ----------- Goods available for sale $42,000 Less ending inventory (1,000 units×$7 per unit) $7,000   --------- Variable cost of goods sold $35,000 variable selling and administrative expenses (5,000 units × $3 per unit) $15,000 --------- 50,000 ---------- Contribution margin ($100,000 − $50,000) 50,000 ---------- Less fixed expenses: Fixed manufacturing overhead $30,000 Fixed selling and administrative expenses $10,000 --------- $40,000 --------- Net operating Income ($50,000 − $40,000) $10,000 =======

The income statements prepared above have different net operating income figures. Now we will explain why net operating income is different under both the costing systems.

Explanation:

Several points can be noted from the income statements prepared above:

Under absorption costing if inventories increase then some of the fixed manufacturing costs of the current period will not appear on the income statement as part of cost of goods sold. Instead, these costs are deferred to a future period and are carried on the balance sheet as part of the inventory account. Such a deferral of cost is known as fixed manufacturing overhead deferred in inventory. The process involved can be explained by referring to income statements prepared above. During the current period 6,000 units have been produced but only 5,000 units have been sold leaving 1,000 unsold units in the ending inventory. Under the absorption costing system each unit produced was assigned $5 in fixed overhead cost. Therefore each unit going into inventory at the end of the period has $5 in fixed manufactured overhead cost attached to it, or a total of $5,000 for 1,000 units (1,000 × $5). This fixed manufacturing overhead cost of the current period deferred in inventory to the next period, when hopefully these units will be taken out of inventory and sold. This deferral of $5,000 of fixed manufacturing overhead costs can be clearly seen by analyzing the ending inventory under the absorption costing method:

Variable manufacturing costs (1000units × $7 per unit)	$7,000
Fixed manufacturing overhead costs (1,000 × $5 per unit)	$5,000
	---------
Total ending inventory value	$12,000
	=======

In summary, under absorption costing, of the $30,000 in fixed manufacturing overhead costs incurred during the period, only $25,000 (5,000 $ per unit) has been included in the cost of goods sold. The remaining $5000 (1000 units not sold  $5 per unit) has been deferred in inventory to the next period.

Under variable costing method the entire $30,000 in fixed manufacturing overhead costs has been treated as an expense of the current period (see the bottom portion of the variable costing income statement).

The ending inventory figure under the variable costing method is $5,000 lower than it is under the absorption costing method. The reason is that under variable costing, Only the variable manufacturing costs are assigned to units of product and therefore included in the inventory:

Variable manufacturing costs (1000units × $7 per unit)

$7,000

The $5,000 difference in ending inventories explains the difference in net operating income reported between the two costing methods. Net operating is $5,000 higher under absorption costing since, as explained above, $5,000 of fixed manufacturing overhead cost has been deferred in inventory to the next period under that costing method. Hopefully,  when the units relating to this $5,000 fixed cost will be sold in the next period the cost attached to these units will be included in the cost of goods sold of the next period. This is called  fixed manufacturing overhead cost released from inventory.

The absorption costing system makes no distinction between fixed and variable costs; therefore, it is not well suited for CVP computations, which are important for good planning and control. To generate data for cost volume profit (CVP) analysis, it would be necessary to spend considerable time reworking and reclassifying costs on the absorption statement.

The variable costing approach to costing units of product works very well with the contribution approach to the income statement, since both concepts are based on the idea of classifying costs by behavior. The variable costing data could be immediately used in cost volume profit (CVP) calculations.

 

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Variable Costing Versus Absorption Costing:

Learning Objectives:

1. Define and explain variable and absorption costing.
2. Explain the difference between variable and absorption costing and calculate unit product cost under each method.

Absorption Costing or Full Costing System:

Definition and explanation:

Absorption costing is a costing system which treats all costs of production as product costs, regardless weather they are variable or fixed. The cost of a unit of product under absorption costing method consists of direct materials, direct labor and both variable and fixed overhead. Absorption costing allocates a portion of fixed manufacturing overhead cost to each unit of product, along with the variable manufacturing cost. Because absorption costing includes all costs of production as product costs, it is frequently referred to as full costing method.

Variable, Direct or Marginal Costing:

Definition and explanation:

Variable costing is a costing system under which those costs of production that vary with output are treated as product costs. This would usually include direct materials, direct labor and variable portion of manufacturing overhead. Fixed manufacturing cost is not treated as a product costs under variable costing. Rather, fixed manufacturing cost is treated as a period cost and, like selling and administrative expenses, it is charged off in its entirety against revenue each period. Consequently the cost of a unit of product in inventory or cost of goods sold under this method does not contain any fixed overhead cost. Variable costing is some time referred to as direct costing or marginal costing. To complete this summary comparison of absorption and variable costing, we need to consider briefly the handling of selling and administrative expenses. These expenses are never treated as product costs, regardless of the costing method in use. Thus under either absorption or variable costing, both variable and fixed selling and administrative expenses are always treated as period costs and deducted from revenues as incurred.

The concepts explained so for are illustrated below

Cost classifications--Absorption versus variable costing

 

Absorption Costing

Variable Costing

 

Product cost	Direct materials Direct Labor Variable Manufacturing overhead	Product cost
	Fixed manufacturing overhead	Period cost
Period cost	Variable selling and administrative expenses
	Fixed selling and administrative expenses

Unit Cost Computation/Calculation:

To illustrate the computation/calculation of unit product costs under both absorption and variable costing consider the following example.

 Example:

A small company that produces a single product has the following cost structure.

Number of units produced 6,000 Variable costs per unit: Direct materials $2 Direct labor $4 Variable manufacturing overhead $1 Variable selling and Administrative expenses $3 Fixed costs per year: Fixed manufacturing overhead $30,000 Fixed selling and administrative expenses $10,000

Required:

1. Compute the unit product cost under absorption costing method.
2. Compute the unit product cost under variable / marginal costing method.

Unit product Cost Absorption Costing Method Direct materials $2 Direct labor $4 Variable manufacturing overhead $1   -------- Total variable production cost $7 Fixed manufacturing overhead $5   -------- Unit product cost $12   ===== Unit product Cost Variable Costing Method Direct materials $2 Direct labor $4 Variable manufacturing overhead $1   -------- Unit product cost $7   ===== (The $30,000 fixed manufacturing overhead will be charged off in total against income as a period expense along with selling and administrative expenses)

Under the absorption costing, notice that all production costs, variable and fixed, are included when determining the unit product cost. Thus if the company sells a unit of product and absorption costing is being used, then $12 (consisting of $7 variable cost and $5 fixed cost) will be deducted on the income statement as cost of goods sold. Similarly, any unsold units will be carried as inventory on the balance sheet at $12 each.

Under variable costing, notice that all variable costs of production are included in product costs. Thus if the company sells a unit of product, only $7 will be deducted as cost of goods sold, and unsold units will be carried in the balance sheet inventory account at only $7.

 

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Difference Between Financial and Managerial Accounting (Financial Accounting Vs Managerial Accounting):

Learning objectives of this article:

• Compare and contrast financial and managerial accounting.
• What is difference between financial and managerial accounting?

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Financial accounting reports are prepared for the use of external parties such as shareholders and creditors, whereas managerial accounting reports are prepared for managers inside the organization.

This contrast in basic orientation results in a number of major differences between financial and managerial accounting, even though both financial and managerial accounting often rely on the same underlying financial data. In addition to the to the differences in who the reports are prepared for, financial and managerial accounting also differ in their emphasis between the past and the future, in the type of data provided to users, and in several other ways. These differences are discussed in the following paragraphs.

Emphasis on the Future:

Since planning is such an important part of the manager's job, managerial accounting has a strong future orientation. In contrast, financial accounting primarily provides summaries of past financial transactions. These summaries may be useful in planning, but only to a point. The future is not simply a reflection of what has happened in the past. Changes are constantly taking place in economic conditions, and so on. All of these changes demand that the manager's planning be based in large part on estimates of what will happen rather than on summaries of what has already happened.

Relevance of  Data:

Financial accounting data are expected to be objective and verifiable. However, for internal use the manager wants information that is relevant even if it is not completely objective or verifiable. By relevant, we mean appropriate for the problem at hand. For example, it is difficult to verify estimated sales volumes for a proposed new store at good Vibrations, Inc., but this is exactly the type of information that is most useful to managers in their decision making. The managerial accounting information system should be flexible enough to provide whatever data are relevant for a particular decision.

Less Emphasis on Precision:

Timeliness is often more important than precision to managers. If a decision must be made, a manager would rather have a good estimate now than wait a week for a more precise  answer. A decision involving tens of millions of dollars does not have to be based on estimates that are precise down to the penny, or even to the dollar. In fact, one authoritative source recommends that, "as a general rule, no one needs more than three significant digits., this means, for example, that if a company's sales are in the hundreds of millions of dollars, than nothing on an income statement needs to be more accurate than the nearest million dollars. Estimates that accurate to the nearest million dollars may be precise enough to make a good decision. Since precision is costly in terms of both time and resources, managerial accounting places less emphasis on precision than does financial accounting. In addition, managerial accounting places considerable weight on non monitory data, for example, information about customer satisfaction is tremendous importance even though it would be difficult to express such data in monitory form.

Segments of an Organization:

Financial accounting is primarily concerned with reporting for the company as a whole. By contrast, managerial accounting forces much more on the parts, or segments, of a company. These segments may be product lines, sales territories divisions, departments, or any other categorizations of the company's activities that management finds useful. Financial accounting does require breakdowns of revenues and cost by major segments in external reports, but this is secondary emphasis. In managerial accounting segment reporting is the primary emphasis.

Generally Accepted Accounting Principles (GAAP):

Financial accounting statements prepared for external users must be prepared in accordance with generally accepted accounting principles (GAAP). External users must have some assurance that the reports have been prepared in accordance with some common set of ground rules. These common ground rules enhance comparability and help reduce fraud and misrepresentations, but they do not necessarily lead to the type of reports that would be most useful in internal decision making. For example, GAAP requires that land be stated at its historical cost on financial reports. However if, management is considering moving a store to a new location and then selling the land the store currently sits on, management would like to know the current market value of the land, a vital piece of information that is ignored under generally accepted accounting principles (GAAP).

Managerial Accounting  Not Mandatory:

Financial accounting is mandatory; that is, it must be done. Various out side parties such as Securities and exchange commission (SEC) and the tax authorities require periodic financial statements. Managerial accounting, on the other hand, is not mandatory. A company is completely free to do as much or as little as it wishes . No regularity bodies or other outside agencies specify what is to be done, for that matter, weather anything is to be done at all. Since managerial accounting is completely optional, the important question is always, "Is the information useful?" rather than, "Is the information required?"

 Summary:

Financial Accounting	Managerial Accounting
Reports to those outside the organization owners, lenders, tax authorities and regulators.	Reports to those inside the organization for planning, directing and motivating, controlling and performance evaluation.
Emphasis is on summaries of financial consequences of past activities.	Emphasis is on decisions affecting the future.
Objectivity and verifiability of data are emphasized.	Relevance of items relating to decision making is emphasized.
Precision of information is required.	Timeliness of information is required.
Only summarized data for the entire organization is prepared.	Detailed segment reports about departments, products, customers, and employees are prepared.
Must follow Generally Accepted Accounting Principles (GAAP).	Need not follow Generally Accepted Accounting Principles (GAAP).
Mandatory for external reports.	Not mandatory.

 

In Business | What number did you have in mind? Caterpillar has long been at the forefront of management accounting practice. When asked by a manager for the cost of something, accountants at caterpillar have been trained to ask "What are you going to use the cost element for?" One management accountant at Caterpillar explains: "we want to make sure the information is formatted and the right elements are included. Do you need a variable cost, do you need a fully burdened cost, do you need overhead applied, are you just talking about discretionary cost? The cost that they really need depends on the decision they are making."

 

 

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Standard Costing and Variance Analysis Formulas

 

Standard Costing and Variance Analysis Formulas:

Learning Objective of the article:

1. Learn the formulas to calculate direct materials, direct labor and factory overhead variances.

This is a collection of variance formulas / equations which can help you calculate variances for direct materials, direct labor, and factory overhead.

1. Direct materials variances formulas
2. Direct labor variances formulas
3. Factory overhead variances formulas

Direct Materials Variances:

Materials purchase price variance Formula:
Materials purchase price variance = (Actual quantity purchased × Actual price) – (Actual quantity purchased × Standard price)

Materials price usage variance formula
Materials price usage variance = (Actual quantity used × Actual price) – (Actual quantity used × Standard price)

materials quantity / usage variance formula
Materials price usage variance = (Actual quantity used × Standard price) – (Standard quantity allowed × Standard price)

Materials mix variance formula
(Actual quantities at individual standard materials costs) –  (Actual quantities at weighted average of standard materials costs)

Materials yield variance formula
(Actual quantities at weighted average of standard materials costs) –  (Actual output quantity at standard materials cost)

Direct Labor Variances:

Direct labor rate / price variance formula:
(Actual hours worked × Actual rate) – (Actual hours worked × Standard rate)

Direct labor efficiency / usage / quantity formula:
(Actual hours worked × Standard rate) – (Standard hours allowed × Standard rate)

Direct labor yield variance formula:
(Standard hours allowed for expected output × Standard labor rate) – (Standard hours allowed for actual output × Standard labor rate)

Factory Overhead Variances:

Factory overhead controllable variance formula:
(Actual factory overhead) – (Budgeted allowance based on standard hours allowed*)

Factory overhead volume variance:
(Budgeted allowance based on standard hours allowed*) – (Factory overhead applied or charged to production**)

Factory overhead spending variance:
(Actual factory overhead) – (Budgeted allowance based on actual hours worked***)

Factory overhead idle capacity variance formula:
(Budgeted allowance based on actual hours worked***) – (Actual hours worked × Standard overhead rate)

Factory overhead efficiency variance formula:
(Actual hours worked × Standard overhead rate) – (Standard hours allowed for expected output × Standard overhead rate)

Variable overhead efficiency variance formula:
(Actual hours worked × Standard variable overhead rate) – (Standard hours allowed × Standard variable overhead rate)

Variable overhead efficiency variance formula:
(Actual hours worked × Fixed overhead rate) – (Standard hours allowed × Fixed overhead rate)

Factory overhead yield variance formula:
(Standard hours allowed for expected output × Standard overhead rate) – (Standard hours allowed for actual output × Standard overhead rate)

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*Fixed overhead budgeted + Standard hours allowed × Standard variable overhead rate

**Standard hours allowed for actual production × Standard overhead rate

***Fixed overhead budgeted + Actual hours worked × Standard variable overhead rate

 

 

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Cost Classification as Manufacturing and Non-manufacturing:

Learning objectives of this article:

• Define and explain manufacturing and non-manufacturing costs.
• What is the difference between manufacturing and non-manufacturing costs costs?
• Identify and give examples of each of the three basic manufacturing cost categories.

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Manufacturing firms are involved in acquiring raw materials producing finished goods and then administrative, marketing and selling activities. All these activities require costs to be incurred. These costs are normally classified by manufacturing companies as manufacturing and non-manufacturing costs. In the following paragraphs we will see how these costs are classified as manufacturing and non-manufacturing.

Manufacturing Costs:

Definition and Explanation of manufacturing cost:

Manufacturing costs are those costs that are directly involved in manufacturing of products and services. Examples of manufacturing costs include raw materials costs and salary of labor workers. Manufacturing cost is divided into three broad categories by most companies.

1.      Direct materials cost

2.      Direct labor cost

3.      Manufacturing overhead cost.

Direct Materials Cost:

The materials that go into final product are called raw materials. This term is somewhat misleading, since it seems to imply unprocessed natural resources like wood pulp or iron ore. Actually raw materials refer to any materials that are used in the final product; and the finished product of one company can become raw material of another company. For example plastic produced by manufacturers of plastic is a finished product for them but is a raw material for Compaq Computers for its personal computers.

Direct Materials are those material that become an integral part of the finished product and that can be physically and conveniently traced to it.  Examples include tiny electric motor that Panasonic uses in its CD players to make the CD spin. According to a study of 37 manufacturing industries material costs averaged about 55% of sales revenue.

Sometimes it is not worth the effort to trace the costs of relatively insignificant materials to the end products. Such minor items would include the solder used to make electrical connection in a Sony TV or the glue used to assemble a chair. Materials such as solder or glue are called indirect materials and are included as part of manufacturing overhead, which is discussed later on this page.

Direct Labor Cost:

The term direct labor is reserved for those labor costs that can be essentially traced to individual units of products. Direct labor is sometime called touch labor, since direct labor workers typically touch the product while it is being made. The labor cost of assembly line workers, for example, is a direct labor cost, as would the labor cost of carpenter, bricklayer and machine operator

Labor costs that cannot be physically traced to the creation of products, or that can be traced only at a great cost and inconvenience, are termed indirect labor and treated as part of manufacturing overhead, along with indirect materials. Indirect labor includes the labor costs of janitors, supervisors, materials handlers, and night security guards. Although the efforts of these workers are essential to production, it would be either impractical or impossible to accurately trace their costs to specific units of product. Hence, such labor costs are treated as indirect labor.

In some industries, major shifts are taking place in the structure of labor costs. Sophisticated automated equipment, run and maintained by skilled workers, is increasingly replacing direct labor. In a few companies, direct labor has become such a minor element of cost that it has disappeared altogether as a separate cost category. However the vast majority of manufacturing and service companies throughout the world continue to recognize direct labor as a separate cost category.

According to a study of 37 manufacturing industries, direct labor averaged only about 10% of sales revenue.

Direct Materials cost combined with direct labor cost is called prime cost.

In equation form:

Prime Cost = Direct Materials Cost + Direct Labor Cost

For example total direct materials cost incurred by the company is $4,500 and direct labor cost is $3,000 then prime cost is $7,500 ($4,500 + $3,000).

Manufacturing Overhead Cost:

Manufacturing overhead, the third element of manufacturing cost, includes all costs of manufacturing except direct material and direct labor. Examples of manufacturing overhead include items such as indirect material, indirect labor, maintenance and repairs on production equipment and heat and light, property taxes, depreciation, and insurance on manufacturing facilities. Indirect materials are minor items such as solder and glue in manufacturing industries. These are not included in direct materials costs. Indirect labor is a labor cost that cannot be trace to the creation of products or that can be traced only at great cost and inconvenience. Indirect labor includes the labor cost of janitors, supervisors, materials handlers and night security guards. Costs incurred for heat and light, property taxes, insurance, depreciation and so forth associated with selling and administrative functions are not included in manufacturing overhead. Studies have found that manufacturing overhead averages about 16% of sales revenue. Manufacturing overhead is known by various names, such as indirect manufacturing cost, factory overhead, and factory burden. All of these terms are synonymous with manufacturing overhead.

Manufacturing overhead cost combined with direct labor is called conversion cost.

In equation form:

Conversion Cost = Direct Labor Cost + Manufacturing Overhead Cost

For example if total direct labor cost is $3,000 and total manufacturing overhead cost is $2,000 then conversion cost is $5,000 ($3,000 + $2,000).

Non-manufacturing Costs:

Definition and explanation of non-manufacturing cost:

Non-manufacturing costs are those costs that are not  incurred to manufacture a product. Examples of such costs are salary of sales person and advertising expenses. Generally non-manufacturing costs are further classified into two categories.

1. Marketing and Selling Costs
2. Administrative Costs

Marketing or Selling Costs:

Marketing or selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customers. These costs are often called order getting or order filling costs. Examples of marketing or selling costs include advertising costs, shipping costs, sales commission and sales salary.

Administrative Costs:

Administrative costs include all executive, organizational, and clerical costs associated with general management of an organization rather than with manufacturing, marketing, or selling. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the organization as a whole.

Summary of manufacturing and non-manufacturing costs

	Manufacturing Costs
	Direct Materials: Materials that can be physically and conveniently traced to a product, such as wood in a table.	Prime Cost (Direct Materials + Direct Labor)
Conversion Cost  (Direct Labor + Overhead Cost)	Direct Labor: Labor costs that can be physically and conveniently traced to a product such as assembly line workers in a plant. Direct labor is also called touch labor cost.
	Manufacturing Overhead: All costs of manufacturing a product other than direct materials and direct labor, such as indirect materials, indirect labor, factory utilities, and depreciation of factory equipment.
	Non-manufacturing Costs
	Marketing or selling costs: All costs necessary to secure customer orders and get the finished product or service into the hands of the customer, such as sales commission, advertising, and depreciation of delivery equipment and finished goods warehouse.
	Administrative Costs: All costs associated with the general management of the company as a whole, such as executive compensation, executive travel costs, secretarial salaries, and depreciation of office building and equipment

 

 

Thanks & BR

 

Samsiah Yunus

Accounts Dept

 

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How to speed up your computer

If you want to speed up a computer, you either need software or a new PC altogether. But if your computer was previously running fast and just lately started performing sluggishly, then you can be reasonably assured that it's not the hardware. This article will discuss easy and safe ways to improve the performance and speed of your computer. You will never have to ask yourself "What can I do to speed up my computer?" ever again.

The first step is to remove all the unwanted files in your computer. They just take up space in your hard drive and burden your PC unnecessarily. Best to just delete all of them if you don't use them. Just back up those files that you want to save for later or future use in a CD or DVD. More free space will mean more resources that your computer's operating system can use to function efficiently and will help keep your computer stable and error-free.

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The registry is another part of your computer that can be cleaned up. It is, more often than not, left out by most people when clearing out files. The registry builds up when you install and uninstall programs. Running certain programs also adds files to the registry. Before long, your registry errors accumulate from uninstalled programs that didn't delete all files or from some other programs that installed registry files that were not used.

Cleaning out your registry regularly is very necessary. After you have deleted your unwanted files and did all the other methods described here, you will still need to clean up your registry.

Article Source: http://EzineArticles.com/?expert=Jeff_Farley

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