Mas 04 - Product Costing 2.doc

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MAS-LECTURE NOTES

ARMIN GLENN ARANETA, CPA PRODUCT COSTING

Absorption Costing (also called full costing, conventional costing) – is a costing method that includes all manufacturing costs (direct materials, direct labor, and both variable and fixed manufacturing overhead) in the cost of a unit of product. It treats fixed manufacturing overhead as a product cost. Variable Costing (also called direct costing) – is a costing method that includes only variable manufacturing costs (direct materials, direct labor, and variable manufacturing overhead) in the cost of a unit of product. It treats fixed manufacturing overhead as a period cost. Distinction between period costs and product costs: Period costs

Product costs

1. Refers to an item charged against current 1. Refers to an item included in product costing revenue on the basis of time period regardless which is apportioned between the sold and of the difference between production and sales unsold units. volume. 2. Does not form part of the cost of inventory.

2. The portion of the cost, which has been allocated to the unsold units, becomes part of the inventory.

3. Diminishes income for the current period by 3. Diminishes current income by that portion its full amount. thereof identified with the sold units only with the remainder being deferred to the next accounting period as part of the cost of ending inventory. PRINCIPAL DIFFERENCES BETWEEN VARIABLE AND ABSORPTION COSTING ABSORPTION COSTING

VARIABLE COSTING

1. Cost Segregation

Seldom segregates costs into Costs are segregated variable and fixed costs variable and fixed

2. Cost of Inventory

Cost of inventory includes all Cost of inventory includes the manufacturing costs. only the variable manufacturing costs.

3. Treatment overhead

of

factory Fixed factory overhead is Fixed factory overhead treated as product cost. treated as period cost.

into

is

4. Income statement

Distinguishes between Distinguishes between production and other costs. variable and fixed costs.

5. Net income

Net income between the two methods may differ from each other because of the difference in the amount of fixed overhead costs recognized as expense during an accounting period. This is due to variations between sales and production. In the long run, however, both methods give substantially the same results since sales cannot continuously exceed production nor production can continually exceed sales.

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DIFFERENCE IN NET INCOME UNDER ABSORPTION AND VARIABLE COSTING Variable and absorption costing methods of accounting for fixed manufacturing overhead result in different levels of net income in most cases. The differences are timing differences, i.e., when to recognize the fixed manufacturing overhead as an expense. In variable costing, it is expensed during the period when the fixed overhead is incurred, while absorption costing, it is expensed in the period when the units to which such fixed overhead has been related are sold. Production equals Sales When production is equal to sales, there is no change in inventory. Fixed overhead expensed under absorption costing equals fixed overhead expensed under variable costing. Therefore, absorption costing income equals variable costing income. Production is greater than Sales When production is greater than sales, there is an increase in inventory. Fixed overhead expensed under absorption costing is less than fixed overhead expensed under variable costing. Therefore, absorption income is greater than variable costing. Production is less than Sales When production is less than sales, there is a decrease in inventory. Fixed overhead expensed under absorption costing is greater than fixed overhead expensed under variable costing. Therefore, absorption income is less than variable costing. THROUGHPUT COSTING (Supervariable Costing) An extreme form of variable costing in which only direct material costs are included as inventoriable costs. All other costs of the period in which they are incurred. TM = Revenue – Direct material COGS Practice Problems: Problem 1: All I ask Company manufactures a professional grade microwave and began operations in 2015. For 2015, the company had no price, spending, or efficiency variances, and writes off production-volume variance to cost of good sold. Actual data for 2015 are given as follows: Units produced Units sold Selling price Variable costs: Materials Manufacturing labor Manufacturing overhead Marketing Fixed costs: Manufacturing Selling and administrative

18, 000 17, 500 P 300 P 30 P 25 P 60 P 45 P 900, 000 750, 000

Requirements: 1. The inventoriable unit cost for internal reporting purposes under variable costing. 2. The inventoriable unit cost for internal reporting purposes under absorption costing. 3. Operating income for 2015 under variable costing. 4. Operating income for 2015 under absorption costing. 5. Compute the throughput margin (TM) and income under throughput costing.

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Problem 2: Ambon Corporation developed the following standard unit cost at 100% of its normal production capacity, which is 20, 000 units per year: Prime costs P 4.00 Factory overhead (40% variable) 5.00 Unit product cost P 9.00 The product is sold for P15 per unit. Variable commercial expenses are P2 per unit sold, and fixed commercial expenses total P50, 000 for the period. During the year, 21, 000 units were produced and 19, 000 units were sold. There is no work in process beginning or ending inventories, and finished goods inventory is maintained at standard cost, which has not changed from the preceding year. In the current year, there is a net unfavorable variable cost variance in the amount of P4, 000. All standard cost variances are written off to COGS at the end of the period. Requirements: 1. Prepare an income statement on the absorption costing basis. 2. Prepare an income statement on the variable costing basis. 3. Compute and reconcile the difference in operating income for the current year under absorption and variable costing. Problem 3: The following information is available for Send my Love Company’s new product line: Sale price per unit P 15 Variable manufacturing cost per unit of production 8 Total annual fixed manufacturing cost 25, 000 Variable administrative cost per unit 3 Total annual fixed and administrative expenses 15, 000 There was no inventory at the beginning of the year. Normal capacity is 12, 500 units. During the year, 12, 500 units were produces and 10, 000 units were sold. Requirements: 1. Ending inventory, assuming the use of direct costing. 2. Ending inventory, assuming the use of absorption costing. 3. Total variable costs charged to expense for the year, assuming the use of direct costing. 4. Total variable costs charged to expense for the year, assuming the use of absorption costing. Problem 4: Just play pretend Company was organized just a year ago. The result of the company’s first year of operations are shown below (absorption costing basis): Just play pretend Company Statement of financial performance Sales (2, 000 units) Less: Cost of goods sold/variable cost: Beginning inventory Cost of goods manufactured Goods available for sale Ending inventory Gross margin Less: Selling and administrative expenses Net income

P 135, 000 P

0 105, 000 P 105, 000 21, 000

84, 000 P 51, 000 42, 000 P 9, 000

The company’s selling and administrative expenses consist of P 32, 000 per year in fixed expenses and P5 per unit sold in variable expenses. The company’s unit product cost is computed as follows:

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Variable manufacturing cost P32 Fixed manufacturing overhead(based on normal capacity of 2, 500 units) 10 Unit product cost P 42 Requirements: 1. Re-do the company’s statement of financial performance in the contribution margin format using variable costing. 2. Reconcile any difference between the net income figure on your variable costing income statement and the net income figure on the absorption costing income statement above. Problem 5: The following information pertains to Jealous Company: Maximum productive capacity 24, 000 units per year Normal capacity 20, 000 units Standard variable manufacturing cost per unit P10 Fixed factory overhead P 40, 000 Variable selling expenses per unit P4 Fixed selling expenses P 30, 000 Unit sales price P20 2015 operating results: Sales 19, 000 units Production 19, 200 units Net unfavorable variance for standard variable manufacturing cost P 10, 000 Requirements: 1. Income under both costing methods. 2. Break-even point. 3. Margin of safety. 4. Required sales to earn after-tax-profit of P 140, 000. 5. Required sales in pesos to earn profit of 10% of sales. Problem 6: During its first year of operations, Almost is never enough Company produced 55, 000 jars of hand cream based on a formula containing 10 percent glycolic acid. Unit sales were 53, 500 jars. Fixed overhead was applied at P0.50 per unit produced. Fixed overhead was underapplied by P 10, 000. This fixed overhead variance was closed to COGS. There was no variable overhead variance. The results of the year’s operations are as follows (on an absorption costing basis): Sales (53, 500 units @ P8.50) P 454, 750 Less: COGS ( 170, 500 ) Gross margin P 284, 250 Less: Selling and admin(all fixed) ( 120, 000 ) Net income P 164, 250 Requirements: 1. Give the cost of the firm’s ending inventory under absorption costing. What is the cost of the ending inventory under variable costing? 2. Compute the income under variable costing. Reconcile the difference between the two income figure. Problem 7: Secret love Song Company began operations on January 1 to produce a single product. It used a standard absorption costing system with a planned production volume of 10, 000 units. During its first year of operations, no variance were incurred and there were no fixed selling or administrative expenses. Inventory on December 31 was 20, 000 units, and net income for the year was P 240, 000. If Secret love Song had used variable costing, its net income would have been P 220, 000. Requirements: Compute the break-even point in units.

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Problem 8: Saludo ako Sa’yo Company had net income for the first 10 months of the current year of P200, 000. They used a standard costing system, and there were no variances through October 31. One hundred thousand units were manufactured during the period, and 100, 000 units were sold. Fixed manufacturing overhead was P2M over the 10-month period. There are no selling and administrative expenses for Saludo ako Sa’yo Company. All variances are disposed of at year-end by an adjustment to COGS. Both variable and fixed costs are expected to continue at the same rates for the balance of the year (i.e., fixed costs at P 200, 000 per month and variable costs at the same variable cost per unit). There were 10, 000 units in inventory on October 31. Eighteen thousand units are to be produced and 22, 000 units are to be sold in total over the last two months of the current year. Assume the standard unit variable costs is the same in the current year as in the previous year. Requirements: 1. If operations proceed as described, will net income be higher under variable or absorption costing for the current year in total? 2. If operations proceed as described, what will net income for the year in total be under: a) variable costing; and b) absorption costing? Ignore income taxes. Problem 9: The following annual flexible budget has been prepared for use in decision relating to Product X. 100, 000 units

150, 000 units

200, 000 units

P 800, 000

P 1, 200, 000

P 1, 600, 000

Variable

P 300, 000

P 450, 000

P 600, 000

Fixed

P 200, 000

P 200, 000

P 200, 000

P500, 000

P 650, 000

P 800, 000

Variable

P 200, 000

P 300, 000

P 400, 000

Fixed

P 160, 000

P 160, 000

P 160, 000

P 360, 000

P 460, 000

P 560, 000

(P 60, 000)

P 90, 000

P 240, 000

Sales volume Manufacturing costs:

Selling and expenses:

Income(Loss)

other

The 200, 000 unit budget has been adopted and will be used for allocating fixed manufacturing costs to units of Product X. At the end of the first six months the following information is available: Units Production completed 120, 000 Sales 60, 000 All fixed costs are budgeted and incurred uniformly throughout the year and all costs incurred coincide with the budget. Over and underapplied fixed manufacturing costs are deferred until year-end. Annual sales have the following seasonal pattern:

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First quarter Second quarter Third quarter Fourth quarter

Portion of annual sales 10% 20% 30% 40% 100%

Requirements: 1. Reported net income (loss) for the first six months under absorption costing. 2. Reported net income (loss) for the first six months under direct costing. “The secret of getting ahead is getting started.”

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