1

Cost Accounting

Chapter 9
Inventory Costing
and
Capacity Analysis
Session 6
Prof. Jorge Merladet

Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved.
 2

Programme for this module

Contents and tasks for each session
S6 Variable accounting, absorption normal accounting.
Accounting methods: Absorption and Variable accounting
Normal accounting
Read p. 340-345

S7 Mini-case: the Strassen Company

Result reconciliation
Capacity issues
Read p. 345-363

S8 Exercises 9.1, 9.2, 9.23, 9.4

9.42, 9.28

S9 Try-it examples from the book (ch 3)

Variable accounting, absorption normal accounting.
Volume-Profit Analysis I: BEP, TOI, Graph
Volume-Profit Analysis II: Scenarios, MoS, OpL, several products

S10 Exercises 3.30

Case study: Terminus Hotel - Part B
Concepts in action: the automakers

S5 Quiz chapter 3 & 9

2
 Notes
Absorption $/unit $ units
standard and Jan Feb March Selling price per unit 3,500
BOP 0 100 100 Var manuf costs 950
Variable Production 1,400 1,375 1,430 Var operating costs 725
Sales 1,300 1,375 1,455 Fixed manuf costs 350 490,000
accounting EOP 100 100 75 Fixed operating costs 120,000
Crystal Clear Corporation’s actual data Standard level of production 1,400
relating to January, February, and March
Allocation ----> Deviation or variance -----------> Adjustment
2017 are as follows: February Underallocation Unfavourable variance/deviation Add cost to compensate
January February March
March Overallocation Favorourable deviation Lower cost to compensate
Unit data
Beginning entry 0 100 100
Production 1,400 1375 1430
Sales 1,300 1375 1455
Variable costs
Manufacturing $ 950
cost per unit Variable Absorption
produced
Operating cost $725
Finished goods inventory Finished goods inventory
per unit sold
Fixed costs Jan Feb March Jan Feb March
Manufacturing $490,000 $490,000 $490,000 BOP 0 95,000 95,000 BOP 0 130,000 130,000
costs + COGM 1,330,000 1,306,250 1,358,500 + COGM
Operating costs $120,000 $120,000 $120,000
- COGS 1,235,000 1,306,250 1,382,250 - COGS
= EOP 95,000 95,000 71,250 = EOP 130,000 130,000 97,500

The selling price per unit is $3,500. The Income Income

budgeted level of production used to statement Jan Feb March statement Jan Feb March
calculate the budgeted fixed Revenues 4,550,000 4,812,500 5,092,500 Revenues 4,550,000 4,812,500 5,092,500
manufacturing cost per unit is 1,400 Variable cost of goods sold: Cost of goods sold:
units. There are no price-, efficiency-, or Beginning inventory 0 95,000 95,000 Beginning inventory 0 130,000 130,000
spending variances. Any production- Variable cost of manufacturing 1,330,000 1,306,250 1,358,500 Variable cost of manufacturing 1,330,000 1,306,250 1,358,500
U O
volume variance is written off to cost of COG available for sale 1,330,000 1,401,250 1,453,500 Fixed cost of manufacturing 490,000 481,250 500,500
Deduct: ending inventory 95,000 95,000 71,250 COG available for sale 1,820,000 1,917,500 1,989,000
goods sold in the month in which it
Variable cost of goods sold: 1,235,000 1,306,250 1,382,250 Deduct: ending inventory 130,000 130,000 97,500
occurs. Variable operating costs: 942,500 996,875 1,054,875 Adj. for product-vol variance 0
U
8,750
O
-10,500
Contribution margin 2,372,500 2,509,375 2,655,375 Cost of goods sold: 1,690,000 1,796,250 1,881,000
1. Prepare income statements for Crystal Gross margin 2,860,000 3,016,250 3,211,500
Clear in January, February, and March Fixed manufacturing costs 490,000 490,000 490,000 Variable operating costs 942,500 996,875 1,054,875

2017 under (a) variable costing and (b) Fixed operating costs 120,000 120,000 120,000 Fixed operating costs 120,000 120,000 120,000
Operating income 1,762,500 1,899,375 2,045,375 Operating income 1,797,500 1,899,375 2,036,625
absorption costing.

2. Explain the difference in operating

income under variable costing and
absorption costing.
 8

Absorption and Variable Accounting

The Income Statement
 9

Absorption and Variable Accounting

The Income Statement (continued)

Only in Absorption Normal Accounting the fixed manufacturing

cost is computed at a unit rate of FMCU
 10

Inventory costing and capacity analysis

Main learning objectives

Absorption accounting & Variable accounting

Normal accounting in Absorption – Product-Volume

Variance

Reconcile results

Denominator Issues

10
 11

Production-volume variances
Under Absorption Costing (from exercise 9-23)

11
 12

Production-volume variances
(Exercise 9-21) – Production volume and Production Variance

12
Absorption accounting: Normal or Actual?
Direct
Indirect manufacturing costs
manufacturing
($, u, $/u)
costs ($)

Normal or
Traced to Actual costing Standard
the job (allocated): costing
(allocated):

actual quantities based on the

actual quantities employed Budget
employed
FMC FMCUbudget x units

Adjustment:
Only later, when actual cost is known  ProdVol Variance
Actual Figures vs Normal Figures

Actual Normal
Wait Real time Adjust to be
Budget accounting real precise
until the end of the anticipates future
month, the quarter or quantities and prices
prices known, but at end of the
the year quantities unknown
period

Account at the
end of the 1. Forecast 2. Allocate 3. Adjust
period

COGS +
real quantities, FMCbudget / Adjustment
FMCallocated=
real prices unitsbudget in the income
statement

Adjustment:
FMCUbudget x FMCactual –
FMCUbudget unitsactual
FMCallocated
 17

Adjustment

Adjustment = FMC actual - FMC allocated

FMC allocated
FMC actual bigger
bigger
Due to: (less production or
(more production
than expected)
than expected)

Underallocation Overallocation
or
(=unfavourable) (=favourable)
 18

Some key ideas…

Absorption vs.Variable Accounting

• Absorption above and below the gross margin…

Absorption accounting puts

in the inventories all manufacturing costs
• Variable accounting as opposed to absorption accounting

Variable accounting puts in the

inventories only variable manufacturing costs,

• Which cost is kept in the inventories until the units are sold in Absorption, but in
Variable Accounting is immediately released as an expense…

Absorption withholds the

FMC of the units produced until they are sold,
while Variable expenses it immediately

18
 19

Some key ideas

Absorption (Actual) vs. Absorption (Standard/Normal)

• Normal costing implies that a “standard cost” or “normal cost” is computed

Normal costing temporarily assumes that
FMCU will be as in the Budget, and
computes the cost per unit manufactured

• For every period, Absorption computes the FMC of the period as a manufacturing
expense, as opposed to that Absorption Standard or Normal computes as
manufacturing cost…
FMCU x units produced

• And then, when it comes to COGS, at the end of the period, needs to adjust…
Adjustment = Actual FMC – Allocated FMC

19
What we learned today
Variable Accounting

Absorption accounting, standard accounting and budgeted FCU

Product-Volume Variance: causes, sign and accounting

Pending: Reconcile differences Absorption vs Variable

Pending: Capacity issues and usage

Remember: do again the exercises we did during our session

Read book Ch9: p.340-345 (Absorp & Var Acc), p. 345-363 (Capacity)

Groups presenting in Session 10, start working

21