Inventory Costing

and Capacity Analysis

Identify what distinguishes
variable costing from
absorption costing.
 Inventory-Costing Methods

The difference between variable costing

and absorption costing is based on the
treatment of fixed manufacturing overhead.

• Variable costing is a method of inventory costing in which only

variable manufacturing costs are included as inventoriable costs

• Absorption costing is a method of inventory costing in which all

variable manufacturing costs and all fixed manufacturing costs are
included as inventoriable costs
Comparing Variable and Absorption costing
Operating Information Units
Beginning Inventory units 0
Production Units 8000
Sales Units 6000
Ending Inventory Units 2000

Actual Price and cost data for the year Amount (Rs)
Selling Price 10000
Variable Manufacturing cost per unit
Direct material cost per unit 1100
Direct manufacturing labor cost per unit 400
Manufacturing overhead cost per unit 500
Total Variable Manufacturing cost per unit 2000
Variable marketing cost per unit sold 1850
Fixed manufacturing costs (all indirect) 10800000
Fixed marketing cost (all indirect) 13800000
Prepare income statements
under absorption costing
and variable costing.
 Throughput Costing
• Super-Variable Costing
• Only direct material costs are truly
variable in nature
• All other variable cost are cost of the
period in which they are incurred.
• Throughput Margin equals revenues
minus all direct material cost of goods
sold.
 Differentiate throughput
costing from variable costing
and absorption costing.
Describe the various
capacity concepts
that can be used in
absorption costing.
 Alternative Denominator-Level
Concepts

Theoretical capacity
Producing at full efficiency all the time

Practical capacity
Reduces theoretical capacity by deducting
unavoidable operating interruptions

Normal capacity
Satisfies average customer demand
over a period

Master-budget capacity
Capacity utilization for current budget period
Budgeted Fixed Manufacturing
cost

Lloyd’s Bicycles produces bicycle parts

for domestic and foreign markets.

Fixed overhead costs are $200,000 within the

relevant range of the various capacity volume.
Budgeted Fixed Manufacturing
cost

Assume that the theoretical capacity is

10,000 units, practical capacity
is 85%, normal capacity is 75%, and
master-budget capacity is 60%.

What is the budgeted fixed manufacturing

cost rate at the various capacity levels?
Budgeted Fixed Manufacturing
Overhead Rate

Theoretical 100%:
$200,000 ÷ 10,000 = $20.00/unit

Practical 85%:
$200,000 ÷ 8,500 = $23.53/unit

Normal 75%:
$200,000 ÷ 7,500 = $26.67/unit

Master-budget 60%:
$200,000 ÷ 6,000 = $33.33/unit
 Understand the major factors
management considers in choosing
a capacity level to compute the
budgeted manufacturing fixed cost.
Choosing a Capacity Level

What factors are considered

in choosing a capacity level?

Product Pricing Performance

costing decision evaluation

Financial
External Reporting Tax requirements
statements
Decision Making

Theoretical capacity: $20

Practical capacity: $23.53

Normal capacity: $26.67

Master-budget capacity: $33.33

 Describe how attempts to
recover fixed manufacturing costs of
Capacity may lead to price increases
and lower demand.
Fixed manufacturing cost over Master budget
capacity

Master-Budget Budgeted variable Budgeted Fixed Budgeted total

utilization (units) manufacturing cost manufacturing cost m9anufacturing
(1) per unit ($) per unit ($) cost per unit ($)
(2) (3) (4)
= $2,00,000/(1)
6000 30 33.33 63.33
5000 30 40 70
4000 30 50 80
3000 30 66.67 96.67
Downward Demand Spiral

The downward demand spiral is the continuing

reduction in demand that occurs when the prices
of competitors are not met and demand drops.