Variable Costing for Management Analysis

11e

Principles of Managerial Accounting

Chapter 5

Prepared by: C. Douglas Cloud

Professor Emeritus of Accounting
Pepperdine University

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Reeve Warren Duchac
 Learning Objectives
1. Describe and illustrate reporting income from
operations under absorption and variable costing.
2. Describe and illustrate the effects of absorption and
variable costing on analyzing income from
operations.
3. Describe management’s use of absorption and
variable costing.
4. Use variable costing for analyzing market segments,
including product, territories, and salespersons
segments.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives
5. Use variable costing for analyzing and explaining
changes in contribution margin as a result of
quantity and price factors.
6. Describe and illustrate the use of variable costing for
service firms.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objective 1

Describe and
illustrate reporting
income from
operations under
absorption and
variable costing.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Absorption Costing

 Absorption costing is required under

generally accepted accounting principles
for financial statements distributed to
external users.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Absorption Costing

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 LO 1

Variable Costing
 For internal use in decision making,
managers often use variable costing,
sometimes called direct costing.
 The cost of goods manufactured includes
only variable manufacturing costs.

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 LO 1

Variable Costing

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 LO 1

Cost of Manufacturing Comparisons

Absorption Costing
Cost of Goods Manufactured

Direct Direct Variable Fixed

Materials Labor Factory OH Factory OH

Cost of Goods Manufactured Period Expense

Variable Costing

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 LO 1

Variable Costing
 Manufacturing margin is sales less variable cost
of goods sold.
 Variable cost of goods sold consists of direct
materials, direct labor, and variable factory
overhead for the units sold.
 Contribution margin is manufacturing margin
less variable selling and administrative expenses.

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 LO 1

Comparing Variable and Absorption Costing

Assume that 15,000 units are manufactured

and sold at a price $50.

(continued)

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 LO 1

Units Manufactured Equal Units Sold

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 EE 5-1

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 LO 1
Units Manufactured Exceed Units Sold

Assume that in the preceding example only 12,000

units of the 15,000 units manufactured were sold.
Examine Exhibit 3 (next two slides) and you will
see that income from operations using variable
costing is $40,000, while absorption costing
provides an income from operations of $70,000.

(continued)

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 LO 1
Units Manufactured Exceed Units Sold

(continued)

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 LO 1
Units Manufactured Exceed Units Sold

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 LO 1
Units Manufactured Exceed Units Sold

Operating Income:
Absorption costing
$70,000
Variable costing
40,000
Why is absorption
Difference costing income higher when
units manufactured
$30,000 exceed units sold?

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 LO 1
Units Manufactured Exceed Units Sold

Operating Income:
Absorption costing
$70,000
Variable costing
40,000
Analysis:
Difference
Units manufactured 15,000
$30,000
Units sold 12,000
Ending inventory units 3,000
Fixed cost per unit x $10
Difference $30,000

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 EE 5-2

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 LO 1
Units Manufactured Less Than Units Sold

Assume that 5,000 units of inventory were on hand

at the beginning of a period, 10,000 units were
manufactured during the period, and 15,000 units
were sold at $50 per unit.

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 LO 1
Units Manufactured Less Than Units Sold

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 LO 1
Units Manufactured Less Than Units Sold

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 LO 1
Units Manufactured Less Than Units Sold

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 EE 5-3

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 LO 1

Effects on Income from Operations

IF Units Manufactured = Units Sold

Absorption Costing Variable Costing

THEN Income from = Income from
Operations Operations

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 LO 1

Effects on Income from Operations

IF Units Manufactured > Units Sold

Absorption Costing Variable Costing

THEN Income from > Income from
Operations Operations

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 LO 1

Effects on Income from Operations

IF Units Manufactured < Units Sold

Absorption Costing Variable Costing

THEN Income from < Income from
Operations Operations

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objective 2

Describe and
illustrate the
effects of
absorption and
variable costing on
analyzing income
from operations.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2

Frand Manufacturing Company FRAND

Frand Manufacturing Company has no beginning

inventory, and sales are estimated to be 20,000
units at $75 per unit, regardless of production
levels.
The management of Frand Manufacturing
Company is evaluating whether to manufacture
20,000 units (Proposal 1) or 25,000 units
(Proposal 2).

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 LO 2

Proposal 1 FRAND

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 LO 2

Proposal 2 FRAND

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 LO 2
Income Analysis Under Absorption and
Variable Costing ND FRA

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 LO 2
Income Analysis Under Absorption and
Variable Costing ND FRA

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 EE 5-4

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 Learning Objective 3

Describe
management’s use
of absorption and
variable costing.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 3

Using Absorption and Variable Costing

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 LO 3

Controlling Costs
 For a specific level of management, controllable
costs are costs that can be influenced by
management at that level.
 Noncontrollable costs are costs that another level
of management controls.

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 LO 3

Pricing Products
 Many factors enter into determining the selling
price of a product.
 The cost of making the product is significant in
all pricing decisions.
 In the short run, fixed costs cannot be avoided.
 In the long run, a company must set its selling
price high enough to cover all costs and expenses
and generate income.

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 LO 3

Planning Production
 In the short run, planning production is limited to
existing capacity.
 In the long run, planning production can consider
expanding capacity.

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 LO 3

Analyzing Contribution Margins

 Managers often plan and control operations by
evaluating the differences between planned and
actual contribution margins.

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 LO 3

Analyzing Market Segments

 A market segment is a portion of a business that
can be analyzed using sales, costs, and expenses to
determine its profitability.

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 Learning Objective 4

Use variable costing for

analyzing market
segments, including
product, territories, and
salespersons
segments.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 4

Analyzing Market Segments

Camelot Fragrance Company manufactures and
sells Gwenevere perfume for women and the
Lancelot cologne line for men. The company’s
data for the month ended March 31, 2012, is
shown in the next slide.

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 LO 4

Analyzing Market Segments

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 LO 4

Sales Territory Profitability Analysis

 Sales territory profitability analysis may lead
management to do the following:
 Reduce costs in lower-profit sales territories
 Increase sales efforts in higher-profit territories

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 LO 4

Sales Territory Profitability Analysis

To illustrate the analysis of profit differences by

sales territory, Exhibit 8 (next slide) shows the
variable costing income statement by sales
territories for Camelot Fragrance Company.

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 LO 4

Sales Territory Profitability Analysis

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 LO 4

Sales Territory Profitability Analysis

Contribution Contribution Margin

Margin Ratio =
Sales

Northern Territory: 43% ($34,400/$80,000)

Southern Territory: 50.5% ($40,400/$80,000)

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 LO 4

Sales Territory Profitability Analysis

 Sales mix, sometimes referred to as product
mix, is the relative amount of sales among
the various products.

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 LO 4

Product Profitability Analysis

 A company should focus its sales efforts on
products that will provide the maximum total
contribution margin.

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 LO 4

Product Profitability Analysis

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 LO 4

Salesperson Profitability Analysis

 A salesperson profitability report is useful
in evaluating sales performance.
 Such a report normally includes total sales,
variable cost of goods sold, variable selling
expenses, contribution margin, and
contribution margin ratio for each
salesperson.

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 LO 4

Salesperson Profitability Analysis

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 EE 5-5

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 Learning Objective 5

Use variable costing

for analyzing and
explaining changes in
contribution margin as
a result of quantity
and price factors.

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 LO 5

Contribution Margin Analysis

 Contribution margin analysis focuses on
explaining the differences between planned and
actual contribution margins.
 A difference between the planned and actual
contribution margin may be caused by an
increase or a decrease in:
 Sales
 Variable costs

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 LO 5

Contribution Margin Analysis

 An increase or a decrease in sales or variable
costs may in turn be due to an increase or a
decrease in the:
 Number of units sold
 Unit sales price or unit cost

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 LO 5

Contribution Margin Analysis

 Quantity factor is the effect of a difference in the
number of units sold, assuming no change in unit
sales price or unit cost.
Sales Actual Planned Planned
Quantity = Units – Units of × Sales
Factor Sold Sales Price

Variable Cost Planned Actual Planned

Quantity = Units of – Units × Unit
Factor Sales Sold Cost

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 LO 5

Contribution Margin Analysis

 Unit price factor or unit cost factor is the effect of
a difference in unit sales price or unit cost on the
number of units sold.
Actual Planned Actual
Unit
Selling – Selling × Units
Price =
Price per Price per Sold
Factor
Unit Unit

Unit Planned Actual Actual

Cost = Cost per – Cost per × Units
Factor Unit Unit Sold

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 LO 5

Contribution Margin Analysis

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 LO 5

Contribution Margin Analysis Noble Inc.

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 LO 5

Contribution Margin Analysis Noble Inc.

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 EE 5-6

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 Learning Objective 6

Describe and
illustrate the use of
variable costing for
service firms.

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 LO 6

Variable Costing for Service Firms

 Unlike a manufacturing company, a service
company does not make or sell a product.
 As a result, service companies do not have
inventory and, thus, do not allocate fixed costs to
inventory using absorption costing concepts.

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 LO 6

Variable Costing for Service Firms

Service firms can report and analyze contribution
margin as the difference between revenues and
variable costs. To analyze a service firm, we will
use Blues Skies Airlines. The fixed and variable
costs associated with operating Blue Skies are
shown in Exhibit 13 (next slide).

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 LO 6

Variable Costing for Service Firms

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 LO 6

Variable Costing for Service Firms

The variable costing income statement for Blue
Skies Airlines is shown in Exhibit 14 (next slide).
Blue Skies Airlines uses the activity base number
of passengers for food and beverage service and
selling expenses. The company uses number of
miles flown for fuel and wages expenses.

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 LO 6

Variable Costing for Service Firms

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 LO 6
Market Segment Analysis for Service Companies

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 LO 6
Market Segment Analysis for Service Companies

Blue Skies Airlines

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 LO 6
Market Segment Analysis for Service Companies

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 LO 6

Contribution Margin Analysis

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 LO 6

Contribution Margin Analysis

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 Variable Costing for Management Analysis

The
The End
End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

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© 2012 Cengage
permitted Learning. All distributed
in a license Rights Reserved.
with aMay notproduct
certain be copied,
or scanned,
service ororotherwise
duplicated,
on ainpassword-protected
whole or in part, except for for
website useclassroom
as use.
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.