Managerial Accounting

Chapter 6:
Variable Costing and
Segment Reporting
Instructor:
Xiomara Vázquez-Guillén, Ph.D

Managerial Accounting Chapter 6 1

 Chapter 6 – Variable Costing and Segment
Reporting: Tools for Management
Learning Objectives:
1. Explain how variable costing differs from
absorption costing and compute the unit product
cost under each method.
2. Prepare income statements using both variable and
absorption costing.
3. Reconcile variable and absorption costing net
operating incomes and explain why the two
amounts differ.
4. Prepare a segmented income statement that
differentiates traceable fixed costs from common
fixed costs and use it to make decisions.

Managerial
Accounting Chapter 6 2
 Measures of Inventory Costing
Absorption Costing
is a method of inventory costing in which all variable &
fixed manufacturing costs are attached to the
product and held with the product until that product
is sold

Variable Costing
is a method of inventory costing in which all variable
manufacturing costs are attached to the product and
held with the product until that product is sold
Managerial
Accounting Chapter 6 3
 Overview of Absorption and
Variable Costing
Absorption Variable
Costing Costing
Direct Materials
Product
Product Direct Labor
Costs
Costs Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Period
Period Variable Selling and Administrative Expenses
Costs
Costs Fixed Selling and Administrative Expenses

Managerial
Accounting Chapter 6 4
Unit Cost Computations
Harvey Company produces a single product
with the following information available:

Chapter 6 5
 Unit Cost Computations
Unit product cost is determined as follows:

Under absorption costing, all production costs, variable and

fixed, are included when determining unit product cost.
Under variable costing, only the variable production costs are
Managerial included in product costs.
Accounting Chapter 6 6
1) Income Comparison of
Absorption and Variable Costing
Let’s assume the following additional information
for Harvey Company.
 200,00 units were sold during the year at a price

of $30 each.
 There is no beginning inventory.

Now, let’s compute net operating income using

both absorption and variable costing.

Chapter 6 7
2) Extended Comparisons of Income
Data Harvey Company – Year Two

Chapter 6 8
 Summary of Key Insights

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Accounting Chapter 6 9
 Impact on the Manager
Opponents of absorption costing argue that
shifting fixed manufacturing overhead costs
between periods can lead to faulty decisions.

These opponents argue that variable costing income

statements are easier to understand because net operating
income is only affected by changes in unit sales. This
produces net operating income figures that are
consistent with managers’ expectations.

Managerial
Accounting Chapter 6 10
 CVP Analysis, Decision Making
and Absorption Costing
Absorption costing does not dovetail with CVP analysis, nor
does it support decision making. It treats fixed manufacturing
overhead as a variable cost. It assigns per unit fixed
manufacturing overhead costs to production.
Treating fixed manufacturing overhead as a
variable cost
cost can:
• Lead to faulty pricing decisions and faulty
keep-or-drop decisions.
Assigning per unit fixed manufacturing
manufacturing overhead
costs to production can:
•• Potentially
Potentially produce positive net
net operating income
even when the number of of units sold is
is less
less than
the breakeven
breakeven point.
 External Reporting and Income Taxes

To
To conform
conform to to
GAAP
GAAP & & IFRS
IFRS requirements,
requirements,
absorption
absorption costing
costing must
must bebe used
used for
for
external
external financial
financial reports.
reports. Under
Under the
the Tax
Tax
Reform
Reform Act
Act of
of 1986,
1986,
absorption
absorption costing
costing must
must be
be
used
used when
when filling
filling out
out
Since
Since top
top executives
executives income
income tax
tax returns.
returns.
are
are typically
typically evaluated
evaluated based
based onon
earnings
earnings reported
reported toto shareholders
shareholders
in
in external
external reports,
reports, they
they may
may feel
feel that
that
decisions
decisions should
should bebe based
based onon
absorption
absorption costing
costing data.
data.
Chapter 6 12
 Advantages of Variable Costing
and the Contribution Approach
Consistent with
CVP analysis.
Management finds Net operating income
it more useful. is closer to
net cash flow.
Consistent with standard
costs and flexible budgeting.
Advantages
Easier to estimate profitability
of products and segments.
Impact of fixed
costs on profits Profit is not affected by
emphasized. changes in inventories.
Managerial
Accounting Chapter 6 13
 Reference
 Garrison, Noreen & Brewer
 Managerial Accounting
 15th Edition.

Managerial Accounting Chapter 6 14