Treating fixed manufacturing overhead costs
What is the basic
difference between absorption costing and variable costing?
·
they differ in how
they handle fixed manufacturing overhead. Under absorption costing, fixed
manufacturing overhead is treated as a product cost and hence is an asset until
products are sold. Under variable costing, fixed manufacturing overhead is
treated as a period cost and is expensed on the current period's income
statement.
Are selling and
administrative expenses treated as product costs or as period costs under
variable costing?
·
(Fixed and variable)
selling administrative expenses are treated as PERIOD costs for both variable
and absorption costing
Explain how fixed
manufacturing overhead costs are shifted from one period to another under
absorption costing.
·
They are included in
product costs along with direct materials, direct labor, and variable manufacturing
overhead. If some of the units are not sold at, say the end of 2016, then they
are carried into 2017 AS INVENTORY. Assuming all those units are sold in 2017,
the 2016 fixed manufacturing overhead cost that was included in the 12.31.2016
ending inventory is included as part of the 2017's COST OF GOODS SOLD.
What are the arguments
in favor of treating fixed manufacturing overhead costs as product costs?
·
Absorption costing
advocates argue that:
1- absorption costing does a better job of MATCHING COSTS WITH REVENUES than
variable costing
2-all manufacturing costs must be assigned to products to properly state the
full cost of costing a product
3-managers, misled when they work with product cost information that fails to
include the allocated share of fixed cost, make incorrect pricing decisions
What are the arguments
in favor of treating fixed manufacturing overhead costs as period costs?
·
Variable costing
advocates argue that:
1- fixed manufacturing costs are not really the cost of any particular unit of
product.If a unit is made or not, the total fixed manufacturing costs will be
exactly the same. Therefore, how can one say that these costs are part of the
costs of the products? These costs are incurred to have the capacity to make
products during a particular period and should be charged against that period
as period costs according to the marketing principle.
If the units produced
and unit sales are equal, which method would you expect to show the higher net
operating income, variable costing or absorption costing? Why?
·
If production and
sales are equal, net operating should be the same under absorption and variable
costing. When production equals sales, inventories do not increase or decrease
and therefore under absorption costing fixed manufacturing overhead cost is not
deferred in inventory or released from inventory.
If the units produced
exceed unit sales, which method would you expect to show the higher net
operating income?
·
Absorption costing
will usually show higher net operating income than variable costing. When
production exceeds sales, inventories increase and under absorption costing
part of the fixed manufacturing overhead cost of the current period is deferred
in inventory to future periods (Less expenses are recorded). In contrast, all
of the fixed manufacturing overhead cost of the current period is immediately
expensed under variable costing.
If fixed manufacturing
overhead costs are released from inventory under absorption costing, what does
this tell you about the level of production in relation to the level of sales?
·
if fixed manufacturing
overhead cost is released from inventory, then inventory levels must have
decreased and therefore production must have been less than sales.
Under absorption
costing, how is it possible to increase net operating income without increasing
sales?
·
net operating income
can be increased by increasing the level of production without any increase in
sales. If production exceeds sales, units of product are added to inventory.
These units carry a portion of the current period's fixed manufacturing
overhead costs into the inventory account, reducing the current period's
reported expenses and causing operating income to increase.
How does Lean
Production reduce or eliminate the difference in reported net operating income
between absorption and variable costing?
·
differences in
reported operating income between absorption and variable costing arise because
of changing levels of inventory. In lean production, goods are produced
strictly to customers' orders. With production geared to sales, inventories are
largely (or entirely) eliminated. If inventories are completely eliminated,
they are zero from one period to another and absorption costing and variable
costing will report the same net operating income
Distinguish between a
traceable cost and a common cost. Give several examples of each,
·
Traceable cost of a
segment is a cost that arises specifically because of the existence of that
segment. If the segment were eliminated, the cost would disappear.(Examples-
salary of the department's supervisor, depreciation of machines used
exclusively by the department, and the costs of supplies used by the
department.)A common cost is a cost that supports more than one segment. If one
of the supported segments were eliminated, there would be no change in the
common fixed cost. (Examples- salary of the general counsel of the entire
company, the lease cost of the headquarters building, corporate image
advertising, and periodic depreciation of machines shared by several
departments)
Explain how the
segment margin differs from the contribution margin.
·
The contribution
margin is the difference between sales revenue and variable expenses. The
segment margin is the amount remaining after deducting traceable fixed expenses
from the contribution margin. The contribution margin is useful as a planning
tool for many decisions, particularly those in which fixed costs don't change.
The segment margin is useful in assessing the overall profitability of a
segment.
Why aren't common
costs allocated to segments under the contribution margin?
·
If common costs were
allocated to segments, then segment costs would increase and segment margins
would decrease. As a consequence, some segments may appear to be unprofitable
and managers may be tempted to eliminate them. If a segment were eliminated
because of the existence of arbitrarily allocated common costs, the overall
profit of the company would decline because that portion of the common fixed
costs allocated to the now-eliminated segment would not have disappeared. Those
common fixed costs previously allocated to the now-eliminated segment would
remain and have to be allocated to one of the remaining business segments.
In what fundamental
ways does activity based costing differ from traditional costing methods such
as job-order costing?
·
activity based costing
differs from traditional costing:
1-ABC seeks to estimate the entire cost of a product not just its manufacturing
cost.Consequently, in addition to manufacturing costs, some nonmanufacturing
costs, such as product design, freight-out, marketing and sales costs, may be
treated as products costs. ABC excludes from product costs some manufacturing
overhead costs such as the costs of unused or idle capacity.
2-
3-
USA 
India