MATCHING COSTS WITH REVENUES
Absorption Costing
·
A costing method that
includes all manufacturing costs-Direct materials, direct labor, and both
variable and fixed manufacturing over head
Common fixed cost
·
a fixed cost that
supports more than one business segment, but is not traceable in whole or in
part to any one of the business segments
Segment
·
any part or activity
of an organization about with managers seeks cost, revenue, or profit data
Segment margin
·
a segment's
contribution margin less its traceable fixed costs. It represents the margin
available after a segment has covered all of its own traceable costs.
traceable fixed cost
·
a fixed cost that is
incurred because of the existence of a particular business segment and that
would be eliminated if the segment were eliminated
Variable costing
·
a costing method that
includes only variable manufacturing costs-Direct materials, direct labor, and
variable manufacturing overhead-in unit product 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 expenses 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.
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.
Variable costing;
• Sales
-VC; Variable COGS (DL, DM, Variable MOH); Variable S&A expenses
Contribution Margin
-FC; fixed MOH; Fixed S&G
Net operating Income
Absorption Costing;
• Sales
-COGS; DL, DM, Variable MOH, Fixed MOH
Gross Margin
-S&G
Net Operating income
Period Costs
·
are all costs that are
not product costs; Selling and administrative
Product costs
·
include all costs
involved in acquiring or making a product; DM, DL, MOH
USA 
India