Mastery Problem: Variable Costing for Management Analysis Absorption vs. Variable Operating income is one of the most important items reported by a company. Depending on the decision-making needs of management, operating income can be determined using absorption costing or variable costing. Select whether the following characteristics are most often associated with absorption costing or variable costing. Required under generally accepted accounting principles (GAAP) W: J Often used for internal use in decision making 11W \\/ Cost of goods manufactured includes only variable manufacturing costs W J Used in reports prepared for external users W911i\": \\/ Fixed factory overhead costs are not part of cost of goods manufactured 3%: J Both xed and variable factory costs are included in cost of goods sold and inventory iAbSO'I'Ehl-Ii thin-lls" V x/ Feedback Check My Work Review the differences between absorption and variable costing, and how each type of costing is used in the organization and for management processes. Absorption Statement Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goo: sold. Saxon, Inc. Absorption Costing Income Statement For the Year Ended December 31 Sales $1,125,000 Cost of goods sold: Cost of goods manufactured $800,000 Ending inventory (200,000) Total cost of goods sold (600,000) Gross profit $525,000 Selling and administrative expenses (260,000) Operating income $265,000 Variable Statement Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statemer includes a computation of manufacturing margin. Saxon, Inc. Variable Costing Income Statement For the Year Ended December 31 Sales $1,125,000 Variable cost of goods sold: Variable cost of goods manufactured $560,000 LINIRY IIVEITY Total variable cost of goods sold (420,000) Manufacturing margin $705,000 Variable selling and administrative expenses (195,000) Contribution margin $510,000 Fixed costs: Fixed manufacturing costs $240,000 Fixed selling and administrative expenses 65,000 Total fixed costs (305,000) Operating income $205,000 Method Comparison Review the income statements on the Absorption Statement and Variable Statement, then complete the following table. The company's sales price per unit is $75, and the number of units in ending inventory is 5,000. There was no beginning inventory. Item Amount Number of units sold 15,000 $ Variable sales and administrative cost per unit 13 Number of units manufactured 20,000 $ V Variable cost of goods manufactured per unit 28 Fixed manufacturing cost per unit 12 Feedback Check My Work Review the definitions of the items in the table, and think backwards from one of the income statements to get the desired values. Manufacturing Decisions Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing operating income, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful. All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs. The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement and the Variable Statement, he notices that the operating income is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the company's capacity for manufacturing, in the coming year. He reasons that this will boost operating income and satisfy the company's owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow. If the answer is zero, enter "(" 1. Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the arininal production InuAl Than aremore similar insama statements of a production laval in MAN nite bistar and add thatIIIIUIIIIDLHJII LU LIlC LGUIC- HDDUIIIC HIGH. LULC'I IIACU LUDLD, LIIIIL VOIIGLHC LUDLD' UIIIL DOICJ PIILC, Clllu LIIC DGICJ tCVCID alc LIIC DUIIIC (It. both production levels. Operating Income Original Production Original Production Additional 10,000 Additional 10,000 Level-Absorption Level-Variable Units-Absorption Units-Variable $ $ $ $ 2. What is the change in operating income from producing 10,000 additional units under absorption costing? $ 3. What is the change in operating income from producing 10,000 additional units under variable costing? $ 4. What would be your recommendation to the production manager? a. Do not produce the extra 10,000 units. The increase in operating income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs. b. Produce the extra 10,000 units. Operating income will be increased, and the production manager will receive praise for creatin higher prots. c. Do not produce the extra 10,000 units. Operating income does not change under absorption costing when the additional units are produced. :1. Produce the extra 10,000 units. It's always a good idea to have extra units on hand and keep the factory operating at capacity even if all the units are not sold. 3.. -; J Feedback Check My Work 1. Following the examples on the Absorption Statement and Variable Statement panels, recompute operating income under the absorption and variable cost methods, given that the additional units are manufactured. Don't forget that fixed costs will remain the same at any production level within the relevant range. 2. Review y0ur chart and determine the change in operating income, focusing only on the change in absorption costing amounts. 3. Review your chart and determine the change in operating income, focusing only on the change in variable costing amounts. 4. What is the best decision the production manager can make when putting the company's needs ahead of his own? Feedback Check My Work Partially correct