Ma 6e PPT CH 08 Se New

CORNERSTONES
of Managerial Accounting, 6e
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CHAPTER 8:
ABSORPTION AND VARIABLE
COSTING, AND INVENTORY
MANAGEMENT
Cornerstones of Managerial
Accounting, 6e
Variable and Absorption Income
Statements
 Many companies consist of separate business
units called profit centers.
 It is important for these companies to determine
both the overall performance of the business and
the performance of the individual profit centers.
LO-1
Variable and Absorption Income
Statements (cont.)
 Therefore, it is important to develop a segmented
income statement for each profit center.
 Two methods of computing income have been
developed:
 one based on variable costing and
 the other based on full or absorption costing.
LO-1
Absorption Costing
 Absorption costing assigns all manufacturing
costs to the product.
 Direct materials, direct labor, variable overhead, and
fixed overhead define the cost of a product.
 Under this method, fixed overhead is assigned to
the product through the use of a predetermined
fixed overhead rate and is not expensed until the
product is sold.
 Fixed overhead is an inventoriable cost.
LO-1
Variable Costing
 Variable costing stresses the difference between
fixed and variable manufacturing costs.
 Variable costing assigns only variable
manufacturing costs to the product; these costs
include direct materials, direct labor, and variable
overhead.
LO-1
Variable Costing (cont.)
 Fixed overhead is treated as a period expense
and is excluded from the product cost.
 Under variable costing, fixed overhead of a
period is seen as expiring that period and is
charged in total against the revenues of the
period.
LO-1
Comparison of Variable and
Absorption Costing Methods
 Generally accepted accounting principles (GAAP)
require absorption costing for external reporting.
 The Financial Accounting Standards Board
(FASB), the Internal Revenue Service (IRS), and
other regulatory bodies do not accept variable
costing as a product-costing method for external
reporting.
LO-1
Absorption Costing Methods (cont.)
LO-1
Absorption Costing Methods (cont.)
 The only difference between the two approaches
is the treatment of fixed factory overhead.
 The unit product cost under absorption costing is
always greater than the unit product cost under
variable costing.
LO-1
Absorption Costing Methods
LO-1
Production, Sales, and Income
Relationships
 The relationship between variable-costing income
and absorption-costing income changes as the
relationship between production and sales
changes.
LO-1
Production, Sales, and Income
Relationships (cont.)
LO-1
Segmented Income Statements
Using Variable Costing
 Variable costing is useful in preparing segmented
income statements because it gives useful
information on variable and fixed expenses.
 A segment is a subunit of a company of sufficient
importance to warrant the production of
performance reports.
LO-2
Segmented Income Statements
Using Variable Costing (cont.)
 Segments can be divisions, departments, product
lines, customer classes, and so on.
 In segmented income statements, fixed expenses
are broken down into two categories:
 direct fixed expenses and
 common fixed expenses.
LO-2
Direct Fixed Expenses
 Direct fixed expenses are fixed expenses that
are directly traceable to a segment.
 These are sometimes referred to as avoidable
fixed expenses or traceable fixed expenses
because they vanish if the segment is eliminated.
 For example, if the segments were sales regions, a
direct fixed expense for each region would be the rent
for the sales office.
LO-2
Common Fixed Expenses
 Common fixed expenses are jointly caused by
two or more segments.
 These expenses persist even if one of the
segments to which they are common is
eliminated.
 Example: Depreciation on the corporate headquarters
building or the salary of the CEO would be a common
fixed expense for most large companies.
LO-2
Decision Making for Inventory
Management
 Inventory can definitely affect operating income.
 In addition to the product cost of inventory, there
are other types of costs that relate to inventories
of raw materials, work in process, and finished
goods.
LO-3
Inventory-Related Costs
 If the inventory is a material or good purchased
from an outside source, then these inventory-
related costs are known as ordering costs and
carrying costs.
LO-3
Inventory-Related Costs (cont.)
 If the material or good is produced internally, then
the costs are called setup costs and carrying
costs.
 Ordering costs are the costs of placing and receiving an
order.
 Carrying costs are the costs of keeping and storing
inventory.
 Stockout costs are the costs of not having a product
available when demanded by a customer or the cost of
not having a raw material available when needed for
production.
LO-3
Economic Order Quantity:
The Traditional Model
 Once a company decides to carry inventory, two
basic questions must be addressed:
 How much should be ordered?
 When should the order be placed?
 In choosing an order quantity, managers need to
be concerned only with ordering and carrying
costs.
LO-3
Economic Order Quantity:
The Traditional Model
 The formulas for calculating these are as follows:
LO-3
The Economic Order Quantity
 Maintaining an order quantity equal to the
average inventory may not be the best choice.
Some other order quantity may produce a lower
total cost.
 The objective is to find the order quantity that
minimizes the total cost.
 The number of units in the optimal size order
quantity is called the economic order quantity
(EOQ).
LO-3
The Economic Order Quantity
 Since EOQ is the quantity that minimizes total
inventory-related costs, a formula for computing it
is:
LO-3
Reorder Point
 Knowing when to place an order (or setup for
production) is also an essential part of any
inventory policy.
 The reorder point is the point in time when a
new order should be placed (or setup started).
 It is a function of the EOQ, the lead time, and the
rate at which inventory is used.
 Lead time is the time required to receive the economic
order quantity once an order is placed or a setup is
started.
LO-3
Reorder Point (cont.)
 Knowing the rate of usage and lead time allows
us to compute the reorder point that
accomplishes these objectives:
Reorder point = Rate of usage x Lead time
LO-3
Safety Stock
 Safety stock is extra inventory carried to serve
as insurance against changes in demand.
 Safety stock is computed by multiplying the lead
time by the difference between the maximum rate
of usage and the average rate of usage:
Safety stock = Maximum - Average x Lead time

daily usage daily usage
LO-3
Just-in-Time Approach
to Inventory Management
 The just-in-time (JIT) approach maintains that
goods should be pulled through the system by
present demand rather than being pushed
through on a fixed schedule based on anticipated
demand.
 The material or subassembly arrives just in time
for production to occur so that demand can be
met.
 Fast-food restaurants use this type of pull system.
LO-3
Limitations of Just-in-Time
Approach
 JIT does have limitations.
 It is often referred to as a program of
simplification—yet this does not imply that JIT is
simple or easy to implement.
 It requires time for building sound relationships
with suppliers.
LO-3
Limitations of Just-in-Time
Approach (cont.)
 Insisting on immediate changes in delivery times
and quality may not be realistic and may cause
difficult confrontations between a company and
its suppliers.
 Reductions in inventory buffers may cause a
regimented workflow and high levels of stress
among production workers.
 It requires careful and thorough planning and
preparation.
LO-3

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CORNERSTONES

Reorder point = Rate of usage x Lead time

Safety stock = Maximum - Average x Lead time

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