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Variable Costing for Management Analysis

Income Under Absorption and Variable Costing

Absorption Costing

Variable Costing

Effects of Inventory

Analyzing Income

Contribution Margin Analysis

Planning Production

Pricing Products

Controlling Costs

Analyzing Market Segments

Variable Costing for Service Businesses

Using Absorption and Variable Costing

Reporting Income

Analyzing Segments

Analyzing Contribution Margin

Absorption costing is required under generally accepted accounting principles for financial statements distributed to external users.

For internal use in decision making, managers often use variable costing. Under variable costing, sometimes called direct costing, the cost of goods manufactured includes only variable manufacturing costs.

Income from operations will vary between absorption and variable costing, depending upon whether there is any change in inventory.

The analysis of the income statement involves comparing the different line items within a statement, as well as following trend lines of individual line items over multiple periods.

controllable costs are costs that can be influenced (increased or decreased) by management at that level. Noncontrollable costs are costs that another level of management controls.

In the short run, fixed costs cannot be avoided. Thus, the selling price of a product should at least be equal to the variable costs of making and selling it. Any price above this minimum selling price contributes to covering fixed costs and generating income.

In the long run, a company must set its selling price high enough to cover all costs and

expenses (variable and fixed) and generate income.

In the short run, planning production is limited to existing capacity. In many cases, operating decisions must be made quickly before opportunities are lost.

In the long run, planning production can include expanding existing capacity.

For planning and control purposes, managers often compare planned and actual contribution margins.

A market segment is a portion of a company that can be analyzed using sales, costs, and expenses to determine its profitability.

Unlike a manufacturing company, a service company does not make or sell a product. Thus, service companies do not have inventory. Since service companies have no inventory, they do not use absorption costing to allocate fixed costs. In addition, variable costing reports of service companies do not report a manufacturing margin.

A contribution margin report for service companies can be used to analyze and evaluate market segments.

Contribution margin is revenues minus all variable expenses. The outcome is then divided by revenues to arrive at a percentage contribution margin. This calculation does not include any apportionment of overhead costs.