Variable Costing for Management Analysis

Variable Costing for Management Analysis

1. Income Under Absorption & Variable Costing

   • Absorption Costing
     • Required under generally accepted accounting principles for financial statements distributed to external users.
     • Cost of goods manufactured include: direct materials, direct labor & factory overhead costs (fixed&variable)
   • Variable Costing/Direct Costing
     • For internal use in decision-making
     • Cost of Goods Manufactured include: Variable Manufacturing costs-- Direct materials, Direct labor, Variable factory overhead
   • Effects of Inventory
     • On income from operations: Units manufactured= units sold, no change in inventory Units manufactured> units sold, increase in inventory Units manufactured<units sold, decrease in inventory
       • Units Manufactured = Units Sold: income from operations will be the same under both methods
       • Units Manufactured> Units Sold: variable costing from operations will be less than for absorption
       • Units Manufactured< Units Sold: variable costing income from operations will be greater than that of absorption costing
   • Analyzing Income
     • Increases or decreases in income from operations can be due to changes in inventory levels, these changes may be misinterpreted as efficiencies of inefficiencies

2. Using Absorption & Variable Costing

   • Controlling Costs
     • Controllable Costs: Costs that can be influenced by management at that level
     • Noncontrollable Costs: Costs that another level of management controls
   • Pricing Products
     • Short Run: the price should be at least equal to the variable costs but should generate enough so you can pay fixed costs. Variable costing is better bc it reports variable & fixed costs and expensed separately.
     • Long Run: The price should be high enough so it covers variablee and fixed costs and also generates income. Absorption costing is more convenient since it includes both variable and fixed costs in the cost of manufacturing a product.
   • Planning Production
     • Short-run: limited to existing capacity. Variable costing tends to be more useful since it reports contribution margin.
     • Long run: May include expanding existing capacity. Absorption costing is more useful bc it considers fixed and variable costs.
   • Analyzing Market Segments
     • Sales Territory Profitability Analysis
       • Used in evaluating past performance & in directing future sales efforts
       • May lead management to do the following: Reduce cost in lower-profit sales territories or Increase sales efforts in higher-profit territories
     • Product Profitability Analysis
       • Used by management in decision-making regarding product sales & promotional efforts
     • Salesperson Profitability Analysis
       • Useful in evaluating sales performance, the report includes total sales, variable cost of goods sold, variable selling expenses, contribution margin and contribution margin ratio
   • Contribution Margin Analysis
     • Explains the differences between planned & actual contribution margins
     • Quantity factor: the effects of a difference in the # of units sold w/no change in units sales price or unit cost
     • Unit Price Factor: effect of a difference in unit sales price or unit cost on the number of units sold

3. Variable Costing for Service Businesses

   • Reporting Income
     • Service companies don't make or sell a product. Since they have no inventory, they don't have absorption costing to allocate fixed costs
   • Analyzing Segments
     • A contribution margin report for service companies can be used to analyze and evaluate market segments
   • Analyzing Contribution Margin

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