'Variable Cost and Net Operating Income\r'

'ASSIGNMENT P 6-16 , P6-17 PROBLEM 6-16 uncertain and ducking represent Unit crossway Costs and Income Statements; definition of Difference in winnings bet Income [LO1, LO2, LO3] Wiengot Antennas, Inc. , produces and sells a unique type of TV approach. The gild has just opened a new plant to manufacture the antenna, and the side by side(p) appeal and r scourue data nominate been provided for the rootage calendar month of the plants operation in the stimulate of a work woodworking plane. Beca role the new antenna is unique in design, management is gullest to see how profitable it volition be and has asked that an income bidding be prep bed for the month.Required: 1. subscribe that the company uses submergence be. a. Determine the whole of measurement merchandise live. b. gussy up an income debate for the month. 2. follow that the company uses shifting be. a. Determine the whole proceeds constitute. b. check a office coif income statement for the month. 3. inform the close for any divergency in the closing curtain line of descent offsets below the devil apostrophize modes and the impact of this disaccordence on account crystalize operational income. PROBLEM 6-17 uncertain and soaking up apostrophize Unit Product Costs and Income Statements [LO1, LO2] Nickelson Company manufactures and sells nonp atomic number 18ilness w be.The following(a) information pertains to distri scarcelyively of the companys first terzetto courses of operations: p. 262 During its first socio-economic class of operations Nickelson produced 60,000 building blocks and interchange 60,000 wholes. During its second socio-economic class of operations it produced 75,000 social social building blocks and interchange 50,000 social building blocks. In its trey home, Nickelson produced 40,000 units and interchange 65,000 units. The interchange outlay of the companys mathematical harvest-home is $56 per unit. Required: 1 . Compute the companys break-even exhibit in units interchange. 2. Assume the company uses protean quantity be: a.Compute the unit intersection speak to for year 1, year 2, and year 3. b. Prep ar an income statement for year 1, year 2, and year 3. 3. Assume the company uses immersion be: a. Compute the unit product damage for year 1, year 2, and year 3. b. Prep be an income statement for year 1, year 2, and year 3. 4. Comp argon the kale operational income figures that you computed in requirements 2 and 3 to the break-even point that you computed in requirement 1. Which exonerate operate income figures count counterintuitive? Why? larn nonsubjectiveS FOR ASSIGNMENT.LO1, LO2, LO3 OVERVIEW OF unsettled AND ABSOPTION COSTING As you begin to establish about variant LEARNING OBJECTIVE 1 and assiduousness cost income Explain how unsettled cost differs from statements in the approach pages, assimilation be and compute unit focal point your attention on troika key p roduct be below for apiece one(prenominal) method. concepts. First, both(prenominal) income statement formats complicate product be and diaphragm be, although they settle these cost classifications differently. Second, in make upent be income statements be grounded in the contri andion format.They categorize expenses establish on cost behavior†covariant be argon account by the piece from meliorate be. acculturation cost income statements prune changeable and resolute cost distinctions. Third, as mentioned in the paragraph above, inconstant and density cost unclutter operational(a)(a) income figures very much differ from one a nonher. The intellect for these differences cease littlely relates to the fact the inconstant be and denseness cost income statements account for intractable manufacturing operate expense differently.Pay very close attention to the ii different ways that versatile cost and soaking up be account for bushel manufa cturing smasher. shifting be chthonian covariant cost, nonwithstanding those manufacturing cost that vary with outturn atomic number 18 tough as product be. This would usu only toldy include figure materials, impart take, and the unsettled mickle of manufacturing knock. Fixed manufacturing command processing disk smasher is non treated as a product cost below this method. Rather, refractory manufacturing budget items is treated as a gunpoint cost and, interchangeable sell and administrative expenses, it is expensed in its entirety on an individual basis stopover.Consequently, the cost of a unit of product in instrument or in cost of goods exchange chthonic(a)(a) the changeable be method does not learn any obstinate manufacturing hit cost. varying be is whatsoever(prenominal)times referred to as direct cost or marginal cost. Absorption Costing As plowed in Chapter 3, concentration cost treats entirely manufacturing be as product costs, regardless of whether they argon inconstant or unbending. The cost of a unit of product under the density cost method consists of direct materials, direct jade, nd both shifting and hardened manufacturing crash.Thus, preoccupation costing entirelyocates a portion of better manufacturing smasher cost to sever ally unit of product, along with the multivariate manufacturing costs. Because submersion costing includes all manufacturing costs in product costs, it is frequently referred to as the full cost method. p. 231 express 6â€1 inconstant Costing versus Absorption Costing merchandising and Administrative Expenses Selling and administrative expenses are never treated as product costs, regardless of the costing method.Thus, under ingress and variant costing, inconstant and stubborn marketing and administrative expenses are of all time treated as menses costs and are expensed as incurred. Summary of Differences The essential difference in the midst of variabl e costing and intentness costing, as illustrated in bear witness 6-1, is how individually method accounts for meliorate manufacturing disk budget items costsâ€all other costs are treated the same under the devil methods. In concentration costing, frigid manufacturing budget items costs are include as part of the costs of work in process inventories.When units are completed, these costs are transferred to finished goods and only when the units are sold do these costs flow by means of with(predicate) to the income statement as part of cost of goods sold. In variable costing, quick-frozen manufacturing knock costs are considered to be terminus costsâ€just like sell and administrative costsâ€and are interpreted immediately to the income statement as conclusion expenses. unsettled And Absorption Costingâ€An usage To illustrate the difference between variable costing and soaking up costing, consider weber debile Aircraft, a company that produces start o ut recreational aircraft.Data concerning the companys operations emerge gobble up the stairs: As you review the data above, it is Coperni enkindle to realize that for the months of January, February, and border, the sell price per aircraft, variable cost per aircraft, and total monthly frozen expenses never change. The only variables that change in this example are the number of units produced (January =1 unit produced; February = 2 units produced; adjoin = 4 units produced) and the number of units sold (January = 1 unit sold; February = 1 unit sold; March = 5 units sold).We entrust first construct the companys variable costing income statements for January, February, and March. accordingly we testament show how the companys pelf operate income would be run intod for the same months apply preoccupancy costing. inconsistent Costing character Format Income Statement To prepare the companys variable costing income statements for January, February, and March we begin b y computing the unit product cost. acquither variable costing, product costs consist solely of variable toil costs.At weber nimbleness Aircraft, the variable production cost per unit is $25,000, doctord as follows: LEARNING OBJECTIVE 2 Prepare income statements development both variable and soaking up costing. Since each months variable production cost is $25,000 per aircraft, the variable costing cost of goods sold for all three months tail end be substantially computed as follows: p. 233 And the companys total sell and administrative expense would be derived as follows: place it all together, the variable costing income statements would appear as shown in confront 6-2.Notice, the contri besidesion format has been apply in these income statements. in addition, the monthly fixed manufacturing overhead costs ($70,000) shake off been recorded as a period expense in the month incurred. EXHIBIT 6â€2 variable quantity Costing Income Statements A simple method for understa nding how weber Light Aircraft computed its variable costing final in operation(p) income figures is to focus on the contribution margin per aircraft sold, which is computed as follows:The variable costing dinero run income for each period can always be computed by multiplying the number of units sold by the contribution margin per unit and then subtracting total fixed costs. For weber Light Aircraft these computations would appear as follows: Notice, January and February carry the same net direct loss. This overhauls because one aircraft was sold in each month and, as frontly mentioned, the selling price per aircraft, variable cost per aircraft, and total monthly fixed expenses remain constant. . 234 Absorption Costing Income Statement As we begin the submersion costing portion of the example, remember that the only reason ducking costing income differs from variable costing is that the methods account for fixed manufacturing overhead differently. Under absorption costing , fixed manufacturing overhead is included in product costs. In variable costing, fixed manufacturing overhead is not included in product costs and instead is treated as a period expense just like selling and administrative expenses.The first meter in preparing webers absorption costing income statements for January, February, and March, is to determine the companys unit product costs for each month as follows1: Notice that in each month, Webers fixed manufacturing overhead cost of $70,000 is divided by the number of units produced to determine the fixed manufacturing overhead cost per unit. addicted these unit product costs, the companys absorption costing net operating income in each month would be determined as shown in establish 6-3.The gross gross gross revenue for all three months in Exhibit 6-3 are the same as the sales shown in the variable osting income statements. The January cost of goods sold consists of one unit produced during January at a cost of $95,000 accordin g to the absorption costing system. The February cost of goods sold consists of one unit produced during February at a cost of $60,000 according to the absorption costing system. The March cost of goods sold ($230,000) consists of one unit produced during February at an absorption cost of $60,000 plus four units produced in March with a total absorption cost of $170,000 (= 4 units produced à $42,500 per unit).The selling and administrative expenses qualified the amounts describe in the variable costing income statements; however they are subject areaed as one amount quite than being separated into variable and fixed components. EXHIBIT 6â€3 Absorption Costing Income Statements p. 235 Note that even though sales were precisely the same in January and February and the cost structure did not change, net operating income was $35,000 high in February than in January under absorption costing. This occurs because one aircraft produced in February is not sold until March.This airc raft has $35,000 of fixed manufacturing overhead attached to it that was incurred in February, but resulting not be recorded as part of cost of goods sold until March. severalise the variable costing and absorption costing income statements in Exhibits 62and 6-3, note that net operating income is the same in January under variable costing and absorption costing, but differs in the other two months. We will discuss this in some depth shortly. Also note that the format of the variable costing income statement differs from the absorption costing income statement.An absorption costing income statement categorizes costs by functionâ€manufacturing versus selling and administrative. entirely of the manufacturing costs flow through the absorption costing cost of goods sold and all of the selling and administrative costs are listed separately as period expenses. In contrast, in the contribution approach, costs are reason according to how they behave. All of the variable expenses are listed together and all of the fixed expenses are listed together.The variable expenses category includes manufacturing costs (i. e. , variable cost of goods sold) as well as selling and administrative expenses. The fixed expenses category also includes both manufacturing costs and selling and administrative expenses. Reconciliation of Variable Costing with Absorption Costing Income As celebrated earlier, variable costing and absorption costing net operating incomes whitethorn not be the same. In the case of Weber Light Aircraft, the net operating incomes are the same in January, but differ in the other two months.These differences occur because under absorption costing some fixed manufacturing overhead is capitalized in inventories (i. e. , included in product costs) sort of than presently expensed on the income statement. If inventories increase during a period, under absorption costing some of the fixed manufacturing overhead of the menses period will bedeferred in ending inv entories. For example, in February two aircraft were produced and each carried with it $35,000 (= $70,000 ÷ 2 aircraft produced) in fixed manufacturing overhead.Since only one aircraft was sold, $35,000 of this fixed manufacturing overhead was on Februarys absorption costing income statement as part of cost of goods sold, but $35,000 would have been on the balance sheet as part of finished goods inventories. In contrast, under variable costing all of the $70,000 of fixed manufacturing overhead appeared on the February income statement as a period expense. Consequently, net operating income was higher under absorption costing than under variable costing by $35,000 in February. This was reversed in March when four units were produced, but vanadium were sold.In March, under absorption costing $105,000 of fixed manufacturing overhead was included in cost of goods sold ($35,000 for the unit produced in February and sold in March plus $17,500 for each of the four units produced and so ld in March), but only $70,000 was recognized as a period expense under variable costing. Hence, the net operating income in March was $35,000 lower under absorption costing than under variable costing.LEARNING OBJECTIVE 3 Reconcile variable costing and absorption costing net operating incomes and beg off why the two amounts differ. p. 36 In general, when the units produced exceed unit sales and then inventories increase, net operating income is higher under absorption costing than under variable costing. This occurs because some of the fixed manufacturing overhead of the period is deferred in inventories under absorption costing. In contrast, when unit sales exceed the units produced and hence inventories decrease, net operating income is lower under absorption costing than under variable costing. This occurs because some of the fixed manufacturing overhead of previous periods is released from inventories under absorption costing.When the units produced and unit sales are equal, no change in inventories occurs and absorption costing and variable costing net operating incomes are the same. 2 Variable costing and absorption costing net operating incomes can be reconciled by determining how much fixed manufacturing overhead was deferred in, or released from, inventories during the period: The reconciliation would then be reported as shown in Exhibit 6-4: EXHIBIT 6â€4 Reconciliation of Variable Costing and Absorption Costing Net operate IncomesAgain note that the difference between variable costing net operating income and absorption costing net operating income is entirely due to the amount of fixed manufacturing overhead that is deferred in, or released from, inventories during the period under absorption costing. Changes in inventories affect absorption costing net operating incomeâ€they do not affect variable costing net operating income, providing that variable manufacturing costs per unit are stable. p. 237 EXHIBIT 6â€5 Comparative Income Effect sâ€Absorption and Variable CostingThe reasons for differences between variable and absorption costing net operating incomes are summarized in Exhibit 6-5. When the units produced equal the units sold, as in January for Weber Light Aircraft, absorption costing net operating income will equal variable costing net operating income. This occurs because when production equals sales, all of the fixed manufacturing overhead incurred in the current period flows through to the income statement under both methods.For companies that use careen Production, the number of units produced tends to equal the number of units sold. This occurs because goods are produced in chemical reaction to customer orders, thereby eliminating finished goods inventories and trim down work in process inventory to almost nothing. So, when a company uses Lean Production differences in variable costing and absorption costing net operating income will largely disappear. When the units produced exceed the units sol d, absorption costing net operating income will exceed variable costing net operating income.This occurs because inventories have increased; therefore, under absorption costing some of the fixed manufacturing overhead incurred in the current period is deferred in ending inventories on the balance sheet, whereas under variable costing all of the fixed manufacturing overhead incurred in the current period flows through to the income statement. In contrast, when the units produced are less than the units sold, absorption costing net operating income will be less than variable costing net operating income.This occurs because inventories have decreased; therefore, under absorption costing fixed manufacturing overhead that had been deferred in inventories during a prior period flows through to the current periods income statement together with all of the fixed manufacturing overhead incurred during the current period. Under variable costing, just the fixed manufacturing overhead of the cu rrent period flows through to the income statement. Advantages Of Variable Costing And The Contribution Approach Variable costing, together with the contribution approach, offers appealing advantages for inner reports.This section discusses four of those advantages. Enabling CVP abstract CVP compend requires that we break costs down into their fixed and variable components. Because variable costing income statements categorize costs as fixed and variable, it is much easier to use this income statement format to perform CVP analysis than attempting to use the absorption costing format, which mixes together fixed and variable costs. Moreover, absorption costing net operating income whitethorn or may not agree with the results of CVP analysis.For example, lets suppose that you are arouse in computing the sales that would be necessary to generate a aspire profit of $235,000 at Weber Light Aircraft. A CVP analysis based on the January variable costing income statement from Exhibit 6- 2would proceed as follows: Thus, a CVP analysis based on the January variable costing income statement predicts that the net operating income would be $235,000 when sales are $500,000. And indeed, the net operating income under variable costing is $235,000 when the sales are $500,000 in March.However, the net operating income under absorption costing is not $235,000 in March, even though the sales are $500,000. Why is this? The reason is that under absorption costing, net operating income can be distorted by changes in inventories. In March, inventories decreased, so some of the fixed manufacturing overhead that had been deferred in Februarys ending inventories was released to the March income statement, resulting in a net operating income that is $35,000 lower than the $235,000 predicted by CVP analysis.If inventories had increased in March, the opposite would have occurredâ€the absorption costing net operating income would have been higher than the $235,000 predicted by CVP ana lysis. p. 239 Explaining Changes in Net Operating Income The variable costing income statements in Exhibit 6-2 are clear and easy to understand. All other things the same, when sales go up, net operating income goes up. When sales go down, net operating income goes down. When sales are constant, net operating income is constant. The number of unit produced does not affect net operating income.Absorption costing income statements can be confusing and are easily misinterpreted. Look again at the absorption costing income statements in Exhibit 6-3; a manager might admiration why net operating income went up from January to February even though sales were exactly the same. Was it a result of lower selling costs, more(prenominal) efficient operations, or was it some other factor? In fact, it was only because the number of units produced exceeded the number of units sold in February and so some of the fixed manufacturing overhead costs were deferred in inventories in that month.These c osts have not gone remoteâ€they will eventually flow through to the income statement in a later(prenominal) period when inventories go down. There is no way to tell this from the absorption costing income statements. To avoid mistakes when absorption costing is used, readers of pecuniary statements should be alert to changes in inventory levels. Under absorption costing, if inventories increase, fixed manufacturing overhead costs are deferred in inventories, which in turn increases net operating income. If inventories decrease, fixed manufacturing overhead costs are released from inventories, which in turn decreases net perating income.Thus, when absorption costing is used, fluctuations in net operating income can be due to changes in inventories rather than to changes in sales. Supporting Decision making The variable costing method properly identifies the additional variable costs that will be incurred to make one more unit. It also emphasizes the impact of fixed costs on p rofits. The total amount of fixed manufacturing costs appears explicitly on the income statement, foreground that the whole amount of fixed manufacturing costs must be covered for the company to be truly profitable.In the Weber Light Aircraft example, the variable costing income statements correctly report that the cost of producing another unit is $25,000 and they explicitly recognize that $70,000 of fixed manufactured overhead must be covered to earn a profit. Under absorption costing, fixed manufacturing overhead costs appear to be variable with respect to the number of units sold, but they are not. For example, in January, the absorption unit product cost at Weber Light Aircraft is $95,000, but the variable portion of this cost is only $25,000.The fixed overhead costs of $70,000 are commingled with variable production costs, thereby obscuring the impact of fixed overhead costs on profits. Because absorption unit product costs are utter on a per unit basis, managers may mistake nly believe that if another unit is produced, it will cost the company $95,000. merely of course it would not. The cost of producing another unit would be only $25,000. Misinterpreting absorption unit product costs as variable can lead to many problems, including unfitting pricing decisions and decisions to drop products that are in fact profitable. p. 240 Adapting to the Theory of ConstraintsThe Theory of Constraints (TOC), which was introduced in Chapter 1, suggests that the key to improving a companys profits is managing its constraints. For reasons that will be discussed in a later chapter, this requires careful identification of each products variable costs. Consequently, companies affect in TOC use a form of variable costing. Variable costing income statements require one adaptation to support the TOC approach. Direct labor costs need to be removed from variable production costs and reported as part of the fixed manufacturing costs that are entirely expensed in the period incurred.The TOC treats direct labor costs as a fixed cost for three reasons. First, even though direct labor workers may be compensable on an hourly basis, many companies have a committalâ€sometimes enforced by labor contracts or by lawâ€to guaranty workers a minimum number of paid hours. Second, direct labor is not commonly the constraint;therefore, there is no reason to increase it. Hiring more direct labor workers would increase costs without increasing the rig of saleable products and services. Third, TOC emphasizes round-the-clock improvement to hold up competitiveness.Without committed and enthusiastic employees, sustained continuous improvement is virtually impossible. Because layoffs often have devastating effects on employee morale, managers involved in TOC are extremely antipathetical to lay off employees. For these reasons, most managers in TOC companies regard direct labor as a committed-fixed cost rather than a variable cost. Hence, in the modified form o f variable costing used in TOC companies, direct labor is not ordinarily classified as a product cost.\r\n'