You are the accounting manager in a medium-sized manufacturing company. The company's first year just ended, and the accounting department is working on closing the books. You plan to present information about unit costs and profits, to the general manager (GM) in two different formats. One method uses variable costing, and the other uses absorption costing. The GM will need to choose one or the other for accounting purposes. Whatever method he chooses will have to remain the method going forward as the choice of the method could impact reported profitability and therefore taxes. (The IRS frowns on firms making accounting methodology changes that impact any period's profits.)
You explain to the GM that if you choose to use the absorptive method, it will not only impact the reported profits of the year that just ended but will have an impact on the reported profits of the upcoming year, too. He doesn't understand what this means and asks for a more detailed explanation.
In about 200 words, explain to him:
- How absorption costing differs from variable costing
- How the absorptive method will not only impact the reported profits of the year that just ended but will also have an impact on the reported profits of the upcoming year
Group Portion:
As the accounting manager, you and your staff need to prepare year-ending information to present to the company's general manager.
Prepare 1 Excel file with 2 worksheets showing the following calculations.
Part A:
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Part A Data
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Budgeted and actual fixed costs
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$1,000,000
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Budgeted unit volume to be produced
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10,000
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Budgeted unit volume sold
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10,000
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Actual variable costs
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$500,000
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Actual unit volume sold
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9,000
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Beginning of year inventory
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0
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End of year inventory
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1,000
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Using the Part A data:
- How many units of production were:
- produced?
- shipped?
- left in inventory?
- How much of the firm's fixed costs stayed in inventory?
- under variable costing?
- under absorption costing?
- Calculate the unit cost:
- using variable costing.
- using absorption costing.
- Based on how much of the firm's fixed costs stayed in inventory, how much of the firm's fixed costs ended up on the year's COGS and income statement?
- under variable costing?
- under absorption costing?
- Under which method (variable or absorption costing), will reported profits be higher? Explain why.
Part B:
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Part B Data
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A firms cost structure is as follows:
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Monthly fixed costs
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$20,000
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Variable cost/unit
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$80
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Selling price/unit
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$100
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Using the Part B data:
- Calculate the firm's break-even point in units of production.
- Predict the firm's profitability if volume is 1,200 units.
Objective:
- Understand how fixed and variable costs behave and how to use them to predict costs, analyze a mixed cost using the high-low method and prepare an income statement using the contribution format.
- Explain how variable costing differs from absorption costing and compute unit product costs under each method, and Identify relevant and irrelevant costs and benefits in a decision situation.