Garrison R 2012 Managerial Accounting 14th Ed McGraw Hill

Garrison R 2012 Managerial Accounting 14th Ed Mcgraw Hill Lear

This module expands on the principle of accumulating costs. It also covers using cost data to make important decisions as they pertain to investment decisions.

It explores two different methods that can be used to accumulate costs: the variable costing system and the absorption costing system. You will learn to differentiate between each system as well as understand the different uses for each type of costing system presented. Cost estimation is the process of estimating the relationship between costs and cost drivers that are responsible for the costs. There are three main reasons why companies estimate costs. These are:

• To manage costs
• To make decisions
• To plan and set standards

There is a simple way and a complex way to break down costs.

The simple way is to break down costs into fixed and variable costs. The complex way is to make cost patterns, such as step costs and mixed costs. There are three commonly used methods when it comes to cost estimation. These methods are:

• Statistical methods using regression analysis
• Account analyses
• Engineering estimates

Statistical methods using regression analysis employ cost drivers, which are independent variables, and costs, which are dependent variables. When simple regression is used, there is one independent variable. When multiple regression is used, there is more than one independent variable. With account analyses, the analyst separates costs from the accounting records into categories and their corresponding cost drivers. With the engineering estimates method, engineers create estimates based on data derived from current practices. These estimates are found by measuring the amount of work involved to complete the activity and then assigning a cost to each activity.

It is important to note that statistical methods require the least amount of data as costs are not divided into categories with cost drivers. Engineering estimates are the most expensive and time-consuming as identifying activities and their costs is difficult. Once an analyst forms a cost estimate, it is important that he or she then create a financial model. The best way to do this is through cost-volume-profit analysis. The cost-volume-profit model shows the effects of any changes within an organization. Examples of changes would be sales volume, prices, and costs.

The basic cost-volume-profit model is great, but it does have limitations. The largest is that it can only account for one cost driver. This model is improved upon by using activity-based costing models. When looking at any financial model, it is important to understand some basic terms. The first is the break-even point. This is when revenues equal expenses at a given sales level. Another important term is contribution margin, which is the amount of money that is left over after all variable costs are covered. Operating leverage is another important term, which is the ratio of contribution margin to operating income. A high operating leverage signals a risky company.

Making financial decisions and measuring costs are very difficult for a company, no matter the size. However, these functions are necessary if the organization is to remain successful. Variable and Absorption Costing Sprintin Case Study Sprintin is a company that manufactures sneakers. The company’s data for the previous year is presented below. Sprintin had no beginning inventories in January. Sale price $156 Fixed manufacturing overhead $7,020,000 Variable manufacturing expense per unit $3,375,000 Fixed operating expense $56 Number of sneakers produced 270,000 Sales commission expense per unit $40 Number of sneakers sold 185,000

Sprintin’s variable costing income statement is as follows: Since fixed manufacturing costs are considered to be a period cost, they are expensed in the period incurred. Sales (185,000 X 156) $28,860,000 Less variable costs (56 +40 = 96 X185,000) Contribution margin 11,100,000 Less fixed costs (7,020,000 + 3,375,000) Operating income $705,000

Sprintin’s absorption costing income statement is as follows: As fixed manufacturing costs are considered to be product costs, they must be allocated between the units sold and units still in inventory. Fixed manufacturing costs = $7,020,000 / 270,000 units produced = $26 per unit. Sales (185,000 X 156) $28,860,000 Less cost of goods sold: Variable (185,000 X 56) + Fixed (185,000 X 26) Gross profit 15,170,690 Less operating expense: Variable (185,000 X40) + Fixed ($3,375,000) Operating income 10,775,000

Inventory under the two methods would be calculated as follows: Inventory in units (270,000 units produced less 185,000 units sold) = 85,000. Under variable costing: Variable manufacturing costs (85,000 X 56) $10,360,000. Under absorption costing: Variable manufacturing costs above $10,360,000 plus Fixed manufacturing costs (85,000 X 26) $2,210,000. Total inventory costs $12,570,000. The difference in variable costing and absorption costing income in our example is equal to the difference in fixed cost included in inventory under the two methods.

Paper For Above instruction

The distinctions and applications of variable costing and absorption costing are fundamental concepts in managerial accounting, impacting how organizations report income and analyze costs. These two systems serve different management purposes and influence decision-making, pricing, and profit analysis.

Variable costing, also known as direct costing, includes only variable production costs in the cost of goods sold and inventory valuation. Fixed manufacturing overhead costs are treated as period expenses and are expensed in the period incurred. This method provides clear insight into the contribution margin per unit, which is pivotal for decision-making processes like pricing, product line analysis, and operational efficiency. Because it separates fixed and variable costs, managers can easily understand how costs behave relative to production volume, which aids in making short-term decisions (Garrison, Noreen, & Brewer, 2012).

Absorption costing, also called full costing, allocates all manufacturing costs, both fixed and variable, to individual units of production. As a consequence, inventory values on the balance sheet include a share of fixed manufacturing overhead. This method complies with generally accepted accounting principles (GAAP), especially for external financial reporting. It influences profit reporting because changes in inventory levels can shift fixed overhead costs between periods, thus affecting net income. For managerial purposes, it obscures the actual contribution margin, making it less suitable for certain decision-making but essential for external reporting (Drury, 2013).

The application differences are evident in practical scenarios such as the Sprintin case. Under variable costing, the income statement isolates the variable expenses, providing clarity on how sales level impacts profitability. Fixed manufacturing overheads are treated as period costs, which makes this method useful for internal decision-making and cost control. Conversely, absorption costing assigns fixed manufacturing costs to ending inventory, impacting income based on production volume and inventory changes.

The decision of which costing method to use depends on the organization's purpose. For internal decision-making, variable costing provides better operational insights. It helps managers understand the contribution margin, which is critical for assessing product performance and planning. On the other hand, absorption costing is mandated for external financial statements, ensuring compliance with accounting standards and accurately representing inventory costs.

Further, understanding the nuances of each system informs management about the implications of production and sales strategies. For example, increasing inventory levels under absorption costing can inflate profits due to fixed cost allocation, leading to potential distortions if not carefully analyzed. Conversely, variable costing provides a more consistent view of profitability, regardless of inventory fluctuations (Weygandt, Kimmel, & Kieso, 2020).

The choice of costing system can influence key financial metrics and managerial decisions. For instance, carryover inventory profits under absorption costing may motivate managers to produce more than they sell, thereby affecting short-term profits and potentially leading to overproduction. This phenomena, known as ‘profit manipulation,’ underscores the importance of selecting an appropriate costing system aligned with strategic objectives (Kaplan & Atkinson, 2015).

In the context of the Sprintin sneakers company, the contrast between the two methods illustrates practical tax and reporting considerations. Under variable costing, the net income reflects only current period expenses, making it easier to analyze operational efficiency. Absorption costing, by allocating fixed costs to inventory, can produce higher net income in periods of increased production, impacting tax liabilities and financial analysis.

In conclusion, understanding the differences between variable and absorption costing, along with their respective advantages and limitations, is essential for effective managerial accounting and decision-making. Both systems provide valuable insights for internal management and external reporting, but their influence on income measurement and inventory valuation varies significantly, requiring managers to choose the appropriate method based on the specific context and purpose.

References

• Drury, C. (2013). Management and Cost Accounting. Cengage Learning.
• Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2012). Managerial Accounting (14th ed.). McGraw-Hill Education.
• Kaplan, R. S., & Atkinson, A. A. (2015). Advanced Management Accounting. Pearson.
• Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2020). Financial & Managerial Accounting (8th ed.). Wiley.