Problem 8: Variable Costing And Absorption Costing In 776201

Problem 8 35variable Costing And Absorption Costing Incometenley Compa

This assignment involves analyzing the differences between variable costing and absorption costing methods in managerial accounting using a practical example of Tenley Company, which produces and sells wooden pallets. The goal is to determine the unit inventory cost, evaluate the ending inventory units and cost, and compute the operating incomes under different costing approaches based on provided data.

To begin, the company produced 300,000 pallets and sold 306,500 at $9 each. The opening inventory consisted of 11,300 pallets, with costs remaining unchanged year-over-year. Operating costs are given, and the calculations are under an actual costing system. The specific tasks include: determining the per-unit inventory cost reported on the balance sheet, the number of units in ending inventory, and its total cost. Subsequently, the problem requires calculating the variable-costing operating income, assessing how changes in sales volume affect absorption and variable costing incomes, and understanding the implications of inventory valuation methods on financial statements.

Paper For Above instruction

Introduction

Cost accounting plays a crucial role in managerial decision-making by providing detailed insights into the production costs and profitability of goods sold. Two primary methods—variable costing and absorption costing—are widely used, each with distinct implications for financial reporting and managerial analysis. This paper examines these methods through the context of Tenley Company, which produces wooden pallets, to elucidate their differences, applications, and impacts on reported income and inventory valuation.

Understanding Variable and Absorption Costing

Variable costing, also called direct costing, considers only variable manufacturing costs—direct materials, direct labor, and variable manufacturing overhead—in product costs. Fixed manufacturing overhead costs are expensed in the period incurred, which affects income statements and aligns with managerial decision-making focused on contribution margin analysis (Garrison, Noreen, & Brewer, 2018). In contrast, absorption costing allocates both variable and fixed manufacturing costs to products, assigning a share of the fixed overhead to each unit, thus incorporating all manufacturing costs into inventory valuation (Hilton & Platt, 2019). These methodological differences influence reported net income, especially when inventory levels fluctuate.

Case Analysis of Tenley Company

Using data provided, Tenley produced 300,000 pallets during the year, with 306,500 units sold at $9 each, and initial ending inventory of 11,300 pallets. The company used actual costing, which calculates costs based on actual incurred expenses, and maintained consistent costs year-over-year. The critical calculation involves determining the per-unit inventory cost at year-end, which includes dividing the total manufacturing costs—including fixed overhead under absorption costing—by total units produced. Since fixed manufacturing overhead is spread across all units under absorption costing, the inventory cost per unit will be higher than under variable costing, especially if production exceeds sales.

Calculation of Per-Unit Inventory Cost

The total manufacturing costs consist of variable costs and fixed overhead. To compute the per-unit inventory cost under absorption costing, divide the total manufacturing costs by total units produced. Given that costs have not changed, and assuming fixed manufacturing overhead remains constant, the per-unit cost includes both variable and allocated fixed costs. The inventory in ending inventory is the difference between units produced and sold (if any), and the total cost of ending inventory is the number of units in inventory multiplied by per-unit cost.

Operating Income under Variable Costing

Variable-costing operating income reflects sales revenue minus variable costs and fixed costs. Since fixed manufacturing overhead is expensed immediately under variable costing, this approach emphasizes contribution margin and provides clearer insight into the variable profitability of products. The calculation involves deducting variable manufacturing costs, variable selling and administrative expenses (if any), and fixed costs from sales revenue.

Impact of Sales Volume on Income

Given the scenario of sales decreasing from 306,500 units to 296,700, the calculation of both absorption and variable costing incomes indicates how inventory levels influence net income. Under absorption costing, if production exceeds sales, some fixed manufacturing overhead costs are deferred in inventory, leading to higher reported income. Conversely, variable costing expense all fixed costs in the period, making the income more sensitive to actual sales volume changes (Kaplan & Atkinson, 2015).

Discussion and Conclusion

The comparison of variable and absorption costing underscores significant considerations for managerial and financial reporting. While absorption costing complies with GAAP and provides a comprehensive view of manufacturing costs, it can distort profitability analysis when inventory levels fluctuate. Variable costing offers managerial clarity for decision-making by isolating variable costs and contribution margins. Managers should recognize the implications of each method on income statements and inventory valuation, especially for internal decision-making and external reporting.

References

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