Variable And Absorption Costing Sprinting Case Study

Variable And Absorption Costing Sprintin Case Study Sprintin Is A

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) $17,760,000 Contribution margin $11,100,000 Less fixed costs (7,020,000 + 3,375,000) $10,395,000 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) $15,170,000 Gross profit $13,690,000 Less operating expense: Variable (185,000 X40) + Fixed (3,375,000) $11,385,000 Operating income $2,915,000

Inventory under the two methods would be calculated as follows: Inventory in units (270,000 units produced less 185,000 units sold) = 85,000

Variable costing: Variable manufacturing costs (85,000 X 56) $4,760,000; Absorption costing: Variable manufacturing costs above $4,760,000; Fixed manufacturing costs (85,000 X 26) $2,210,000; Total inventory costs $6,970,000. 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.

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Cost allocation plays a pivotal role in managerial accounting, especially in the context of different costing systems such as variable and absorption costing. The Sprintin case study exemplifies how these systems influence financial statements and management decisions.

Variable costing, also known as direct costing, attributes only variable manufacturing costs to products. Fixed manufacturing overheads are treated as period expenses, impacting the income statement in the period they are incurred. This method provides clarity on the contribution margin which is vital for assessing the profitability of individual products and making decisions related to pricing, production, and discontinuation of product lines.

Absorption costing, on the other hand, allocates both variable and fixed manufacturing overheads to products. It considers fixed manufacturing costs as part of the product's cost, distributing these costs across units produced. Consequently, inventory valuation under absorption costing includes fixed manufacturing overheads, which can lead to discrepancies in reported income depending on inventory levels. This approach aligns with generally accepted accounting principles (GAAP) and is often utilized for external financial reporting.

The case study illustrates this with the fixed manufacturing overhead rate of $26 per unit, derived by dividing total fixed manufacturing costs by total units produced. The inventory valuation differs significantly between the two methods due to this allocation, which in turn affects the gross profit and net income figures. Under variable costing, the operating income is significantly lower, emphasizing the influence of fixed overheads on profitability.

Understanding the impact of inventory valuation methods is essential for effective managerial decision-making. For instance, during periods of increasing inventory, absorption costing typically reports higher income because some fixed costs are deferred in inventory. Conversely, during periods of decreasing inventory, absorption costing might report lower income as fixed costs are released from inventory.

Strategic decision-making benefits from the insights provided by variable costing because it highlights the contribution margin and the variable costs associated with each unit, aiding in decisions related to product line expansion or discontinuation. Conversely, absorption costing provides a comprehensive view necessary for external reporting and compliance, ensuring that all manufacturing costs are appropriately accounted for.

Cost behavior analysis further complements these systems by enabling managers to understand how costs respond to changes in activity levels. Variable costs change proportionally with output, fixed costs remain constant in total, and mixed costs have characteristics of both. Recognizing these patterns supports the development of accurate budgets, forecasts, and cost management strategies.

In the broader context, the effective allocation of overhead costs involves sophisticated techniques such as activity-based costing (ABC). ABC assigns overhead costs based on activities that drive costs, providing more accurate product costing, especially in complex manufacturing environments like Sprintin's sneaker production. This method reduces cost distortion and enhances decision-making accuracy.

Furthermore, the choice of costing system has implications beyond internal decision-making. It influences managerial behavior, cost control, and performance evaluation. Managers tend to focus on variable costs for short-term decisions, as they are controllable and directly linked to output levels, while fixed costs are often viewed as less controllable in the short term.

In conclusion, the Sprintin case vividly demonstrates the differences between variable and absorption costing and underscores the importance of understanding cost allocation methods for effective managerial decision-making. The choice of costing system impacts financial reporting, inventory valuation, and strategic decisions—making careful consideration of each system's implications essential for managerial success and operational efficiency.

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