Managerial accounting

Case: 19-4 Landau Company

Question 1:

The income statements prepared under absorption costing and variable costing usually produce different net operating income figures. Under absorption costing if inventories increase then some of the fixed manufacturing costs of the current period will not appear on the income statement as part of cost of goods sold. Instead, these costs are deferred to a future period and are carried on the balance sheet as part of the inventory account. Such a deferral of cost is known as fixed manufacturing overhead deferred in inventory, as the accountant said that the July production was well below standard volume because of employee vacations this caused overhead to be under absorbed so as we can see in the income statement a large amount of overhead volume the amount 63,779 is deducted from gross margin and it cause less income however the sales are increased, but in variable costing because we dont include this overhead volume and we have just a fix amount of fix cost for every month this problem is not visible.
Income Statement June and July
Sales revenues Cost of sales at standard Standard gross margin product cost variance labor material overhead volume overhead spending actual gross margin fixed production overhead admin income before taxes 865,428 448,640 380,788 (16,259) 12,416 1,730 3,604 382,729 0 301,250 81,029 865,428 337,517 527,911 (16,259) 12,416 0 3,604 527,672 192,883 301,250 33,539 931,710 521,758 409,952 (11,814) 8,972 (63,779) 2,832 346,163 0 310,351 35,813 931,710 363,367 568,343 (11,814) 8,972 0 2,832 568,333 192,833 310,351 65,109

And as we can see in income statement the income of June under variable costing is 33,539 and under 81,029 under full costing the less income that is showed by variable cost is good to avoid tax and some point, but it is not a good point from owners and banks loaners point of view as the company seems to be not that much profitable, and so variable costing is not a good method to prepare external report.

The absorption costing system makes no distinction between fixed and variable costs; therefore, it is not well suited for CVP computations, which are important for good planning and control. To generate data for cost volume profit (CVP) analysis, it would be necessary to spend considerable time reworking and reclassifying costs on the absorption statement. The variable costing approach to costing units of product works very well with the contribution approach to the income statement, since both concepts are based on the idea of classifying costs by behavior. The variable costing data could be immediately used in CVP computations and so Terry Silver as the marketing manager can understand the variable cost better and July seems to be better month for him.

The argument of the controller to support variable cost that it would eliminate the time consuming efforts of allocating fixed overheads to individual products is true as the variable cost is easier to apply in this situation and as variable costing segregate the cost of materials, direct labor and etc from fixed overhead cost managements cost control efforts would be enhanced. And also using variable costing to find the profitability of some individual product will help us to determine the product which is more desirable one to sell, because we dont apply all of the overhead volume on all products, but there will be some problem with paying the fix costs if we start to mark up the products in basis on their variable costs. As we can see under variable costing product 243 is more desirable one to sell, but it is not a proper method for marking up the cost of products.
Full Costing
Product 129 243 standard Production cost 2.54 3.05 Selling price 4.34 5.89 unit margin 1.8 2.84 margin percent 41.5 82.5

Variable Costing
Product 129 243 standard Production cost 1.38 2.37 Selling price 4.34 5.89 unit margin 2.96 3.52 margin percent 68.2 59.8

Question 2: I think choosing variable costing for monthly income statement is not a good decision as this costing method has some disadvantage the same as its advantages, as we said the variable costing has some advantages such as The data that are required for cost volume profit (CVP) analysis can be taken directly from a variable costing format income statement. These data are not available on a conventional income statement based on absorption costing. Under variable costing, the profit for a period is not affected by changes in inventories. Other things remaining the same (i.e. selling prices, costs, sales mix, etc.), profits move in the same direction as sales when variable costing is in use. Managers often assume that unit product costs are variable costs. This is a problem under absorption costing, since unit product costs are a combination of both fixed and variable costs. Under variable costing, unit product costs do not contain fixed costs. But despite these advantages, absorption costing must be used almost exclusively for external reporting purposes and it is predominant choice for internal reports as well. Absorption costing is also attractive to many accountants because they believe it better matches costs with revenues. Advocates of absorption costing argue that all manufacturing costs must be assigned to products in order to properly match the costs of producing units of product with the revenues from the units when they are sold. The fixed costs of depreciation, taxes, insurance, supervisory, salaries, and so on, are just as essential to manufacturing products as are the variable costs. Advocates of variable costing argue that fixed manufacturing costs are not really the costs of any particular unit of product. These costs are incurred to have the capacity to make products during a particular period and will be incurred even if nothing is made during the period. Moreover, whether a unit is made or not, the fixed manufacturing cost will be exactly the same. Therefore, variable costing advocates argue that fixed manufacturing costs are not part of the costs of producing a particular unit of product and thus the matching principle dictates that fixed manufacturing costs should be charged to the current period. At any rate, absorption costing is the generally accepted method for preparing mandatory external financial reports and income tax returns, but as absorption costing it is not so useful for management to use to make decision, planning and control they can prepare a variable costing statement for these reasons.