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Variable cost as a decision tools

Product cost:
Per unit production cost is called product cost. It can also define, cost are those costs that
directly with the purchase or manufacture.

Period cost:
Period costs are those cost that are directly taken to the income statement as expense.
Product cost.

Product cost

Product cost

Variable costing method ; : Absorption costing method

Variable costing method:


Variable costing is the costing method that includes only variable manufacturing
overhead - direct new material, direct labor and variable factory overhead.

Absorption costing method:


Absorption costing is the costing method that includes both variable manufacturing and
fixed manufacturing overhead directly as the products costs. It includes direct new
material, direct labor and both variable and fixed manufacturing overhead.
Difference between variable cost and absorption costing method

Absorption costing Variable costing

1 . Absorption costing is the costing method 1. Variable costing is the costing method
that includes both variable that includes only variable manufacturing
manufacturing and fixed manufacturing overhead - direct raw material, direct
overhead directly as the products costs. labor and variable factory overhead.
It includes direct new material , direct
labor and both variable and fixed
manufacturing overhead

2. Its another name is full cost. 2. It's another name is direct cost.
3. Ending inventory is higher. 3. Ending inventory is lower than the
absorption costing method.
4. Fixed manufacturing cost is treated as 4. Fixed manufacturing cost is treated
product cost. as period.

Example 1:

No. of units product Direct material per unit Direct 6,000 units
labor per unit Direct cost overhead per unit $2 $4 $1
Variable selling and administrative
Expense per unit $3
Fixed cost per unit $30,000
Requirement:
Compute per unit product cost under
a) Absorption costing method
b) Variable costing method

Solution:

Absorption costing method Variable costing method


Direct material $2 $2
Direct labor $4 $4
Variable overhead per unit $1 $1
Fixed overhead per unit $5
(30000/6000)_____________________________________________________
S12 $7

Example 2:

If beginning inventory 6000 units


Ending inventory 5000
Sold during the year 10,000

Find-

(a) Units produce = Ending inventory +Unit sold -Beginning inventory


-5,000+10,000-6000 =9000 Units
Example 3:

Desk Computer Company has the following information:

Selling price per computer $200


Beginning inventory $ 1000 units
Ending inventory $ 2000
Unit sold $8000
Units produced $9000

Variable cost per unit:


Direct material $60
Direct labor $30
Variable manufacturing cost $ 10
Variable selling and administrative $20

Fixed cost:
Fixed overhead $300,000
Fixed selling and administrative cost $450,000

Requirement:
(1) Compute per unit product cost
under-
(a)Variable costing method
(b)Absorption costing method
(2) Prepare income statement under
(a)Variable costing method
(b)Absorption costing method
(3) Show the effect on profit for using both methods in year -1 and year-2.
Solution:
A B
Absorption costing method Variable costing method

Direct material $60 $60


Direct labor $30 $30
Variable manufacturing cost $10 $10
Fixed overhead $33.33
2(a) Income statement under variable cost method:

Description
Revenue:

Sale (200*8000) 1,600,000


Less: cost of goods sold:
Beginning inventory (1000*100) 100,000 onn
Production cost(l 00*9000) nnn
1,000,000
(-) Ending inventory (2000*100) (200,000)
(800,000)
Gross margin 800,000

Less: others expense:


Variable selling and administrative(20*8000) 160,000
Fixed selling and administrative Fixed overhead 450,000
300.000
Net Loss (910,000)
(1.100.000)
In come statement Under Absorption Costing method

Description $ $
Revenue: 133330
Sale (200*8000) Less: cost
1199970
of goods sold:

1,600,000

Beginning inventory (1000*133.33)


1333300
Production cost(133. 33*9000)
(-) Ending inventory (2000*133.33) (266660)
Gross margin
160,000
Less: others expense:
450,000
(1066640)

Variable selling and administrative(20*SOOO)


Fixed selling and administrative 533360
Net Loss

(76640)

(610,000)
3) Cost inventory under variable Cost
method = (100*2000) =TK.200, 000
Closing inventory under absorption Costing
method =TK.(133.33*2000) =TK.266, 660
If V.C method is used current year profit will be lower and next year profit will be high and
if A.C method is used the effect on profit will be just inverse.
Job Order Costins

A cost system used in situation where many different products are produced
during a period.

Period costing:
A costing system used in those manufacturing situations where a single
homogenous product is product for long period of time.

Cost driver:
A factor that causes overhead cost.
For example
Direct labors hours
Machine hours
Compute time etc.

Standard budget Under applied overhead Over applied overhead


100,000 11,000 11,000

Over applied:
A credit balance of the manufacturing overhead account that occur. When the
amount of overhead cost applied to work in process in greater than the amount of
overhead cost actually incurred during a period.

Under applied:
A debit balance of the manufacturing overhead account that occurs when the
amount of overhead cost applied to work in process in lower than the amount of overhead
cost actually incurred during a period.

Per determine overhead rate:


:e used to change overhead cost to in production.

Estimated total manufacturing cost


;termine overhead rate (FOR)
Estimated total allocation base

head applied job = FOR* Amount of allocation base incurred during a period.

cise (3-3)

t labor - hours
ine - hours
"material cost
facturing overhead
Company

Company
A B c cost driver
60000 30000 40000

A 25000 90000 18000Direct labor hours


$ 300000 160000 240000
432000 270000 384000
B Machine hours

termine overhead rates are computed by using the following cost drives-
C Raw material
Required -
(a) Compute predetermines overhead rates for A, B, C companies.
(b) Company produce product in caring 7000 direct labor. What is the overhead cost for
company A. What would the condition of overhead applied or under applied if the
actual overhead cost =$430000?

Solution:

a) For company A

Estimated total manufacturing cost


POR=
Estimated total allocation base =
432000 60000
= 7.2

For company B

Estimated total manufacturing cost


POR= ____________________________
Estimated total allocation base =
270000 90000
__ -)
>r company C

Estimated total manufacturing cost


POR= ______________________________
Estimated total allocation base =
$384000
240000 =
1.6 = 160%

>mpany A =7.2 per direct labor hours


B =3 per machine hours
C =160% raw materials

(b) Total manufacturing overhead applied


$(70000*7.2) $504000
Actual cost _______430000
$740000
Activity based costing

Activity based costing:


A costing method based on activity that designed to provide management with
cost information for strategic decision that potentially affect capacity and therefore fixed
costs.

Activity:
An event that caused the consumption of overhead resources in an organization.

Over Riding Problem:


An efficient employee takes burden of an inefficient employee.

Activity cost pool:


Example:
Processing Units
Assembling units.
No. of order.

Opportunity cost:
Opportunity cost is the cost of forgoing the nest best alternative.
Example:

Security Rate of Return


X . 20% (If invest security X)
Y 15% ( Opportunity Cost)
Z 10%
P 5%
Q 3%
Sunk
already incurred and have no effect in future decision. For example, Furniture is
Cost:
purchased by Tk.50000; its residual value would be Tk.5000. Here Tk.50000 is
S
sunk cost because furniture was purchased by taking decision in the past.
unk
Cost
Relevant cost:
is the
Relevant cost is the costing system that differs among the courses of
costs
action and expected future cost.
that is
Sunk Cost:
Sunk Cost is the costs that is already incurred and have no effect in future
decision. For example, Furniture is purchased by Tk.50000; its residual value would be
Tk.5000. Here Tk.50000 is sunk cost because furniture was purchased by taking decision
in the past.

Relevant cost:
Relevant cost is the costing system that differs among the courses of action and
expected future cost.
'"',
j

3. Classify the following cost with reason:

(a).............................A company is considering selling an old machine.


The machine has a book
value of Tk. 20,000. In evaluating the decision to sell the machine, the Tk.
20,000 isa.................
(b)........................As an alternative to the old machine the company can
rent a new one. It
will cost Tk. 3,000 a year. In analyzing the cost-volume behavior the
rental is a.............
(c)................................................................................................To run
the firm's machines, there are two alternative courses of action.
One is to pay the operator a base salary plus a small amount per unit
produced. This makes the total cost of the operators a..................
(d) periods. This means that the total operator cost would now be
s the a.................
alternat (e).........................................................................................The machine
ive, the mentioned in (a) could be sold for Tk. 8,000. If the firm
firm considers retaining and using it, the Tk. 8,000 is a.................
can (f).................................................................................................If the
pay the firm wishes to use the machine any longer, it must be repaired. For
operato the decision to retain the machine, the repair cost i s a ....................
rs a flat (g)....................................................................................................The
salary. machine is charged to the foreman of each department at a rate of Tk.
It 3,000 a year. In evaluating the foreman, the charge isa....................
would (h) Tk.5000 is used to winding up the company is a.........
then (i) Cost of closing stock Tk.4000 i s a .............
use one (j) Depreciation cost Tk. 1000 isa............
machin
e when
volume4. (a) XYZ Company has the following cost function,
is low, 2C= 4000+4X, If 1000 units produced and sold 800 units @ 20% profit on sales.
two
when it Find:
expand i) Total Cost
s, and ii) Total Revenue
three iii) Total Profit.
during
peak (b)You have supplied the following information
Fixed Cost Tk.50000, M/S Raito 40%, V/P Ratio 60%,

Determine:
(a) Break Even Sales
(b) Total Sales
(c) Margin of safety.
(d) Total contribution Margin

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