Chapter 9 lecture Inventory costing and capacity analysis Flashcards
the two most common methods of costing inventory in manufacturing companies
- variable costing
- absorption costing
the choice of variable vs absorption costing determines what
which manufacturing costs are treated as inventoriable costs
a method if inventory costing in which all variable and fixed manufacturing costs are included as inventoriable costs. you can say that inventory “absorbs” all manufacturing costs
absorption cost
a method of inventory costing in which all variable manufacturing costs (direct and indirect) are included as inventoriable costs
variable costs
a method of inventory costing in which only direct materials are included as inventoriable costs. all other costs are expensed
throughput costing
________ Costing is the required inventory method for external financial reporting in most countries (GAAP approved)
absorption costing
absorption costing
- it is cost-effective and less confusing (everything is built so that we use absorption costing that’s why its less confusing)
- it measures the cost of all manufacturing resources (variable or fixed) necessary to produce inventory
-it can help prevent managers from taking actions that make their performance measure look good but that hurt the income they report to shareholders
an important attribute of ______ costing is that it enables a manager to increase margins and operating income by producing more ending inventory
absorption
a manager whose bonus is based on reported absorption costing income may be motivated to
build up an undesirable level of inventories
to reduce the undesirable effects of absorption costing, management can:
- use variable costing for internal reporting
- focus on careful budgeting and inventory planning
- incorporate an internal carrying charge for inventory
- change (lengthen) the period used to evaluate performance
- include nonfinancial as qwll as financial variables in the measures to evaluate performance
spending on fixed manufacturing costs enables firms to do what ?
obtain the scale of capacity needed to satisfy the exepected market demand from customers
______ is one of the most stragetic and most difficult decicsions managers face
determining the right amount of spending or the appropriate level of capacity
______ will rise and fall with production
total variable costs
too much capacity means
firms will incur the cost of unused capacity
too little capacity means
that demand from some customers may be unfulfilled
the choice of capacity level used to allocate budgeted fixed manufacturing costs to produce can greatly affect
pro forma operating income
4 different capacity levels can be used as the denominator to compute the budgeted fixed manufacturing cost rate
- theoretical capacity
- practical capacity
- normal capacity utilization
- master budget capacity utilization
- is the level of capacity based on producing at full efficiency all the time
factor - based on supply/inputs
theoretical capacity
commentary - this things levels, in the real world, are unattainable but they represent the ideal goal of capacity utilization a company can aspire to
theoretical capacity
- is the level of capacity that reduces theoretical capacity by considering unavoidable operating interruptions like scheduled maintenance time and shutdowns for holidays
factor - based on supply/inputs
practical capacity
some of the considerations taken into acount for _______ capacity are more predictable than others. plant shutdowns are typically scheduled a year or more in advance; sickness or other interruptions can only be estimated based on past results
practical capacity
- is the level of capacity utilization that satisfies average customer demand over a period that is long enough to consider seasonal, cyclical, and trend factors
factors - based on demand
normal capacity utilization
closely related to master budget capacity, but relies almost entirely on past results as a representation of typical/normal demand levels
normal capacity utilization
is the level of capacity utilization that managers expecct for the current budget period which is typically one year
factor - based on demand
master budget capacity utilization
closely reltaed to normal capacity, but relies more on expectations/predictions in the near term as opposed to an average of previous levels of demand
master budget capacity utilization
the choice of denominator level capacity to use may differ based on the purpose for which the choice is being made. 5 of these purposes include
- product costing and capacity management
- pricing
- performance evaluation
- external reporting
- tax requirements
using _______ like practical capacity as the denominator sets the cost of capacity (which is the fixed cost in the numerator) at the cost of supplying the capacity, regardless of production/unit volume
1. product costing and capacity management
supply based capacity
- benefit: highlights the cost of capacity acquired but not used
in contrast to supply based capacity, ________ hides the amount unsused capacity because is allocated all of the cost of supplyint the capacity to the amount of production/unit volume, regardless of how much capacity it really takes
1. product costing and capacity management
demand based capacity
- problem: management doesnt get alerted when there is unused capacity
production decisions made on demand based capacity can lead to
the continuing reduction in the demand for products that occurs when competitor prices are not met; as demand drops further, higher and higher unit costs result because fixed costs are spread over dewer units
downward demand spiral
when there are large differences between supply of capacity and the demand for capacity, the difference should be classified as
planned unused capacity
