Lecture 6 Flashcards
Absorption costing
Fixed manufacturing costs are assigned to inventory
Each unit produced absorbs some FOH
variable costing
Fixed manufacturing costs are not assigned to inventory
FOH is a period expense (directly goes to the income statement)
Variable costing (measuring costs)
WIP balance = v*Q
Incurred (economics) measuring costs
Incurred = FOH + v*Q
Absorption costing (measuring costs) (wip balance)
WIP balance = PDRQ + vQ
units produced to costs (measuring costs)
Absorption costing costs the most for units producced
Incurred/actual costing costs the second most for units produced
Variable costing costs the least for units produced
Problems with absorption costing
1) Discourages work with positive contribution margin (CM) but negative gross margin (can lead to death spiral)
2) Discourages the use of OH drivers
(Machine hours are really free (fixed costs –> pay the same whether or not we use them, but we act like they are expensive)
3) Encourages inventory build-up
4) Subject to denominator effects
Death sprial
Low demand causes a product line to report low (absorption) gross margins
1) Confusing gross margin and contribution margin
The firm eliminates the product line
2) Using expected sales as the base
The firm lowers its activity base, causing full costs to remaining lines to rise
3) Basing prices on absorption costs
The firm raises prices on remaining products
Gross margin formula
Revenue minus COGS, where COGS includes allocated fixed costs
Contribution margin
Revenue minus variable costs
PDR demonimators
Budgeted production
Theoretical capacity
Practical capacity
Budgeted production
The amount we expect to produce next period - bad denominator
Theoretical capacity
The amount that could be produced under ideal, impossible-to-achieve conditions - bad denominator
Practical capacity
What wed probably have if the market could support it. Allows for surge, buffer, mistakes, etc. - Good denominator
using something other than budgeted production as our denominator means were expecting a
Write off
Problems with variable costing
1) easy to forget about FOH and not charge enough to cover the costs
2) Encourages overuse of fixed (limited) resources
3) Violates GAAP
Absorption costing is good for
Long run pricing decisions and recovering fixed costs
Costing system used for external reporting
Variable costing is good for
Closer to true cost behavior
Useful for short term decisions
No incentive to build up inventory
no denominator effects
Cost accounting
Costs for inventory and external reporting
Informs important decisions in a business
Management accounting
Budgeting: Translate plans into concrete action
Variance analysis: deviations of operations against original plan
Short/long term production decisions
Performance management and evaluation
Internal and external pricing
The budgeting cycle
Planning the performance of the organization: starts with vision/strategy
Frame of reference: A set of specific expectations against which actual results are compared
Analysis of variance
Correcting actions
