Question

For Graded Discussion Forum #4, Variable Costing, everyone answers the same questions in 500 words or less. Post once (you won't see other posts until you make your post) and then respond to one other post. These questions (except for the image of the vignette) are formatted to casily copy-paste to your discussion post. 1) Ch 21 begins with a discussion of the differences between Absorption Costing and Variable Costing. Think back to the various methods we have worked with this semester -- job order costing, process costing, activity- based, and just in time. Which of these are absorption? Which are variable? Both absorption and variable? Neither absorption or variable? Why? 2) In the variable costing income statement, how are the fixed manufacturing costs reported and how are the fixed selling and administrative expenses reported? How is this different from absorption costing income statements? How does this difference impact the usefulness of a variable costing income statement? 3) Why is variable costing not used for external reporting? 4) Read the following vignette from Financial and Managerial Accounting by Warren, Reeve. Answer the questions. Integrity, Objectivity, and Ethics in Business TAKING AN ABSORPTION HIT" Aligning production to demand is a critical decision in Heinz executive's response: Yeah The manufacturing business Managers must not allow the temporary bene costs were somewhat up...as we improve our inver fits of excess production through higher absorption of tory position, obviously you've got loss inventory to spread foxed costs to guide their decisions. Likewise, if demand your fried costs over, so you take what accountants fals, production should be dropped and inventory liquid would call an absorption hit as we reduce costs. And that ated to match the new demand level, even though earn will be something that as we pull down inventory over the ings will be penalized. The following interchange provides years, that will be an additional P&L cost hurdle that we an example of an appropriate response to lowered de need to overcome. mand for HJ. Heinz Company Management operating with integrity will seek the tang Analyst's question: Could you tak for a moment about ble benefits of reducing inventory, even though there manufacturing costs during the quarter? You had high may be an adverse impact on published financial state ghted that they were up and that gross margins at Heinements caused by absorption costing USA wore down. Why was that the case? "Management operating with integrity will seek the tangible benefits of reducing inventory, even though there may be an adverse impact on published financial statements."

Answer 1

1) Absorption costing and Variable costing are Cost Accounting methods of products and services. It depends on company which Cost accounting method they have to follow depending on the requirement. Job order costing, process costing, activity based are methods of Costing to arrive at unit cost. In this method of Costing either Absorption costing or variable costing can be applied to arrive at product cost. The fundamental difference lies in Absorption costing considers fixed manufacturing overhead as part of product cost but Variable costing treats the same as period cost. The unit cost reported under absorption costing will be higher than unit cost reported under Variable costing.

2) In Variable costing fixed manufacturing cost is not part of product cost since it is treated as period cost and charged to the period in which it is incurred. Fixed selling and administration expenses are also treated as period cost and charged to the period in which it is incurred.

In absorption costing fixed manufacturing overhead is treated as part of product cost and hence any inventory at the period end will carry a portion of fixed overhead in it in addition to variable cost.

Variable costing is relevant to management from decision making point of view and helps the management understanding results better and make reliable decisions. Variable costing is often used in different evaluations like Differential cost analysis, Make vs Buy, Sell Vs process further, Division analysis etc

3) Variable costing is not used for external reporting because it is not in line with GAAP requirements. As per GAAP Inventory should be valued at full product cost including fixed overheads. But Variable Costing treats fixed overheads as period cost and excludes in inventory valuation.

4) A) Since Heinz is listed company in stock exchange Vignette specifies “Published “Financial Statement. It has to report its results to shareholders and investors.

B) Tangible benefits of reducing inventory

• Better inventory turnover
• Better inventory days on hand
• Better Working capital management
• Better cash conversion cycle

C) Heinz uses a pre-determined overhead rate to allocated overheads to its production. If production is less there will be lower absorption of overheads and hence under absorbed overheads will be hit to Cost of Goods sold during the year. Also because of lower production there will lower inventory at the period end to carry over the fixed overheads. If Inventory was higher portion of fixed overhead would have been carried over and profit reported during the period would be higher

D) Source of other financial hit is the inventory balance which is carried over from one period and consumed in over other period. It will increase the cost of goods sold when inventories are consumed in subsequent period

E) Assumptions of CVP which can be related here are

• Cost can be classified into variable cost and fixed cost
• Selling price and  variable cost per unit remain constant through the relevant range of output
• Cost relationships are linear with output
• Volume is the only factor affecting variable cost
• Fixed cost is constant at all levels of output