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8-1
Inventory Valuation Inventory Valuation Approaches and Just-Approaches and Just-
in-Time Inventory in-Time Inventory ManagementManagement
Inventory Valuation Inventory Valuation Approaches and Just-Approaches and Just-
in-Time Inventory in-Time Inventory ManagementManagement
CChaptehapterr
88
Prepared by Douglas Cloud
Pepperdine University
Prepared by Douglas Cloud
Pepperdine University
8-2
1. Explain the primary characteristics of the absorption costing and variable costing inventory valuation methods.
2. Prepare absorption costing and variable costing income statements.
3. Evaluate the benefits and limitations of variable costing.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
ContinuedContinuedContinuedContinued
8-3
4. Describe just-in-time (JIT) inventory management and discuss how it is used to reduce raw materials, work-in-process, and finished goods inventories.
5. Explain the change required in performance evaluation and record keeping when an organization adopts the JIT approach to inventory management.
ObjectivesObjectivesObjectivesObjectives
8-4
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
Absorption Costing
Direct materialsDirect labor
Variable manufacturing overheadFixed manufacturing overhead
Product CostsProduct Costs
8-5
Variable Costing
Direct materialsDirect labor
Variable manufacturing overhead
Product CostsProduct Costs
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
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Absorption Costing
Variable selling and administrativeFixed selling and administrative
Period CostsPeriod Costs
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
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Variable Costing
Variable selling and administrativeFixed selling and administrativeFixed manufacturing overhead
Period CostsPeriod Costs
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
A Comparison of AbsorptionA Comparison of Absorption and Variable Costing and Variable Costing
8-8
Basic ConceptsBasic ConceptsBasic ConceptsBasic Concepts
Absorption costing treats fixed manufacturing overhead as
product cost...
Absorption costing treats fixed manufacturing overhead as
product cost...
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…whereas, variable costing treats fixed manufacturing overhead as a period cost.
…whereas, variable costing treats fixed manufacturing overhead as a period cost.
Basic ConceptsBasic ConceptsBasic ConceptsBasic Concepts
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Nutech Company manufactured 4,000 units.
Cost per Unit Using Variable Costing
Direct materials $ 7Direct labor 5Variable manufacturing overhead 4Total unit cost $16
Inventory ValuationsInventory ValuationsInventory ValuationsInventory Valuations
8-11
Nutech Company manufactured 4,000 units.
Cost per Unit Using Absorption Costing
Direct materials $ 7Direct labor 5Variable manufacturing overhead 4Fixed manufacturing overhead ($8,000 ÷ 4,000 units) 2Total unit cost $18
Inventory ValuationsInventory ValuationsInventory ValuationsInventory Valuations
8-12
Contribution FormatContribution FormatContribution FormatContribution Format
Sales $000Less variable expenses:
Cost of goods sold (000Selling (000Administrative (000
Contribution margin $000Less fixed expenses:
Manufacturing (000Selling (000Administrative (000
Net income $000
)))
)))
8-13
Functional FormatFunctional FormatFunctional FormatFunctional Format
Sales $000Less cost of goods sold (000Gross profit $000Less operating expenses:
Selling (000Administrative (000
Net income $000
)
))
8-14
Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)
Absorption Costing--Production Equals Sales
Sales (4,000 @ $30) $120,000Less cost of goods sold (at $18/unit) - 72,000Gross profit $ 48,000Selling and administrative expenses:
Variable (at $3 per unit) $ 12,000Administrative 10,000Total - 22,000
Net income $ 26,000
JuneJune
8-15
Variable Costing--Production Equals Sales
Sales (4,000 @ $30 per unit) $120,000Variable expenses:
Cost of goods sold (@ $16 per unit) $ 64,000Selling and administrative (@ $3/unit) 12,000
Total - 76,000Contribution margin $ 44,000Fixed expenses:
Manufacturing overhead $ 8,000Selling and administrative 10,000Total - 18,000
Net income $ 26,000
Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)
JuneJune
8-16
Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)
Absorption Costing--Production Exceeds Sales
Sales (2,500 @ $30 per unit) $75,000Less cost of goods sold (at $18/unit) -45,000Gross profit $30,000Selling and administrative expenses:
Variable (at $3 per unit) $ 7,500Administrative 10,000Total -17,500
Net income $12,500
JulyJulyJulyJuly
8-17
Variable Costing--Production Exceeds Sales
Sales (2,500 @ $30 per unit) $ 75,000Variable expenses:
Cost of goods sold (@ $16 per unit) $ 40,000Selling and administrative (@ $3/unit) 7,500
Total -47,500Contribution margin $ 27,500Fixed expenses:
Manufacturing overhead $ 8,000Selling and administrative 10,000Total - 18,000
Net income $ 9,500
Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)
JulyJulyJulyJuly
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JulyJulyJulyJuly
Reconciliation of Income DifferencesReconciliation of
Income Differences
Variable costing net income
$9,500
+
Increase (or minus decrease) in inventoried fixed manufacturing overhead
+ $3,000
=Absorption costing net income
= $12,500
1,500 units x $2 per unit
1,500 units x $2 per unit
8-19
Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)
Absorption Costing--Sales Exceed Production
Sales (5,500 @ $30/unit) $165,000Less cost of goods sold (at $18/unit) - 99,000Gross profit $ 66,000Selling and administrative expenses:
Variable (at $3 per unit) $ 16,500Administrative 10,000Total - 26,500
Net income $ 39,500
AugustAugustAugustAugust
8-20
Variable Costing--Sales Exceed Production
Sales (5,500 @ $30 per unit) $165,000Variable expenses:
Cost of goods sold (@ $16 per unit) $ 88,000Selling and administrative (@ $3/unit) 16,500
Total -104,500Contribution margin $ 60,500Fixed expenses:
Manufacturing overhead $ 8,000Selling and administrative 10,000Total - 18,000
Net income $ 42,500
Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)Comparison (Production Constant)
AugustAugustAugustAugust
8-21
AugustAugustAugustAugust
1,500 units x $2 per unit1,500 units x $2 per unit
Beginning inventory
Reconciliation of Income DifferencesReconciliation of
Income Differences
Absorption costing net income
+
Decrease (or minus increase) in inventoried fixed manufacturing overhead
=Variable costing net income
$39,500 + $3,000 = $42,500
8-22
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
Absorption Costing--Production Equals Sales
Sales (4,000 @ $30) $120,000Beginning inventory $ -0-Variable manufacturing costs 64,000Fixed manufacturing costs 8,000Cost of goods available $ 72,000Less ending inventory -0-Cost of goods sold - 72,000
Gross profit $ 48,000
Continued next slide OctoberOctoberOctoberOctober
8-23
Absorption Costing--Production Equals Sales
Gross profit $ 48,000Selling and administrative expenses:
Variable (at $3 per unit) $ 12,000Fixed 10,000Total - 22,000
Net income $ 26,000
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
OctoberOctoberOctoberOctober
8-24
Variable Costing--Production Equals Sales
Sales (4,000 @ $30 per unit) $120,000Variable expenses:
Cost of goods sold (@ $16 per unit) $ 64,000Selling and administrative (@ $3/unit) 12,000
Total - 76,000Contribution margin $ 44,000Fixed expenses:
Manufacturing overhead $ 8,000Selling and administrative 10,000Total - 18,000
Net income $ 26,000
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
OctoberOctoberOctoberOctober
8-25
Absorption Costing--Production Exceeds Sales
Sales (4,000 @ $30) $120,000Beginning inventory $ -0-Variable manufacturing costs 80,000Fixed manufacturing costs 8,000Cost of goods available $ 88,000Less ending inventory 17,600Cost of goods sold - 70,400
Gross profit $ 49,600
Continued next slide
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
NovemberNovemberNovemberNovember
8-26
Gross profit $ 49,600Selling and administrative expenses:
Variable (at $3 per unit) $ 12,000Fixed 10,000Total - 22,000
Net income $ 27,600
Absorption Costing--Production Exceeds Sales
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
NovemberNovemberNovemberNovember
8-27
Variable Costing--Production Exceeds Sales
Sales (4,000 @ $30 per unit) $120,000Variable expenses:
Cost of goods sold (@ $16 per unit) $ 64,000Selling and administrative (@ $3/unit) 12,000
Total - 76,000Contribution margin $ 44,000Fixed expenses:
Manufacturing overhead $ 8,000Selling and administrative 10,000Total - 18,000
Net income $ 26,000
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
NovemberNovemberNovemberNovember
8-28
NovemberNovember1,000 units x $1.60 per unit1,000 units x $1.60 per unit
Ending inventory
Reconciling of Income Differences
Reconciling of Income Differences
+
Decrease (or minus increase) in inventoried fixed manufacturing overhead
Absorption costing net income
=Variable costing net income
$26,000 + $1,600 = $27,600
8-29
Absorption Costing--Sales Exceed Production
Sales (4,000 @ $30) $120,000Beginning inventory $ 17,600Variable manufacturing costs 51,200Fixed manufacturing costs 8,000Cost of goods available $ 76,800Less ending inventory 3,700Cost of goods sold - 73,100
Gross profit $ 46,900
Continued next slide
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
DecemberDecemberDecemberDecember
8-30
Gross profit $ 46,900Selling and administrative expenses:
Variable (at $3 per unit) $ 12,000Fixed 10,000Total - 22,000
Net income $ 24,900
Absorption Costing--Sales Exceed Production
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
DecemberDecemberDecemberDecember
8-31
Variable Costing--Sales Exceed Production
Sales (4,000 @ $30 per unit) $120,000Variable expenses:
Cost of goods sold (@ $16 per unit) $ 64,000Selling and administrative (@ $3/unit) 12,000
Total - 76,000Contribution margin $ 44,000Fixed expenses:
Manufacturing overhead $ 8,000Selling and administrative 10,000Total - 18,000
Net income $ 26,000
Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)Comparison (Sales Constant)
DecemberDecemberDecemberDecember
8-32
DecemberDecemberDecemberDecember
1,000 units x $1.60 per unit1,000 units x $1.60 per unit
Beginning inventory200 units x $2.50 per unit200 units x $2.50 per unit
Beginning inventory
Reconciling of Income Differences
Reconciling of Income Differences
Absorption costing net income
+
Decrease (or minus increase) in inventoried fixed manufacturing overhead
=Variable costing net income
$24,900 + $1,600 = $26,000– $500
8-33
Inventories have value only to the extent that they avoid the necessity of incurring
costs in the future.
Inventories have value only to the extent that they avoid the necessity of incurring
costs in the future.
Proponents of Proponents of Variable Variable CostingCosting
Another advantage is that variable costing matches
revenue with the direct cost of producing those
revenues.
Another advantage is that variable costing matches
revenue with the direct cost of producing those
revenues.
8-34
Fixed manufacturing costs are incurred for only one
purpose, namely to manufacture the product.
Fixed manufacturing costs are incurred for only one
purpose, namely to manufacture the product.
Proponents of Proponents of Absorption Absorption
CostingCosting
By omitting fixed costs from inventory, variable costing
understates long-run variable costs and misleads decision makers into underestimating
true production costs.
By omitting fixed costs from inventory, variable costing
understates long-run variable costs and misleads decision makers into underestimating
true production costs.
8-35
Theory of Constraints
Emphasis on: Throughput
Product cost components:
Direct materials
8-36
Variable Costing
Emphasis on: Contribution margin
Product cost components:
Direct materialsDirect laborVariable manufacturing
overhead
8-37
Traditional Absorption
Costing
Emphasis on: Gross profit
Product cost components:
Direct materialsDirect laborVariable manufacturing
overheadFixed manufacturing
overhead
8-38
ABC Absorption
Costing
Emphasis on: Gross profit
Product cost components:
Direct materialsDirect laborManufacturing overhead
Unit levelBatch levelProduct levelFacility level
8-39
Full ABC
Emphasis on: Net income
Product cost components:
Direct materialsDirect laborUnit level costsBatch level costsProduct level costsOrder level costsCustomer level costsMarket segment level costsFacility levels costs
8-40
Just-in-Time (JIT)Just-in-Time (JIT)Just-in-Time (JIT)Just-in-Time (JIT)
JIT is a comprehensive inventory management philosophy that stresses policies, procedures, and attitudes by managers and other workers that result in the efficient production of high quality goods while maintaining the minimum
level of inventories.
8-41
1. Developing long-term relationships with a limited number of vendors.
2. Selecting vendors on the basis of service and material quality, as well as price.
3. Establishing procedures for employees to order materials for current needs directly from approved vendors.
4. Accepting vendor deliveries directly to the shop floor or department store.
The JIT approach to reducing raw materials includes:
Just-in-Time (JIT)Just-in-Time (JIT)Just-in-Time (JIT)Just-in-Time (JIT)
8-42
Dysfunctional Effects of Traditional Dysfunctional Effects of Traditional Performance MeasuresPerformance Measures
Dysfunctional Effects of Traditional Dysfunctional Effects of Traditional Performance MeasuresPerformance Measures
To achieve quantity discounts and favorable prices, a purchasing agent may order excessive inventory, thereby increasing subsequent storage, obsolescence, and handling.
To obtain a low price, a purchasing agent may order from a supplier whose not been certified as meeting quality specifications.
ContinuedContinuedContinuedContinued
8-43
Dysfunctional Effects of Traditional Dysfunctional Effects of Traditional Performance MeasuresPerformance Measures
Dysfunctional Effects of Traditional Dysfunctional Effects of Traditional Performance MeasuresPerformance Measures
To avoid having idle employees and equipment, a supervisor may refuse to halt production to determine the quality problem, thereby increasing inspection, rework, and spoiled costs.
To obtain low fixed costs per unit under absorption costing, a supervisor may produce in excess of current needs, thereby causing subsequent increase in storage, obsolescence, and handling costs.
8-44
Performance EvaluationPerformance Evaluation
When applied to a specific item of raw materials or finished goods inventory turnover is
computed as follows:
Inventory turnover =Annual demand in units
Average inventory (in units)
8-45
When stated in dollars, inventory turnover can be used as a measure of
the overall success of the organization in reducing inventory.
Inventory turnover =Cost of goods sold
Average inventory (in dollars)
Performance EvaluationPerformance Evaluation
8-46
Cycle Time =
Setup Time +
Proc-essing Time
+Move-ment Time
+Wait-ing
Time+
Inspec-tion
Time
Cycle efficiency =Processing time
Cycle time
Performance EvaluationPerformance Evaluation
8-47
Product CostingProduct CostingProduct CostingProduct Costing
Another advantage of JIT is that it reduces the
amount of detailed bookkeeping.
Another advantage of JIT is that it reduces the
amount of detailed bookkeeping.
Also, many of the distinctions and arguments regarding
absorption versus variable costing are moot.
Also, many of the distinctions and arguments regarding
absorption versus variable costing are moot.
8-48
CChapter
88
The The EndEndThe The EndEnd
8-49