Profit Reporting for Management Analysis

Chapter M 4

Determination of Net Income

Absorption costingAll manufacturing costs included in finished

goods and remain an asset until the good is sold

Used in financial reportingSales minus cost of goods sold = Gross

profit

Determination of Net Income

Variable costingCost of goods manufactured is composed

only of variable manufacturing costsDirect materialsDirect laborVariable factory overhead

Fixed manufacturing costs are treated as expense

Example 1

Manufacturing costs

Total Cost Per unit costs

Variable $375,000 $25

Fixed $150,000 $10

Total $525,000 $35

Company manufactures 15,000 units which it sells all of Them at $50 per unit

Selling and administrative Variable selling expense is $75,000 Fixed selling expenses is $50,000

Example 1: Absorption Costing Income Statement

Sales

'15,000 units @ $35 750,000.00$

Cost of goods sold

15,000 @ $35 525,000.00$

Gross profit 225,000.00$

Selling and Administrative 125,000.00$

Operating income 100,000.00$

Variable Costing Income Statement

SalesMinus variable cost of goods soldManufacturing marginManufacturing marginMinus variable selling expensesContribution marginContribution marginMinus fixed costsOperating income

Example 1: Variable CostingSales

15,000@ $50 750,000.00$

Variable cost of goods sold

15,000 *$25 375,000.00$

Manufacturing margin 375,000.00$

Variable selling expenses

'15,000 @$5 75,000.00$

Contribution margin 300,000.00$

Fixed costs

Fixed manufacturing 150,000.00$

50,000.00$ 200,000.00$

Operating income 100,000.00$

Variable and Absorption yield the same operating incomeBecause no inventories exist.

Example 2

Same information as example 1 but

Manufactures 15,000 units

Sells 12,000 unitsSales price is $50 per

unit

Example 2: Absorption CostingSales

'12,000 units @ $50 600,000.00$

Cost of goods sold

Manufactured 15,000 @$35 525,000.00$

Ending inventory 3,000@$35 105,000.00$ 420,000.00$

Gross profit 180,000.00$

Selling and Administrative

Variable 12,000 @ $5 60,000.00$

Fixed 50,000.00$ 110,000.00$

Operating income 70,000.00$

Example 2: Variable CostingSales

'12,000 units @ $50 600,000.00$

Variable cost of goods sold

Manufacturing 15000@$25 375,000.00$

Ending inventory 3,000@$25 75,000.00$ 300,000.00$

Manufacturing margin 300,000.00$

Variable selling expenses

12,000@$5 60,000.00$

Contribution margin 240,000.00$

Fixed costs

Fixed manufacturing 150,000.00$

50,000.00$ 200,000.00$

Operating income 40,000.00$

Difference

Absorption income is $70,000

Variable costing is $40,000

Difference is $30,000

Which is the difference in cost of goods sold per unit

Absorp $35Variable$25Times the number of

units in inventory 3,000

Example with Beginning Inventory

Suppose that the same example as 1 but we have beginning inventory

If manufactured units are 10,000, beg inv is 5,000 and sold 15, 000 units at $50 per unit

Example 3Manufacturing Costs Total Cost Per UnitVariable 250,000.00$ 25.00$ Fixed 150,000.00$ 15.00$ Total 400,000.00$ 40.00$ Beginning inventory Manufacturing costs Variable 125,000.00$ 25.00$ Fixed 50,000.00$ 10.00$ Total 175,000.00$ 35.00$

Selling and Administrative Variable selling 75,000.00$ $5 per unit Fixed 50,000.00$ Total 125,000.00$

Example 3: Absorption Costing

Sales (15,000 units @ $50) $750,000Cost of goods sold Beg Inv (5,000 units @$35) $175,000 Manufactured (10,000 units @ $40) $400,000 $575,000Gross profit $175,000Selling and Administrative Variable (15,000 @ $5 per unit) $75,000 Fixed $50,000 $125,000Operating income $50,000

Example 3: Variable Costing

Sales (15,000 units @ $50) $750,000Variable cost of goods sold Beg Inv (5,000 units @$25) $125,000 Manufactured (10,000 units @ $25) $250,000 $375,000Manufacturing margin $375,000 Variable Selling(15,000 @ $5) $75,000Contribution margin $300,000Fixed costs Fixed manufacturing $150,000 Fixed selling $50,000 $200,000Operating income $100,000

Example 3: Difference

If manufactured units are less than sales then difference in income of $50,000 comes from the difference in cost of goods sold of $10 per unit times 5,000 units.

Income Analysis

Since absorption costing, inventories fixed cost for the period, the company may show higher income if it produces more than it sells. Thus, inflating operating income.

Income Analysis

  20,000 units 25,000 units

Sales 20,000 @ $75 $1,500,000 $1,500,000

COGS    

20,000 @ $55 1,100,000  

25,000 @ 51   1,275,000

Less ending inventory 5,000 @ 51

  (255,000)

Gross profit 400,000 480,000

Selling and adm 200,000 280,000

Operating income 200,000 200,000

Controlling Costs

All costs are controllable in long run by someone in the business but not all controllable at the same level of management

ControllableInfluenced by

management at that level

NoncontrollableAnother level of

management has control

Used to fix responsibility

Pricing Products

Variable costs are used in setting prices because it gives better control over costs

Analyzing market segments

Market analysis is performed by sales and marketing department in order to determined the profit contribute by market segments

Is a portion of the business that can be assigned to a manager for profitability responsibility

ExampleNorthern Southern Total

Sales Froem $60,000 $30,000 $90,000 Sern $20,000 $50,000 $70,000Total $80,000 $80,000 $160,000Var. prod costs Froem 12% $7,200 $3,600 $10,800 Sern 12% $2,400 $6,000 $8,400Total variable $9,600 $9,600 $19,200Promotion costs $0 Froem 30% $18,000 $9,000 $27,000 Sern 30% $4,000 $10,000 $14,000Total $22,000 $19,000 $41,000Sales commission $0 Froem 20% $12,000 $6,000 $18,000 Sern 10% $2,000 $5,000 $7,000Total $14,000 $11,000 $25,000

Product Profitability Analysis

Froem SernSales $90,000 $70,000Variable COGS $10,800 $8,400Manufacturing margin $79,200 $61,600Var selling expense Promotion costs $27,000 $14,000 Sales commissions $18,000 $7,000Contribution margin $34,200 $40,600Ratio 38% 58%

Sales Territory AnalysisNorthern Southern

Sales $80,000 $80,000Variable COGS $9,600 $9,600Manufacturing margin $70,400 $70,400Var selling expense Promotion costs $22,000 $19,000 Sales commissions $14,000 $11,000Contribution margin $34,400 $40,400Ratio 43% 51%