M3A1: Discussion—Absorption versus Variable Costing

Must be fully orginal.

  

There are several ways a company can allocate overhead costs to products produced or services provided. Two of these methods are absorption costing and variable costing. This assignment will allow you to explore the two methods of costing and compare/contrast the different uses of each costing system.

Using the module readings and the Argosy University online library resources, research absorption and variable costing. Use your research and/or your experiences as a working professional to complete this assignment.

Respond to the following:

• Explain the differences between absorption costing and variable costing.
• Explain, with the help of an example, how a company could use a variable costing system, as well as an absorption costing system. You have the option of using the company you work for as an example.
• Explain which method is better for the company being discussed.

Support your recommendation with references to your readings or scholarly articles.

Write your initial response in 4–5 paragraphs. Apply APA standards to citation of sources.

 

Do the following when responding to your peers:

• Read all posts from your peers.
• Explain how their experiences differ from yours.
• Provide substantive comments by contributing new, relevant information or quotes from course readings, Web sites, or other sources; building on the remarks or questions of others; or sharing practical examples of key concepts from your experiences, professional or personal.

16

16

8

40

Assignment 1 Grading Criteria	Maximum Points
Initial response: Was insightful, original, accurate, and timely.Was substantive and demonstrated advanced understanding of concepts.Compiled/synthesized theories and concepts drawn from a variety of sources to support statements and conclusions.
Discussion response and participation: Responded to a minimum of two peers in a timely manner.Offered points of view supported by research.Asked challenging questions that promoted the discussion.Drew relationships between one or more points in the discussion.
Writing: Wrote in a clear, concise, formal, and organized manner.Responses were error free.Information from sources, where applicable, was paraphrased appropriately and accurately cited.
Total:

 

This module expands on the principle of accumulating costs. It also covers using cost data to make important decisions as they pertain to investment decisions. It explores two different methods that can be used to accumulate costs: the variable costing system and the absorption costing system. You will learn to differentiate between each system as well as understand the different uses for each type of costing system presented.

Cost estimation is the process of estimating the relationship between costs and cost drivers that are responsible for the costs. There are three main reasons why companies estimate costs. These are:

· To manage costs

· To make decisions

· To plan and set standards

There is a simple way and a complex way to break down costs. The simple way is to break down costs into fixed and variable costs. The complex way is to make cost patterns, such as step costs and mixed costs.
There are three commonly used methods when it comes to cost estimation. These methods are:

· Statistical methods using regression analysis

· Account analyses

· Engineering estimates

Statistical methods using regression analysis employ cost drivers, which are independent variables and costs, which are dependent variables. When simple regression is used, there is one independent variable. When multiple regression is used, there is more than one independent variable.

With account analyses, the analyst separates costs from the accounting records into categories and their corresponding cost drivers. With the engineering estimates method, engineers create estimates based on the data derived from current practices. These estimates are found by measuring the amount of work involved to complete the activity and then assigning a cost to each activity. It is important to note that statistical methods require the least amount of data as costs are not divided into categories with cost drivers. Engineering estimates are the most expensive and time consuming as identifying activities and their costs is difficult.

Garrison, R. (2012). Managerial Accounting (14th ed). McGraw-Hill Learning Solutions.

Retrieved from

http://digitalbookshelf.argosy.edu/books/0077588002/outline/5

Link to textbook reading

http://digitalbookshelf.argosy.edu/books/0077588002/outline/5

Once an analyst forms a cost estimate, it is important that he or she then create a financial model. The best way to do this is through cost-volume-profit analysis. The cost-volume-profit model shows the effects of any changes within an organization. Examples of changes would be sales volume, prices, and costs. The basic cost-volume-profit model is great, but it does have limitations. The largest is that it can only account for one cost driver. This model is improved upon by using activity-based costing models. When looking at any financial model, it is important to understand some basic terms. The first is the break-even point. This is when revenues equal expenses at a given sales level. Another important term is contribution margin, which is the amount of money that is left over after all variable costs are covered. Operating leverage is another important term, which is the ratio of contribution margin to operating income. A high operating leverage signals a risky company.
Making financial decisions and measuring costs are very difficult for a company, no matter the size. However, these functions are necessary if the organization is to remain successful.

Variable and Absorption Costing

Sprintin Case Study
Sprintin is a company that manufactures sneakers. The company’s data for the previous year is presented
below. Sprintin had no beginning inventories in January.

Sale price $156
Fixed manufacturing overhead $7,020,000
Variable manufacturing expense per unit $3,375,000
Fixed operating expense $56
Number of sneakers produced 270,000
Sales commission expense per unit $40
Number of sneakers sold 185,000

Sprintin’s variable costing income statement is as follows:
Since fixed manufacturing costs are considered to be a period cost, they are expensed in the period
incurred.

Sales (185,000 X 156) $28,860,000
Less variable costs (56 +40 = 96 X185,000) 17,760,000
Contribution margin 11,100,000
Less fixed costs (7,020,000 + 3,375,000) 10,395,000
Operating income $705,000

Sprintin’s absorption costing income statement is as follows:
As fixed manufacturing costs are considered to be product costs, they must be allocated between the units
sold and units still in inventory.
Fixed manufacturing costs = $7,020,000 / 270,000 units produced = $26 per unit.

Sales (185,000 X 156) $28,860,000
Less cost of goods sold:
Variable (185,000 X 56) + Fixed (185,000 X 26)
Gross profit

15,170,000
13,690,000

Less operating expense:
Variable (185,000 X40) + Fixed (3,375,000)
Operating income

10,775,000
$2,915,000

Inventory under the two methods would be calculated as follows:
Inventory in units (270,000 units produced less 185,000 units sold) = 85,000

Variable costing: Variable manufacturing costs (85,000 X 56) $10,360,000
Absorption costing: Variable manufacturing costs above 10,360,000
Fixed manufacturing costs (85,000 X 26) 2,210,000
Total inventory costs $12,570,000

The difference in variable costing and absorption costing income in our example is equal to the difference in
fixed cost included in inventory under the two methods.

Page 1 of 1
Managerial Accounting

©2012 Argosy University Online Programs