Module 4 - Case
- Variable Costing
emphasizes short-term profit analysis, so the income statement is very important. Consequently, we?ll examine and discuss income statements in this first case. The assignment for this module is divided into two parts:
Use the background material and Internet to answer the questions below.
Discuss and analyze the difference between managerial and financial accounting
. Pay particular attention to:
? How is managerial accounting
different from financial accounting
? Comment on the different needs and use of financial
information for internal purposes.
? The managerial accounting
profession and its role in today?s business environment. How has it changed over time?
? Comment on the Certified Management Accountant (CMA) designation. How is it different from the CPA certification?
? Explain the main differences between the absorption and contribution (behavioral, variable) income statements. Will net income always be the same under the two approaches? If not, explain the difference.
? Comment specifically on why companies feel the need to create yet another income statement in a different format. What information can the company gleam from this approach which is helpful as a tool in the decision making process.
? Explain situations in which break-even analysis can be a useful tool. Explain the break-even formula and provide a specific example using numbers for a product with which you are familiar. Reasonable estimates are adequate. Don't forget to include the source of the information.
It is important to answer the questions as posed. The discussion should be five pages and written in a clear and concise manner. Support your discussion with references in APA format. You are encouraged to use Excel or other compatible spreadsheet when computations are involved.
Absorption Income versus Variable Costing (Contribution Margin)
It is hard enough to learn one method of preparing an income statement. Nevertheless, managerial accountants often find that the traditional income statement (absorption income or income statement prepared in accordance with US GAAP) does not meet their needs. Internally, the organization needs an income statement that is helpful in analyzing individual products and services or groups of products and services. This information is then used in the decision making process.
There is no one format required for an internal income statement other than it should be useful to an organization. Some variation of a behavioral income statement is often favored since it is useful for planning. In this type of income statement, costs are categorized according to behavior (variable and fixed) rather than by function (cost of goods sold and operating expenses). Preparing a behavioral income statement is commonly referred to as using a variable costing or contribution margin approach. Variable costing is not just a formal approach to preparing an income statement, but a way of thinking. It is useful for coming up with estimates in ?what-if? scenarios.
There are two essential differences between absorption income and variable costing.
First, there is major difference in the way costs are organized. In the absorption income statement, costs are organized by function - product costs versus operating costs. In the variable costing income statement, costs are organized by behavior - variable costs versus fixed costs.
Second, the traditional statement uses cost of goods sold as the intermediate step while the variable costing approach statement uses contribution margin as the intermediate step.
The essential points in this module are:
? Costs organized by cost behavior can be quite useful to decision making than costs organized by function.
? Contribution Margin is a very relevant point of information. It tells the user of the statement the net benefit to the organization that is the result of the activity. That is, we will incur the fixed costs in any event. The variable costs are incurred only as the activity level increases. Thus, the contribution margin (the difference between revenue and variable costs) is a measure of the benefit of that activity.
? Net income will be the same under both approaches only when there is no change in beginning or ending inventory (assuming constant prices).
Costs organized by function (absorption income)
? Cost of goods sold (product costs or expenses)
? Selling and administrative expenses (operating costs or expenses)
Costs organized by behavior (variable costing)
? Total variable costs change in direct proportion to changes in activity.
? Total fixed costs remain unchanged within a specified activity range.
Cost-Volume Profit Analysis
Cost-volume-profit (CVP) analysis is possible when information about cost behavior is available. It helps managers understand the interrelationships among cost, volume, and profit by focusing their attention on the interactions among the prices of products, volume of activity, per unit variable costs, total fixed costs, and mix of products sold. It is a vital tool used in many business decisions such as deciding what products to manufacture or sell, what pricing policy to follow, what marketing strategy to employ, and what type of productive facilities to acquire.
Martin, J.R. (n.d.) Management Accounting
: Concepts, Techniques, and Controversial Issues - Chapter 1: Introduction.Management And Accounting
Web Home Page. Retrieved from http://maaw.info/Chapter1.htm
Introduction to Managerial Accounting
(2007, July 25) [Video File]. Retrieved from http://www.youtube.com/watch?v=pBCRmjnwWgo
Read one of the following:
Walter, L.M. (2011). Principles of Accounting
: A Complete Online Text, chapter 23 (the section titled Variable costing versus absorption costing) and chapter 18. Retrieved from http://www.principlesofaccounting.com/
Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011). Accounting
Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting
, 73-87. http://textbookequity.com/oct/Textbooks/TBQ_PA_Accounting_managerial.pdf
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