Module 1 Case Absorption vs. Variable Costing
This case study will look at Jokkmok Industries and one of its managers, Mr. Rosen, who is bucking for a promotion to CEO. His division uses absorption costing and has the ability to produce 50,000 units a quarter with a fixed overhead amount of $600,000. While the sales forecast shows that the company will only sell 25,000 units during each of the next two quarters, Mr. Rosen wants to double his budgeted production for the second quarter from 25,000 to 50,000 units. We will look at Mr. Rosen’s decision and see how it affects his company’s bottom line by putting the figures from last quarter and the next quarter into an absorption income statement and a contribution margin statement. From this we will be able to see the differences in production costs from the two income statements. These figures will let us be able to assess if Mr. Rosen has improved his division’s performance by increasing production. We will also be able to tell if absorption costing is a viable option for management to use when making decisions like increasing production when sales are not forecasted to improve. We will also discuss a few shortcomings of the absorption approach and how it relates to management. And finally, we will see if Mr. Rosen’s decision would allow him to be considered for the CEO position.
Absorption vs. Variable Costing (Contribution margin) “The main difference between variable costing and absorption costing is the accounting for fixed manufacturing costs.” (Horngren C. n.d.) This is never more evident than in this case study. Income statements prepared using these different methods usually produce different net operating income, and they will also produce different costs per unit sold. In order to completely fill out the income statements we will need to look at the 1st quarter’s income statement listed in Table 1. From the data in table 1 we will need more data to input into the absorption and contribution margin income statements. This
Absorption vs. Variable Costing (Contribution margin) “The main difference between variable costing and absorption costing is the accounting for fixed manufacturing costs.” (Horngren C. n.d.) This is never more evident than in this case study. Income statements prepared using these different methods usually produce different net operating income, and they will also produce different costs per unit sold. In order to completely fill out the income statements we will need to look at the 1st quarter’s income statement listed in Table 1. From the data in table 1 we will need more data to input into the absorption and contribution margin income statements. This
References: Horngren C. (n.d.) Chapter 9: Absorption/Variable Costing Retrieved from http://www.csus.edu/indiv/p/pforsichh/accountinginfo/121/documents/newCh09In-ClassProblemsHorngren13e-MYCOPY-X2.pdf Bragg, S (2013) What is fixed overhead?, AccountingTools. Retrieved from http://www.accountingtools.com/questions-and-answers/what-is-fixed-overhead.html Accountingexplanation.com. (n.d.). Advantages, Disadvantages, and Limitations of Variable Costing Systems. Retrieved from http://www.accountingexplanation.com/advantages_disadvantages_limitations_of_variable_costing.htm Accountingexplanation.com. (n.d.). Income Comparison of Variable and Absorption Costing. Retrieved from http://www.accountingexplanation.com/income_comparison_of_variable_and_absorption_costing.htm