Profit Reporting for Management Analysis

1. Profit Reporting for Management Analysis Chapter M 4

2. Determination of Net Income • Absorption costing • All manufacturing costs included in finished goods and remain an asset until the good is sold • Used in financial reporting • Sales minus cost of goods sold = Gross profit

3. Determination of Net Income • Variable costing • Cost of goods manufactured is composed only of variable manufacturing costs • Direct materials • Direct labor • Variable factory overhead • Fixed manufacturing costs are treated as expense

4. Example 1 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

5. Example 1: Absorption Costing Income Statement

6. Variable Costing Income Statement • Sales • Minus variable cost of goods sold • Manufacturing margin • Minus variable selling expenses • Contribution margin • Minus fixed costs • Operating income

7. Example 1: Variable Costing Variable and Absorption yield the same operating income Because no inventories exist.

8. Example 2 • Same information as example 1 but • Manufactures 15,000 units • Sells 12,000 units • Sales price is $50 per unit

9. Example 2: Absorption Costing

10. Example 2: Variable Costing

11. 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 $35 Variable$25 Times the number of units in inventory 3,000 Difference

12. 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

13. Example 3

14. Example 3: Absorption Costing

15. Example 3: Variable Costing

16. 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.

17. 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.

18. 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 Income Analysis

19. All costs are controllable in long run by someone in the business but not all controllable at the same level of management Controllable Influenced by management at that level Noncontrollable Another level of management has control Used to fix responsibility Controlling Costs

20. Pricing Products • Variable costs are used in setting prices because it gives better control over costs

21. 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

22. Example

23. Product Profitability Analysis

24. Sales Territory Analysis