Question

Absorption, variable, and throughput costing EnRG Inc. produces trail mix packaged for sale in convenience stores in the Northeast section of the United States. At the beginning of April 2008, EnRG has no inventory of trail mix. Demand for the next three months is expected to remain constant at 50,000 bags per month. EnRG plans to produce to demand, 50,000 bags in April. However, many of the employees take vacation in June, so EnRG plans to produce 70,000 bags in May and only 30,000 bags in June.

Costs for the three months are expected to remain unchanged. The costs and revenues for April, May and June are expected to be:

Suppose the actual costs, market demand, and levels of production for April, May, and June are as expected.

1. Compute operating income for April, May, and June under variable costing.

2. Compute operating income for April, May, and June under absorption costing. Assume that the denominator level for each month is that month’s expected level of output.

3. Compute operating income for April, May, and June under throughput costing.

4. Discuss the benefits and problems associated with using throughput costing.

 

Answer 1

Absorption, variable, and throughput costing 

(1)        

Variable Costing

 

(2)       

Absorption Costing

 

(3)        

Throughput costing 

 

(4)         

The benefit of using throughput costing is that net income is reduced if managers produce more units than they can sell. By treating all costs, except direct material costs, as period costs, the income statement expenses not only the cost of goods sold but also the direct labor and variable overhead costs associated with units in ending inventory. So reported income is reduced by the cost of unnecessary production. For performance evaluation purposes, variable costing is superior to absorption costing because it prevents managers from increasing income by just increasing production. In the same way, throughput costing may be considered superior to variable costing because not only is management not rewarded for producing more than can be sold, they are penalized for excess production. In this example, income is highest when management produced less than demand and therefore reduced inventory that already existed.

The benefit of using throughput costing is that net income is reduced if managers produce more units than they can sell. By treating all costs, except direct material costs, as period costs, the income statement expenses not only the cost of goods sold but also the direct labor and variable overhead costs associated with units in ending inventory. So reported income is reduced by the cost of unnecessary production. For performance evaluation purposes, variable costing is superior to absorption costing because it prevents managers from increasing income by just increasing production. In the same way, throughput costing may be considered superior to variable costing because not only is management not rewarded for producing more than can be sold, they are penalized for excess production. In this example, income is highest when management produced less than demand and therefore reduced inventory that already existed.