Question

ANSWER ALL QUESTIONS...

(1) "Distinguish between the two (2) Product Costing Methods of Absorption Costing and Variable Costing".

(2) "Describe the format of the Segment Reporting Income Statement and identify the uses and benefits of this type of Income Statement".

(3) "Discuss the three (3) types of Inventory Related Costs".

(4) "Discuss the benefits and uses of the Economic Order Quantity (EOQ) computation".

(5) "Discuss the benefits and uses of the Reorder Point computation".

Answer 1

(1) Absorption costing includes all costs, including fixed costs, in figuring the cost of production, while variable costing only includes the variable costs directly related to production. Companies that use variable costing keep overhead and other fixed-cost operating expenses separate from production costs.

The fixed costs that differentiate variable and absorption costing are those overhead expenses, such as salaries and building rental, that do not change with changes in production levels.

Variable costing can make it more difficult to determine ideal pricing, since it does not directly consider all of the costs the company has to cover to be profitable. However, by looking only at the costs directly associated with production, variable costing makes it easier for a company to compare the potential profitability of manufacturing one product over another.

One of the advantages of absorption costing is that it is the costing method required for a company to be in compliance with generally accepted accounting principles (GAAP). Even if a company decides to use variable costing in-house, it is required by law to use absorption costing in any external financial statements it publishes. Absorption costing is also the costing method that a company is required to use for calculating and filing its taxes.

Absorption costing provides a more accurate accounting of net profitability, especially when a company doesn't sell all of its products in the same accounting period when they are manufactured. Absorption costing is not as helpful as variable costing for comparing profitability of different product lines.

Variable costing enables a company to run cost-volume profit analysis, which is designed to reveal the company's break-even point in production by determining how many products a company must manufacture and sell to reach the point of profitability.

(2) Three types of Inventory Related costs are discuss as under:-

1. Holding\Carrying cost:

They are expenses such as storage, handling, insurance, taxes, obsolescence, theft, and interest on funds financing the goods. These charges increase as inventory levels rise. To minimize carrying costs, management makes frequent orders of small quantities. Holding costs are commonly assessed as a percentage of unit value, rather than attempting to derive monetary value for each of these costs individually. This practice is a reflection of the difficulty inherent in deriving a specific per unit cost, for example, obsolescence or theft.


2. Ordering costs:

Ordering costs are those fees associated with placing an order, including expenses related to personnel in purchasing department, communications, and the handling of related paper work. Lowering these costs would be accomplished by placing small number of orders, each for a large quantity. Unlike carrying costs, ordering expenses are generally expressed as a monetary value per order.


3. Stock-out costs:

They include sales that are lost, both short and long term, when a desired item is not available; the costs associated with back ordering the missing item; or expenses related to stopping the production line because a component part has not arrived. These charges are probably the most difficult to compute, but arguably the most important because they represent the costs incurred by customers when an inventory policy falters.

(4) Benefits and uses of EOQ Computation are as follows:-

• Constant or uniform demand: The demand or usage is even through-out the period.
• Known demand or usage: Demand or usage for a given period is known i.e. deterministic.
• Constant unit price: Per unit price of material does not change and is constant irrespective of the order size.
• Constant Carrying Costs: The cost of carrying is a fixed percentage of the average value of inventory.
• Constant ordering cost: Cost per order is constant whatever be the size of the order..

(5)

A reorder point is the inventory unit quantity on hand that triggers the purchase of a predetermined amount of replenishment inventory. If the purchasing process and supplier fulfillment work as planned, the reorder point should result in the replenishment inventory arriving just as the last of the on-hand inventory is used up. The result is no interruption in production and fulfillment activities, while minimizing the total amount of inventory on hand.

The reorder point can be different for every item of inventory, since every item may have a different usage rate, and may require differing amounts of time to receive a replenishment delivery from a supplier. For example, a company can elect to buy the same part from two different suppliers; if one supplier requires one day to deliver an order and the other supplier requires three days, then the company's reorder point for the first supplier would be when there is one day's supply left on hand, or three days' supply for the second supplier.