Module 1 – Case
ACCOUNTING COST SYSTEMS AND COST BEHAVIOR
Preparation of an Income Statement for The Serious Reader Company
The first case of this course provides an opportunity to prepare a segmented variable costing (contribution margin, behavioral) income statement and analyze the information. This is a very small company and the information may seem simplistic at first glance. Don’t forget that numbers and hands-on practice best illustrate many basic accounting concepts.
The Serious Reader Company is a small online retailer operating out of a garage apartment. The owner buys books at garage sales, thrift shops, library sales, and whenever an opportunity arises. The company classifies all books into five categories based on cost of acquisition and estimated sales price. See below for details about books purchased and sold during the last year (20XX).
Price CategoriesABCDEUnits Sold4,0001,000500400400Unites Purchased6,0001,2001,0001,0001,000Resale Price$4.00$12.00$20.00$45.00$60.00Cost$0.50$4.00$10.00$20.00$20.00
In addition to purchasing inventory (used books), the company incurs some operating expenses.
Variable Operating Expenses Shipping per book$1.50Common fixed expenses Internet-related costs$10,000 Travel, etc.$4,000 Advertising$1,000 Other overhead$5,000
Computations (use Excel)
- Prepare a segmented variable costing (behavioral) income statement for the company in good format.
- Prepare a second variable costing statement assuming 90% of all the books in each category purchased were actually sold.
- Prepare a third variable costing statement assuming that the price is increased by 50% for all five categories (use original sales information).
- The owner enjoys the used-book business. Any suggestions as how to turn this into a full-time business venture so the owner can quit his other job? Prepare another income statement to support your idea.
Memo (use Word)
Interpret the results from the computations and explain how the information is useful. Write a 4- or 5-paragraph memo to the owner of the business. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.
Short essay to comment on the questions below (use Word). Start with an introduction and end with a summary or conclusion. Use headings. Maximum length of two pages.
- Why do many organizations make the effort to prepare a different type of income statement for internal purposes?
- Variable costing is not just about preparing income statements. Provide at least three scenarios in which understanding how costs behave is useful.
Each submission should include two files: (1) An Excel file; and (2) A Word document. The Word document shows the memo first and short essay last. Assume a knowledgeable business audience and use required format and length. Individuals in business are busy and want information presented in an organized and concise manner.
Module 1 – Background
ACCOUNTING COST SYSTEMS AND COST BEHAVIOR
Modular Learning Objectives
Keep the following objectives in mind as you work through the material in this module:
- Define managerial accounting.
- Describe the role of managerial accounting.
- Differentiate between variable and fixed costs.
- Prepare a contribution margin (variable costing) income statement.
- Recognize various approaches to categorizing costs.
- Prepare and analyze a segmented income statement.
Begin this module by familiarizing yourself with the following sections pertaining to managerial accounting while keeping the above six objectives in mind. Click on the three arrows to explore each topic in more detail.
Check Your Understanding
Check your understanding to make sure that you have a good grasp of the background material. If you are not comfortable with the concepts, review some of the material again or go to the optional resource for more examples.
Click on the quiz icon for an ungraded, 20-question true-or-false self-study quiz to check your progress. If you are not satisfied with the score, review some of the material again. For more in-depth information, review materials listed under optional reading at the bottom of this page.
Contribution margin income and absorption income are two distinct approaches to assess operating profit. Many companies use both approaches. The two approaches have benefits and limitations.
Multiple descriptive names exist for the two methods of costing and computation of income. For example, the contribution margin approach is also known as variable costing, direct costing. or marginal costing. Absorption income and costing are also known as full costing, GAAP income, financial accounting income, or traditional costing.
Management mostly uses the information provided by variable costing method for estimates and internal decision-making purposes. Variable costing is appropriate for detailed analysis of a product or service. GAAP is required for publicly released and audited financial statements. Management uses both approaches for internal decision-making.
Cost behavior refers to the way different types of production costs change when there is a change in level of production.
There are two main types of costs according to their behavior:
Fixed costs are those, which do not change with the level of activity within the relevant range. These costs will incur even if no units are produced. For example rent expense, straight-line depreciation expense, etc. Fixed cost per unit decreases with increase in production.
Variable costs change in direct proportion to the level of production. This means that total variable cost increase when more units are produced and decreases when less units are produced. Although variable in total, these costs are constant per unit.
For further detail refer to Dr. Walther’s accounting text and videos.
Walther, L. (2017). Chapter 17: Introduction to Managerial Accounting.