CHAPTER 9

INVENTORY COSTING AND CAPACITY ANALYSIS

9.1 No. Differences in operating income between variable costing and absorption costing are
due to accounting for fixed manufacturing costs. Under variable costing only variable
manufacturing costs are included as inventoriable costs. Under absorption costing both variable
and fixed manufacturing costs are included as inventoriable costs. Fixed marketing and
distribution costs are not accounted for differently under variable costing and absorption costing.
9-2 The term direct costing is a misnomer for variable costing for two reasons:
a. ariable costing does not include all direct costs as inventoriable costs. !nly variable
direct manufacturing costs are included. "ny fixed direct manufacturing costs# and any
direct nonmanufacturing costs# $either variable or fixed% are excluded from inventoriable
costs.
b. ariable costing includes as inventoriable costs not only direct manufacturing costs but
also some indirect costs $variable indirect manufacturing costs%.
9-3 No. The difference between absorption costing and variable costs is due to accounting
for fixed manufacturing costs. "s service or merchandising companies have no fixed
manufacturing costs# these companies do not make choices between absorption costing and
variable costing.
9-4 The main issue between variable costing and absorption costing is the proper timing of
the release of fixed manufacturing costs as costs of the period:
a. at the time of incurrence# or
b. at the time the finished units to which the fixed overhead relates are sold.
ariable costing uses $a% and absorption costing uses $b%.
9-5 No. " company that makes a variable&cost'fixed&cost distinction is not forced to use any
specific costing method. The (tassen )ompany example in the text of )hapter * makes a
variable&cost'fixed&cost distinction. "s illustrated# it can use variable costing# absorption
costing# or throughput costing.
" company that does not make a variable&cost'fixed&cost distinction cannot use variable
costing or throughput costing. +owever# it is not forced to adopt absorption costing. For
internal reporting# it could# for example# classify all costs as costs of the period in which they are
incurred.
9-6 ariable costing does not view fixed costs as unimportant or irrelevant# but it maintains
that the distinction between behaviors of different costs is crucial for certain decisions. The
planning and management of fixed costs is critical# irrespective of what inventory costing
method is used.
9-7 Under absorption costing# heavy reductions of inventory during the accounting period
might combine with low production and a large production volume variance. This combination
could result in lower operating income even if the unit sales level rises.
*&,
9-8 $a% The factors that affect the breakeven point under variable costing are:
,. Fixed costs#
-. )ontribution margin per unit.
$b% The factors that affect the breakeven point under absorption costing are:
,. Fixed costs#
-. )ontribution margin per unit#
.. /roduction level in units in excess of breakeven sales in units.
0. Denominator level chosen to set the fixed manufacturing cost rate.
9-9 1xamples of dysfunctional decisions managers may make to increase reported operating
income are:
a. /lant managers may switch production to those orders that absorb the highest amount of
fixed manufacturing overhead# irrespective of the demand by customers.
b. /lant managers may accept a particular order to increase production even though another
plant in the same company is better suited to handle that order.
c. /lant managers may defer maintenance beyond the current period to free up more time
for production.
9-10 "pproaches used to reduce the negative aspects associated with using absorption costing
include:
a. )hange the accounting system:
2 "dopt either variable or throughput costing# both of which reduce the incentives of
managers to produce for inventory.
2 "dopt an inventory holding charge for managers who tie up funds in inventory.
b. 1xtend the time period used to evaluate performance. 3y evaluating performance over a
longer time period $say# . to 4 years%# the incentive to take short&run actions that reduce
long&term income is lessened.
c. 5nclude nonfinancial as well as financial variables in the measures used to evaluate
performance.
9-11 The theoretical capacity and practical capacity denominator&level concepts emphasi6e
what a plant can supply. The normal capacity utilization and master-budget capacity utilization
concepts emphasi6e what customers demand for products produced by a plant.
9-12 The downward demand spiral is the continuing reduction in demand for its product that
occurs when the prices of competitors7 products are not met and $as demand drops further%#
higher and higher unit costs result in more and more reluctance to meet competitors7 prices.
/ricing decisions need to consider competitors and customers as well as costs.
9-13 No. 5t depends on how a company handles the production&volume variance in the end&of&
period financial statements. For example# if the ad8usted allocation&rate approach is used# each
denominator&level capacity concept will give the same financial statement numbers at year end.
*&-
9-14 For tax reporting in the U.(.# the 59( re:uires companies to use the practical capacity
concept. "t year end# proration of any variances between inventories and cost of goods sold is
re:uired $unless the variance is immaterial in amount%.
9-15 No. The costs of having too much capacity'too little capacity involve revenue
opportunities potentially forgone as well as costs of money tied up in plant assets.
9-16 $.; min.% Vara!"# a$% a!&'r()'$ *'&)$+, #-("a$$+ '(#ra)$+
$*'.# %//#r#$*#&.
,. <ey inputs for income statement computations are:
A(r" 0a1
3eginning inventory
/roduction
=oods available for sale
Units sold
1nding inventory
;
4;;
4;;
.4;
,4;
,4;
0;;
44;
4-;
.;
The fixed cost per unit and total manufacturing costs per unit under absorption costing are:
A(r" 0a1
$a% Fixed manufacturing costs
$b% Units produced
$c%>$a%?$b% Fixed manufacturing costs per unit
$d% ariable manufacturing costs per unit
$e%>$c%@$d% Total manufacturing costs per unit
A-#;;;#;;;
4;;
A0#;;;
A,;#;;;
A,0#;;;
A-#;;;#;;;
0;;
A4#;;;
A,;#;;;
A,4#;;;
*&.
9-16 $)ont7d.%
$a% ariable costing
A(r" 2003 0a1 2003
9evenues
a
AB#0;;#;;; A,-#0B;#;;;
ariable costs
3eginning inventory A ; A,#4;;#;;;
ariable manufacturing costs
b
4#;;;#;;; 0#;;;#;;;
)ost of goods available for sale 4#;;;#;;; 4#4;;#;;;
Deduct ending inventory
c
,#4;;#;;; .;;#;;;
ariable cost of goods sold .#4;;#;;; 4#-;;#;;;
ariable operating costs
d
,#;4;#;;; ,#4C;#;;;
Total variable costs 0#44;#;;; C#DC;#;;;
)ontribution margin .#B4;#;;; 4#D-;#;;;
Fixed costs
Fixed manufacturing costs -#;;;#;;; -#;;;#;;;
Fixed operating costs C;;#;;; C;;#;;;
Total fixed costs -#C;;#;;; -#C;;#;;;
!perating income A,#-4;#;;; A.#,-;#;;;
a
A-0#;;; E .4;F A-0#;;; E 4-;
c
A,;#;;; E ,4;F A,;#;;; E .;
b
A,;#;;; E 4;;F A,;#;;; E 0;;
d
A.#;;; E .4;F A.#;;; E 4-;
$b% "bsorption costing
A(r" 2003 0a1 2003
9evenues
a
AB#0;;#;;; A,-#0B;#;;;
)ost of goods sold
3eginning inventory A ; A-#,;;#;;;
ariable manufacturing costs
b
4#;;;#;;; 0#;;;#;;;
Fixed manufacturing costs
c
-#;;;#;;; -#;;;#;;;
)ost of goods available for sale D#;;;#;;; B#,;;#;;;
Deduct ending inventory
d
-#,;;#;;; 04;#;;;
)ost of goods sold 0#*;;#;;; D#C4;#;;;
=ross margin .#4;;#;;; 0#B.;#;;;
!perating costs
ariable operating costs
e
,#;4;#;;; ,#4C;#;;;
Fixed operating costs C;;#;;; C;;#;;;
Total operating costs ,#C4;#;;; -#,C;#;;;
!perating income A,#B4;#;;; A -#CD;#;;;
a
A-0#;;; E .4;F A-0#;;; E 4-;
d
$A,0#;;; E ,4;F A,4#;;; E .;%
b
A,;#;;; E 4;;F A,;#;;; E 0;;
e
$A.#;;; E .4;F A.#;;; E 4-;%
c
$A0#;;; E 4;;%F $A4#;;; E 0;;%
*&0
9-16 $)ont7d.%
-. G > G
"pril:
A,#B4;#;;; G A,#-4;#;;; > $A0#;;; E ,4;% G $A;%
AC;;#;;; > AC;;#;;;
Hay:
A-#CD;#;;; G A.#,-;#;;; > $A4#;;; E .;% G $A0#;;; E ,4;%
G A04;#;;; > A,4;#;;; G AC;;#;;;
G A04;#;;; > G A04;#;;;
The difference between absorption and variable costing is due solely to moving fixed
manufacturing costs into inventories as inventories increase $as in "pril% and out of inventories
as they decrease $as in Hay%.
9-16 E-*#" A(("*a)'$
Inventory Costing and Capacity Analysis
Nascar Motors
Original Data
Unit Data April May
Beginning Inventory 0 150
Production 500 400
Sales 350 520
Ending Inventory 150 30
Revenue and Cost Data
Selling Price $24000 $24000
!aria"le #osts
Manu$acturing #osts per %nit Produced $10000 $10000
&perating #osts per %nit Sold 3000 3000
'i(ed #osts
Manu$acturing #osts $2000000 $2000000
&perating #osts )00000 )00000
!aria"le A"sorption
Inventoriable Costs #osting #osting
!aria"le Manu$acturing #osts $10000 $10000
'i(ed Indirect Manu$acturing #osts 4000 5000
*otal Inventoria"le #osts $10000 $14000
*&4
E-*#" S'"2)'$ 9-16 $)ont7d%
Problem 1
Panel A: ariable Costing
April May
+evenues ,350 ( $24000- 520 ( $24000. $/400000 $124/0000
!aria"le #osts
Beginning Inventory ,$10000 ( 0- 150. 0 1500000
!aria"le Manu$acturing #osts ,$10000 ( 500- 400. 5000000 4000000
#ost o$ 1oods Availa"le $or Sale 5000000 5500000
Ending Inventory ,$10000 ( 150- 30. 1500000 300000
!aria"le #ost o$ 1oods Sold 3500000 5200000
!aria"le &perating #osts ,$3000 ( 350- 520. 1050000 15)0000
*otal !aria"le #osts 4550000 )2)0000
#ontri"ution Margin 3/50000 5220000
'i(ed #osts
'i(ed Manu$acturing #osts 2000000 2000000
'i(ed &perating #osts )00000 )00000
*otal 'i(ed #osts 2)00000 2)00000
&perating Inco3e $1250000 $3120000
Panel !: Absorption Costing
April May
+evenues $/400000 $124/0000
#ost o$ 1oods Sold
Beginning Inventory ,$14000 ( 0- 150. 0 2100000
!aria"le Manu$acturing #osts ,$10000 ( 500- 400. 5000000 4000000
'i(ed Manu$4 #osts ,$4000 ( 500- $5000 ( 400. 2000000 2000000
#ost o$ 1oods Availa"le $or Sale 2000000 /100000
Ending Inventory ,$14000 ( 150- $15000 ( 30. 2100000 450000
#ost o$ 1oods Sold 4500000 2)50000
1ross Margin 3500000 4/30000
&perating #osts
!aria"le &perating #osts ,$3000 ( 350- 520. 1050000 15)0000
'i(ed &perating #osts )00000 )00000
*otal &perating #osts 1)50000 21)0000
&perating Inco3e $1/50000 $2)20000
*&C
9-17 $-; min.% T3r'2+3(2) *'&)$+ 4*'$)$2a)'$ '/ E-#r*&# 9-165.
,. A(r" 2003 0a1 2003
9evenues
a
AB#0;;#;;; A,-#0B;#;;;
Direct material cost of goods sold
3eginning inventory
Direct materials in goods manufactured
b
A ;
.#.4;#;;;
A,#;;4#;;;
-#CB;#;;;
)ost of goods available for sale
Deduct ending inventory
c
.#.4;#;;;
,#;;4#;;;
.#CB4#;;;
-;,#;;;
Total direct material cost of goods sold
Throughput contribution
!ther costs
-#.04#;;;
C#;44#;;;
.#0B0#;;;
B#**C#;;;
Hanufacturing costs .#C4;#;;;
d
.#.-;#;;;
e
!ther operating costs ,#C4;#;;;
f
-#,C;#;;;
g
Total other costs
!perating income
4#.;;#;;;
A D44#;;;
4#0B;#;;;
A.#4,C#;;;
a
A-0#;;; E .4;F A-0#;;; E 4-;
e
$A.#.;; E 0;;% @ A-#;;;#;;;
b
AC#D;; E 4;;F AC#D;; E 0;; f $A.#;;; E .4;% @ AC;;#;;;
c
AC#D;; E ,4;F AC#D;; E .;
g
$A.#;;; E 4-;% @ AC;;#;;;
d
$A.#.;; E 4;;% @ A-#;;;#;;;
-. !perating income under:
A(r" 0a1
"bsorption costing
ariable costing
Throughput costing
A,#B4;#;;;
,#-4;#;;;
D44#;;;
A-#CD;#;;;
.#,-;#;;;
.#4,C#;;;
5n "pril# throughput costing has the lowest operating income whereas in Hay# throughput costing has the highest operating income.
Throughput costing puts greater emphasis on sales as the source of operating income than does either absorption or variable costing.
.. Throughput costing puts a penalty on producing without a corresponding sale in the same period. )osts other than direct
materials that are variable with respect to production are expensed in the period of incurrence# whereas under variable costing they
would be capitali6ed. "s a result# throughput costing provides less incentive to produce for inventory than either variable costing or
absorption costing.
*&D
9-18 $0; min.% Vara!"# a$% a!&'r()'$ *'&)$+, #-("a$$+ '(#ra)$+
$*'.# %//#r#$*#&.
,. <ey inputs for income statement computations are:
6a$2ar1 7#!r2ar1 0ar*3
3eginning inventory
/roduction
=oods available for sale
Units sold
1nding inventory
;
,#;;;
,#;;;
D;;
.;;
.;;
B;;
,#,;;
B;;
.;;
.;;
,#-4;
,#44;
,#4;;
4;
The fixed manufacturing costs per unit and total manufacturing costs per unit under absorption costing are:
6a$2ar1 7#!r2ar1 0ar*3
$a% Fixed manufacturing costs
$b% Units produced
$c%>$a%?$b% Fixed manufacturing costs per unit
$d% ariable manufacturing costs per unit
$e%>$c%@$d% Total manufacturing costs per unit
A0;;#;;;
,#;;;
A0;;
A*;;
A,#.;;
A0;;#;;;
B;;
A4;;
A*;;
A,#0;;
A0;;#;;;
,#-4;
A.-;
A*;;
A,#--;
*&B
9-18 $)ont7d.%
$a% ariable )osting
6a$2ar1 2004 7#!r2ar1 2004 0ar*3 2004
9evenues
a
A,#D4;#;;; A-#;;;#;;; A.#D4;#;;;
ariable costs
3eginning inventory
b
A ; A-D;#;;; A -D;#;;;
ariable manufacturing costs
c
*;;#;;; D-;#;;; ,#,-4#;;;
)ost of goods available for sale
1nding inventory
d
*;;#;;;
-D;#;;;
**;#;;;
-D;#;;;
,#.*4#;;;
04#;;;
ariable cost of goods sold
ariable operating costs
e
Total variable costs
C.;#;;;
0-;#;;;
,#;4;#;;;
D-;#;;;
0B;#;;;
,#-;;#;;;
,#.4;#;;;
*;;#;;;
-#-4;#;;;
)ontribution margin
Fixed costs
Fixed manufacturing costs
Fixed operating costs
Total fixed costs
!perating income
0;;#;;;
,0;#;;;
D;;#;;;
40;#;;;
A ,C;#;;;
0;;#;;;
,0;#;;;
B;;#;;;
40;#;;;
A -C;#;;;
0;;#;;;
,0;#;;;
,#4;;#;;;
40;#;;;
A *C;#;;;
a
A-#4;; E D;;F A-#4;; E B;;F A-#4;; E ,#4;;
b
AI E ;F A*;; E .;;F A*;; E .;;
c
A*;; E ,#;;;F A*;; E B;;F A*;; E ,#-4;
d
A*;; E .;;F A*;; E .;;F A*;; E 4;
e
AC;; E D;;F AC;; E B;;F AC;; E ,#4;;
*&*
9-18 $)ontJd.%
$b% "bsorption )osting
6a$2ar1 2004 7#!r2ar1 2004 0ar*3 2004
9evenues
a
)ost of goods sold
3eginning inventory
b
A ;
A,#D4;#;;;
A .*;#;;;
A-#;;;#;;;
A 0-;#;;;
A.#D4;#;;;
ariable manufacturing costs
c
*;;#;;; D-;#;;; ,#,-4#;;;
Fixed manufacturing costs
d
0;;#;;; 0;;#;;; 0;;#;;;
)ost of goods available for sale ,#.;;#;;; ,#4,;#;;; ,#*04#;;;
Deduct ending inventory
e
.*;#;;; 0-;#;;; C,#;;;
)ost of goods sold *,;#;;; ,#;*;#;;; ,#BB0#;;;
=ross margin B0;#;;; *,;#;;; ,#BCC#;;;
!perating costs
ariable operating costs
f
0-;#;;; 0B;#;;; *;;#;;;
Fixed operating costs ,0;#;;; ,0;#;;; ,0;#;;;
Total operating costs 4C;#;;; C-;#;;; ,#;0;#;;;
!perating income A -B;#;;; A -*;#;;; A B-C#;;;
a
A-#4;; E D;;F A-#4;; E B;;F A-#4;; E ,#4;;
b
$AIE ;F A,#.;; E .;;F A,#0;; E .;;%
c
A*;; E ,#;;;# A*;; E B;;# A*;; E ,#-4;
d
$A0;; E ,#;;;%F $A4;; E B;;%F $A.-; E ,#-4;%
e
$A,#.;; E .;;%F $A,#0;; E .;;%F $A,#--; E 4;%
f
AC;; E D;;F AC;; E B;;F AC;; E ,#4;;
*&,;
9-18 $)ont7d.%
-. G > G
Kanuary: A-B;#;;; G A,C;#;;; > $A0;; E .;;% G A;
A,-;#;;; > A,-;#;;;
February: A-*;#;;; G A-C;#;;; > $A4;; E .;;% G $A0;; E .;;%
A.;#;;; > A.;#;;;
Harch: AB-C#;;; G A*C;#;;; > $A.-; E 4;% G $A4;; E .;;%
G A,.0#;;; > G A,.0#;;;
The difference between absorption and variable costing is due solely to moving fixed
manufacturing costs into inventories as inventories increase $as in Kanuary% and out of inventories
as they decrease $as in Harch%.
*&,,
9-19 $-;G.; min.% T3r'2+3(2) *'&)$+ 4*'$)$2a)'$ '/ E-#r*&# 9-185.
,.
6a$2ar1 7#!r2ar1 0ar*3
9evenues
a
Direct material cost of goods sold
3eginning inventory
b
A ;
A,#D4;#;;;
A,4;#;;;
A-#;;;#;;;
A ,4;#;;;
A.#D4;#;;;
Direct materials in goods manufactured
c
)ost of goods available for sale
Deduct ending inventory
d
Total direct material cost of goods sold
4;;#;;;
4;;#;;;
,4;#;;;
.4;#;;;
0;;#;;;
44;#;;;
,4;#;;;
0;;#;;;
C-4#;;;
DD4#;;;
-4#;;;
D4;#;;;
Throughput contribution ,#0;;#;;; ,#C;;#;;; .#;;;#;;;
!ther costs
Hanufacturing
e
!perating
f
Total other costs
!perating income
B;;#;;;
4C;#;;;
,#.C;#;;;
A 0;#;;;
D-;#;;;
C-;#;;;
,#.0;#;;;
A -C;#;;;
*;;#;;;
,#;0;#;;;
,#*0;#;;;
A,#;C;#;;;
a
A-#4;; E D;;F A-#4;; E B;;F A-#4;; E ,#4;;
b
$AI E ;F A4;; E .;;F A4;; E .;;%
c
A4;; E ,#;;;F A4;; E B;;F A4;; E ,#-4;
d
A4;; E .;;F A4;; E .;;F A4;; E4;
e
$A0;; E ,#;;;% @ A0;;#;;;
$A0;; E B;;% @ A0;;#;;;
$A0;; E ,#-4;% @ A0;;#;;;
f
$AC;; E D;;% @ A,0;#;;;
$AC;; E B;;% @ A,0;#;;;
$AC;; E ,#4;;% @ A,0;#;;;
*&,-
9-19 $)ontJd.%
-. !perating income under:
6a$2ar1 7#!r2ar1 0ar*3
"bsorption costing
ariable costing
Throughput costing
A-B;#;;;
,C;#;;;
0;#;;;
A-*;#;;;
-C;#;;;
-C;#;;;
AB-C#;;;
*C;#;;;
,#;C;#;;;
Throughput costing puts greater emphasis on sales as the source of operating income than does
absorption or variable costing.
.. Throughput costing puts a penalty on producing without a corresponding sale in the same
period. )osts other than direct materials that are variable with respect to production are expensed
when incurred# whereas under variable costing they would be capitali6ed as an inventoriable cost.
9-20 $0; min% Vara!"# 8&. a!&'r()'$ *'&)$+.
,.

5ncome (tatement for the Lwatch )ompany# ariable )osting
For the Mear 1nded December .,# -;;0
9evenues: A-- E .04#0;; AD#4*B#B;;
ariable costs
3eginning inventory: A4.,; E B4#;;; A 0..#4;;
ariable manufacturing costs: A4.,; E -*0#*;; ,#4;.#**;
)ost of goods available for sale ,#*.D#0*;
Deduct ending inventory: A4.,; E .0#4;; ,D4#*4;
ariable cost of goods sold ,#DC,#40;
ariable operating costs: A,.,; E .04#0;; .D*#*0;
Total variable costs $at standard costs% -#,0,#0B;
"d8ustment for variances ;
Total variable costs -#,0,#0B;
)ontribution margin 4#04D#.-;
Fixed costs
Fixed manufacturing overhead costs ,#00;#;;;
Fixed operating costs ,#;B;#;;;
"d8ustment for fixed cost variances ;
Total fixed costs -#4-;#;;;
!perating income A-#*.D#.-;
*&,.
9-20 $)ont7d.%
"bsorption )osting Data
Fixed manufacturing overhead allocation rate >
Fixed manufacturing overhead'Denominator level machine&hours > A,#00;#;;;'C#;;;
> A-0; per machine&hour
Fixed manufacturing overhead allocation rate per unit >
Fixed manufacturing overhead allocation rate'standard production rate > A-0;'4;
> A0.B; per unit
5ncome (tatement for the Lwatch )ompany# "bsorption )osting
For the Mear 1nded December .,# -;;0
9evenues: A-- E .04#0;; AD#4*B#B;;
)ost of goods sold
3eginning inventory $A4.,; @ A0.B;% E B4#;;; A B0,#4;;
ariable manuf. costs: A4.,; E -*0#*;; ,#4;.#**;
Fixed manuf. costs: A0.B; E -*0#*;; ,#0,4#4-;
)ost of goods available for sale A.#DC,#;,;
Deduct ending inventory: $A4.,; @ A0.B;% E .0#4;; $.0,#44;%
"d8ust for manuf. variances $A0.B; E 4#,;;%
a
-0#0B;
)ost of goods sold .#00.#*0;
=ross margin 0#,40#BC;
!perating costs
ariable operating costs: A,.,; E .04#0;; A .D*#*0;
Fixed operating costs ,#;B;#;;;
"d8ust for operating cost variances ;
Total operating costs ,#04*#*0;
!perating income A-#C*0#*-;
a
/roduction volume variance
> N$C#;;; hours E 4;% G -*0#*;;% E A0.B;
> $.;;#;;; G -*0#*;;% E A0.B;
> A-0#0B;
-. Lwatch7s pre&tax profit margins G
Under variable costing:
9evenues AD#4*B#B;;
!perating income -#*.D#.-;
/re&tax profit margin .B.DO
Under absorption costing:
9evenues AD#4*B#B;;
!perating income -#C*0#*-;
/re&tax profit margin .4.4O
*&,0
9-20 $)ont7d.%
.. !perating income using variable costing is about *O higher than operating income calculated
using absorption costing.
ariable costing operating income G "bsorption costing operating income >
A-#*.D#.-; G A-#C*0#*-; > A-0-#0;;
Fixed manufacturing costs in beginning inventory under absorption costing G
Fixed manufacturing costs in ending inventory under absorption costing >
$A0.B; E B4#;;;% G $A0.B; E .0#4;;% > A-0-#0;;
0. The factors the )F! should consider include:
$a% 1ffect on managerial behavior# and
$b% 1ffect on external users of financial statements.
"bsorption costing has many critics. +owever# the dysfunctional aspects associated with
absorption costing can be reduced by:
)areful budgeting and inventory planning#
"dding a capital charge to reduce the incentives to build up inventory# and
Honitoring nonfinancial performance measures.
*&,4
9-21 $,; min.% A!&'r()'$ a$% 8ara!"# *'&)$+.
The answers are ,$a% and -$c%. )omputations:
,. A!&'r()'$ C'&)$+:
9evenues
a
)ost of goods sold:
ariable manufacturing costs
b
Fixed manufacturing costs
c
=ross margin
A-#0;;#;;;
.C;#;;;
A0#B;;#;;;
-#DC;#;;;
-#;0;#;;;
!perating costs:
ariable operating
d

Fixed operating
!perating income
,#-;;#;;;
0;;#;;; ,#C;;#;;;
A 00;#;;;
a
A0; E ,-;#;;;
b
A-; E ,-;#;;;
c
Fixed manufacturing rate > AC;;#;;; ? -;;#;;; > A. per output unit
Fixed manufacturing costs > A. E ,-;#;;;
d
A,; E ,-;#;;;
-. Vara!"# C'&)$+:
9evenues
a
ariable costs:
ariable manufacturing cost of goods sold
b

ariable operating costs
c
)ontribution margin
Fixed costs:
Fixed manufacturing costs
Fixed operating costs
!perating income
A-#0;;#;;;
,#-;;#;;;
C;;#;;;
0;;#;;;
A0#B;;#;;;
.#C;;#;;;
,#-;;#;;;
,#;;;#;;;
A -;;#;;;
a
A0; E ,-;#;;;
b
A-; E ,-;#;;;
c
A,; E ,-;#;;;
*&,C
9-22 $0; min% A!&'r()'$ 8&. 8ara!"# *'&)$+.
,. The number of Himic pills sold in -;;0 is:
00#B;; E .C4 E . > 0*#;4C#;;; pills
1nding inventory on December .,# -;;0# is 4#C*0#;;; pills:
Unit data
3eginning inventory ;
/roduction 40#D4;#;;;
(ales 0*#;4C#;;;
1nding inventory 4#C*0#;;;
ariable cost data
Hanufacturing costs per pill produced
Direct materials A;.;4
Direct manufacturing labor ;.;0
Hanufacturing overhead ; .,,
Total variable manufacturing costs A; .-;
Fixed cost data
Hanufacturing costs A D#.4B#0;;
9PD 0#*;4#C;;
(=P" ,*#C--#0;;
Qholesale selling price per pill A,.-;
Fixed manufacturing costs allocation rate per pill A;.,4 $=iven%
$D#.4B#0;; ? 40#D4;#;;;%
-. ariable costing:
9evenues: A,.-; E 0*#;4C#;;; A4B#BCD#-;;
ariable costs
3eginning inventory A ;
ariable manuf. cost: A;.-; E 40#D4;#;;; ,;#*4;#;;;
)ost of goods available for sale ,;#*4;#;;;
Deduct ending inventory: A;.-; E 4#C*0#;;; ,#,.B#B;;
ariable cost of goods sold *#B,,#-;;
ariable marketing costs: A;.;D E 0*#;4C#;;; .#0..#*-;
"d8ust for variable&cost variance ;
Total variable costs ,.#-04#,-;
)ontribution margin 04#C--#;B;
Fixed costs
Fixed manufacturing costs D#.4B#0;;
Fixed 9PD 0#*;4#C;;
Fixed marketing ,*#C--#0;;
Total fixed costs .,#BBC#0;;
!perating income A,.#D.4#CB;
*&,D
922 $)ont7d.%
"bsorption costing:
9evenues: A,.-; E 0*#;4C#;;; A4B#BCD#-;;
)osts of goods sold
3eginning inventory A ;
ariable manuf. cost: A;.-; E 40#D4;#;;; ,;#*4;#;;;
Fixed manuf. costs: A;.,4 E 40#D4;#;;; B#-,-#4;;
)ost of goods available for sale ,*#,C-#4;;
Deduct ending inventory: A;..4 E 4#C*0#;;; $,#**-#*;;%
"d8ust for manuf. variances
a
$B40#,;; %
)ost of goods sold ,C#.,4#4;;
=ross margin 0-#44,#D;;
!perating costs
ariable marketing costs: A;.;D E 0*#;4C#;;; .#0..#*-;
Fixed 9PD 0#*;4#C;;
Fixed marketing ,*#C--#0;;
"d8ustment for operating cost variances ;
Total operating costs -D#*C,#*-;
!perating income A,0#4B*#DB;
a
/roduction & volume variance > $;.,4 E 40#D4;#;;; units% G AD#.4B#0;;; > AB40#,;;F
.. The difference of AB40#,;; is due to:
>

,
_
costing absorption under
inventory ending in costs
ing manufactur Fixed

,
_
costing absorption under
inventory beginning in costs
ing manufactur Fixed
> $A;.,4 E 4#C*0#;;;% A;
> AB40#,;;
*&,B
9-23 $-;&.; min.% C'.(ar&'$ '/ a*)2a"-*'&)$+ .#)3'%&.
The numbers are simplified to ease computations. This problem avoids standard costing and its
complications.
,. ariable&costing income statements:
2003 2004
(ales
/roduction
,#;;; units
,#0;; units
(ales
/roduction
,#-;; units
,#;;; units
9evenues $A. per unit% A.#;;; A.#C;;
ariable costs:
3eginning inventory
ariable cost of goods manufactured
)ost of goods available for sale
Deduct ending inventory
a
A ;
D;;
D;;
$-;; %
A -;;
4;;
D;;
$,;; %
ariable cost of goods sold
ariable operating costs
ariable costs
)ontribution margin
Fixed costs
Fixed manufacturing costs
Fixed operating costs
Total fixed costs
!perating income
4;;
,#;;;
D;;
0;;
,#4;;
,#4;;
,#,;;
A 0;;
C;;
,#-;;
D;;
0;;
,#B;;
,#B;;
,#,;;
A D;;
a
Unit inventoriable costs:
Mear ,: AD;; ? ,#0;; > A;.4; per unitF A;.4; E $,0;; G ,;;;%
Mear -: A4;; ? ,#;;; > A;.4; per unitF A;.4; E $0;; @ ,#;;; G ,#-;;%
*&,*
9-23 $)ontJd.%
-. "bsorption&costing income statements:
2003 2004
(ales
/roduction
,#;;; units
,#0;; units
(ales
/roduction
,#-;; units
,#;;; units
9evenues $A. per unit%
)ost of goods sold:
3eginning inventory
ariable manufacturing costs
Fixed manufacturing costs
a
)ost of goods available for sale
Deduct ending inventory
b
A ;
D;;
D;;
,#0;;
$0;; %
A.#;;;
A 0;;
4;;
D;;
,#C;;
$-0; %
A.#C;;
)ost of goods sold
=ross margin
!perating costs:
ariable operating costs
Fixed operating costs
Total operating costs
!perating income
,#;;;
0;;
,#;;;
-#;;;
,#0;;
A C;;
,#-;;
0;;
,#.C;
-#-0;
,#C;;
A C0;
a
Fixed manufacturing costs:
Mear ,: AD;; ? ,#0;; > A;.4; per unit
Mear -: AD;; ? ,#;;; > A;.D; per unit
b
Unit inventoriable costs:
Mear ,: A,#0;; ? ,#0;; > A,.;; per unitF A,.;; E $,0;; G ,;;;%
Mear -: A,#-;; ? ,#;;; > A,.-; per unit A,.-; E $0;; @ ,#;;; G ,#-;;%
*&-;
9-23 $)ontJd.%
.. 2003 2004
ariable )osting:
!perating income A0;; AD;;
1nding inventory -;; ,;;
"bsorption )osting:
!perating income AC;; AC0;
1nding inventory 0;; -0;
Fixed manuf. overhead
2 in beginning inventory ; -;;
2 in ending inventory -;; ,0;
>
Mear ,: AC;; G A0;; > A;.4; E 0;; G A;
> A-;;
Mear -: AC0; G AD;; > $A;.D; E -;;% G $A;.4; E 0;;%
> GAC;
The difference in reported operating income is due the amount of fixed manufacturing
overhead in the beginning and ending inventories. 5n Mear ,# absorption costing has a higher
operating income of A-;; due to ending inventory having A-;; more in fixed manufacturing
overhead than does beginning inventory. 5n Mear -# variable costing has a higher operating income
of AC; due to ending inventory under absorption costing having AC; less in fixed manufacturing
overhead than does beginning inventory.
0. a. "bsorption costing is more likely to lead to inventory build&ups than variable costing.
Under absorption costing# operating income in a given accounting period is increased by
inventory buildup# because some fixed manufacturing costs are accounted for as an asset
$inventory% instead of as a cost of the period of production.
b. "lthough variable costing will counteract undesirable inventory build&ups# other
measures can be used without abandoning absorption costing. 1xamples include:
$,% careful budgeting and inventory planning#
$-% incorporating a carrying charge for inventory#
$.% changing the period used to evaluate performance to be long&term#
$0% including nonfinancial variables that measure inventory levels in performance
evaluations.
*&-,
9-24 $,; min.% Ca(a*)1 .a$a+#.#$), %#$'.$a)'r-"#8#" *a(a*)1 *'$*#()&.
,. d
-. c# d
.. d
0. a
4. c
C. a# b
D. a
B. b
*. c# d
,;. b
,,. a# b
9-25 $-4 min.% D#$'.$a)'r-"#8#" (r'!"#.
,. 3udgeted fixed manufacturing overhead costs rates:
D#$'.$a)'r
L#8#" Ca(a*)1
C'$*#()
92%+#)#% 7-#%
0a$2/a*)2r$+
O8#r3#a% (#r
P#r'%
92%+#)#%
Ca(a*)1
L#8#"
92%+#)#% 7-#%
0a$2/a*)2r$+
O8#r3#a% C'&)
Ra)#
Theoretical A .#B;;#;;; -#BB; A ,#.,*.00
/ractical .#B;;#;;; ,#B;; -#,,,.,,
Normal .#B;;#;;; ,#;;; .#B;;.;;
Haster&budget .#B;;#;;; ,#-;; .#,CC.CD
The rates are different because of varying denominator&level concepts. Theoretical and practical
capacity levels are driven by supply&side concepts# i.e#. Rhow much can 5 produceIS Normal and
master&budget capacity levels are driven by demand&side concepts# i.e#. Rhow much can 5 sellIS $or
Rhow much should 5 produceIS%
-. 5n order to incorporate fixed manufacturing costs into unit product costs# fixed
manufacturing costs have to be uniti6ed for inventory costing. "bsorption costing is the method
used for tax reporting to the 59( and for financial reporting using generally accepted accounting
principles.
The choice of a denominator level becomes relevant under absorption costing because fixed
costs are accounted for along with variable costs at the individual product level. ariable and
throughput costing account for fixed costs as a lump sum# expensed in the period incurred.
.. The variances that arise from use of the theoretical or practical level concepts will signal
that there is a divergence between the supply of capacity and the demand for capacity. This is
useful input to managers. "s a general rule# however# it is important not to place undue reliance on
the production volume variance as a measure of the economic costs of unused capacity.
*&--
9-25 $)ont7d.%
0. Under a cost&based pricing system# the choice of a master&budget level denominator will
lead to high prices when demand is low $more fixed costs allocated to the individual product level%#
further eroding demandF conversely it will lead to low prices when demand is high# forgoing
profits. This has been referred to as the downward demand spiralTthe continuing reduction in
demand that occurs when the prices of competitors are not met and demand drops# resulting in even
higher unit costs and even more reluctance to meet the prices of competitors. The positive aspect of
the master&budget denominator level is that it indicates the price at which all costs per unit would
be recovered to enable the company to make a profit. Haster&budget denominator level is also a
good benchmark against which to evaluate performance.
9-26 $.; min.%Vara!"# a$% a!&'r()'$ *'&)$+ a$% !r#a:#8#$ ('$)&.
,. /roduction > (ales @ 1nding 5nventory & 3eginning 5nventory
> -0-#0;; @ -0#B;; .-#C;;
> -.0#C;; cases
-. 3reakeven point in cases:
a. ariable )osting:
UT >
/er Unit Hargin on )ontributi
5ncome !perating Target )osts Fixed Total +
UT >
% - A ,0 A C A ,; A ,C $A *0 A
; A % B;; # 4CB # C A C;; # D4. # . $A
+ + + +
+ +
UT >
0C A
0;; # .-- # ,; A
UT > --0#0;; cases
b. "bsorption costing:
Fixed manuf. cost rate > A.#D4.#C;; ? -.0#C;; > A,C per case
UT >
/er Unit Hargin on )ontributi
/roduced
Units
in Units (ales
3reakeven
9ate )ost
Hanuf. Fixed
!5
Target
)ost
Fixed Total
1
1
]
1

,
_

+ +
UT >
[ ]
0C A
% C;; # -.0 UT $ ,C A 0;; # .-- # ,; A +
UT >
0C A
C;; # D4. # . UT ,C 0;; # .-- # ,; A +
*&-.
9-26 $)ont7d.%
UT >
0C A
UT ,C B;; # 4CB # C A +
0C UT ,C UT > AC#4CB#B;;
.; UT > AC#4CB#B;;
UT > -,B#*C; cases.
.. 5f grape prices increase by -4O# the cost of grapes per case will increase from A,C in -;;0 to
A-; in -;;4. This will decrease the unit contribution margin from A0C in -;;0 to A0- in -;;4.
a. ariable )osting:
UT >
A0-
0;; # .-- # ,; A
> -04#DD- cases $rounded up%
b. "bsorption )osting:
UT >
A0-
UT ,C A B;; # 4CB # C A +
A0- UT > AC#4CB#B;; @ A,C UT
A-C UT > AC#4CB#B;;
UT > -4-#C0D cases $rounded up%
*&-0
9-27 $,4 min.% A9C a$% *a(a*)1 2&a+#.
,. Ra)# (#r ;$) '/
A*)8)1 C'&) Dr8#r
Hachine setup A4;;#;;; activity costs ? 4#;;; setup&hours
> A,;; per setup&hour
Haterial handling A-;;#;;; activity costs ? ,;;#;;; pounds
of material > A- per pound
)ost "llocation:
Hachine setup
Daska $.#;;; setup&hours E A,;;% A.;;#;;;
<othi $,#4;; setup&hours E A,;;% ,4;#;;;
Total machine setup costs allocation A04;#;;;
Haterial handling
Daska $0;#;;; pounds E A-% A B;#;;;
<othi $4;#;;; pounds E A-% ,;;#;;;
Total material handling costs allocation A,B;#;;;
-. )ost of unused capacity:
Hachine setup $A4;;#;;; G A04;#;;;% A 4;#;;;
Haterial handling $A-;;#;;; G A,B;#;;;% -;#;;;
Total cost of unused capacity A D;#;;;
*&-4
9-28 $,4 min.% A9C a$% *a(a*)1 2&a+#.
1. A*)8)1 Ra)# (#r ;$) '/ C'&) Dr8#r
/ower A-;;#;;; activity costs ? 4;#;;;
kilowatt hours > A0 per kilowatt hour
Uuality inspection A.;;#;;; activity costs ? ,;#;;;
inspections > A.; per inspection
)ost allocation:
/ower
Tulsa $,;#;;; kilowatt hours E A0% A 0;#;;;
!kla $.4#;;; kilowatt hours E A0% ,0;#;;;
Total power costs allocation A,B;#;;;
Uuality inspection
Tulsa $4#;;; inspections E A.;% A,4;#;;;
!kla $0#;;; inspections E A.;% ,-;#;;;
Total :uality inspection costs allocation A-D;#;;;
2. )ost of unused capacity:
/ower $A-;;#;;; G A,B;#;;;% A -;#;;;
Uuality inspection $A.;;#;;; G A-D;#;;;% .;#;;;
Total cost of unused capacity A 4;#;;;
*&-C
9-29 $-4 min.% C'&) !#3a8'r, a*)8)1-!a&#% *'&)$+, *a(a*)1 2&a+#.
1. 3udgeted fixed rate per bill processed:
$A.;#;;; E 4% ? $C#;;; E 4% > A4.;;
3udgeted variable rate per bill processed:
$A--#4;;% ? $C#;;; E 4% > ;.D4
3udgeted rate per bill processed > A4.D4
2. )apacity available# C#;;; bills E 4 employees .;#;;; bills
3. )apacity available > )apacity used @ Unused capacity
Unused capacity > )apacity available G )apacity used
> .;#;;; bills G -C#;;; bills
> 0#;;; bills
4. )ost of capacity supplied > )ost of capacity used @ )ost of unused capacity
For fixed costs#
A,4;#;;; > $A4 E -C#;;; bills% @ $A4 E 0#;;; bills%
> A,.;#;;; @ A-;#;;;
Fixed cost resources have costs of unused capacity when all the fixed cost capacity is not
used to produce products or services.
For variable costs#
)ost of capacity supplied > A;.D4 E -C#;;; bills > A,*#4;;
)ost of capacity used > A;.D4 E -C#;;; bills > A,*#4;;
There is no unused capacity for variable costs. ariable cost resources are only ac:uired
when they are used.
*&-D
9-30 $0; min.% Vara!"# *'&)$+ 8#r&2& a!&'r()'$ *'&)$+.
,. "bsorption )osting:
Havis )ompany 5ncome (tatement
For the Mear 1nded December .,# -;;0
9evenues $40;#;;; E A4.;;% A-#D;;#;;;
)ost of goods sold:
3eginning inventory $.;#;;; E A..D;
a
% A ,,,#;;;
ariable manufacturing costs $44;#;;; E A..;;% ,#C4;#;;;
Fixed manuf. costs $44;#;;; E A;.D;% .B4#;;;
)ost of goods available for sale -#,0C#;;;
Deduct ending inventory $0;#;;; E A..D;% ,0B#;;;
)ost of goods sold $at std. costs% ,#**B#;;;
=ross margin $at standard costs% D;-#;;;
Deduct ad8ustment for variances $4;#;;;
b
E A;.D;% .4#;;;
=ross margin CCD#;;;
!perating costs:
ariable operating costs $40;#;;; E A,% 40;#;;;
Fixed operating costs ,-;#;;;
"d8ustment for variances ;
Total operating costs CC;#;;;
!perating income A D#;;;
a
A..;; @ $AD.;; ? ,;% > A..;; @ A;.D; > A..D;
b
N$,; E C;#;;;% G 44;#;;;%V > 4;#;;; units
-. ariable )osting:
Havis )ompany 5ncome (tatement
For the Mear 1nded December .,# -;;0
9evenues A-#D;;#;;;
ariable costs:
3eginning inventory $.;#;;; E A..;;% A *;#;;;
ariable manufacturing costs
$44;#;;; E A..;;% ,#C4;#;;;
)ost of goods available for sale ,#D0;#;;;
Deduct ending inventory $0;#;;; E A..;;% ,-;#;;;
ariable manufacturing cost of goods sold ,#C-;#;;;
ariable operating costs 40;#;;;
Total variable costs $at std. cost% -#,C;#;;;
"d8ustment for variances ;
Total variable costs -#,C;#;;;
)ontribution margin 40;#;;;
Fixed costs:
Fixed manufacturing overhead costs 0-;#;;;
Fixed operating costs ,-;#;;;
"d8ustment for fixed cost variances ;
Total fixed costs 40;#;;;
*&-B
!perating income A ;
9-30 $)ont7d.%
.. The difference in operating income between the two costing methods is:
>
AD#;;; G A; > N$0;#;;; E A;.D;% G $.;#;;; E A;.D;%V
AD#;;; > A-B#;;; G A-,#;;;
AD#;;; > AD#;;;
The absorption&costing operating income exceeds the variable costing figure by AD#;;; because of
the increase of AD#;;; during -;;0 of the amount of fixed manufacturing costs in ending inventory
vis&a&vis beginning inventory.
0.
Total fixed
manufacturing
costs
A0-;#;;;
A.B4#;;;
"ctual P bu dget line
Und erallocated W "llocated line
XAD.;;
44#;;; C;#;;;
Hachine&hou rs
4. "bsorption costing is more likely to lead to buildups of inventory than does variable costing.
"bsorption costing enables managers to increase reported operating income by building up
inventory which reduces the amount of fixed manufacturing overhead included in the current
periodJs cost of goods sold.
Qays to reduce this incentive include:
$a% )areful budgeting and inventory planning#
$b% )hange the accounting system to variable costing or throughput costing#
$c% 5ncorporate a carrying charge for carrying inventory#
$d% Use a longer time period to evaluate performance than a :uarter or a year# and
$e% 5nclude nonfinancial as well as financial measures when evaluating management performance.
*&-*
9-31 $,;&-; min.% 9r#a:#8#$ 2$%#r a!&'r()'$ *'&)$+
4*'$)$2a)'$ '/ Pr'!"#. 9-305.
,. The unit contribution margin is A4 G A. G A, > A,. Total fixed costs $A40;#;;;% divided by
the unit contribution margin $A,.;;% e:uals 40;#;;; units. Therefore# under variable costing
40;#;;; units must be sold to break even.
-. 5f there are no changes in inventory levels# the breakeven point can be the same# 40;#;;;
units# under both variable costing and absorption costing. +owever# as the chapter demonstrates#
under absorption costing# the breakeven point is not uni:ueF operating income is a function of both
sales and production. (ome fixed overhead is Yheld backY when inventories rise $,;#;;; units E
A;.D; > AD#;;;%# so operating income is positive even though sales are at the breakeven level as
commonly conceived.
>
margin on contributi Unit
produced
Units
units
in sales
3reakeven
x
rate
overhead
manuf. Fixed
income
operating
Target
costs
fixed Total
1
1
1
]
1

,
_

,
_

,
_

,
_

Zet N > 3reakeven sales in units

N >
;; . , A
% ;;; [ 44; N $ D; . ; A ; A ;;; [ 40; A + +
N >
A;..;N > A,44#;;;
N > 4,C#CCD units $rounded%
Therefore# under absorption costing# when 44;#;;; units are produced# 4,C#CCD units must
be sold for the income statement to report 6ero operating income.
/roof of -;;0 breakeven point:
=ross margin# 4,C#CCD units E $A4.;; G A..D;% ACD,#CCD
!utput level H!+ variance# as before A .4#;;;
*&.;
Harketing and administrative costs:
ariable# 4,C#CCD units E A,.;; 4,C#CCD
Fixed ,-;#;;; CD,#CCD
!perating income A ;
*&.,
9-31 $)ont7d.%
.. 5f no units are sold# variable costing will show an operating loss e:ual to the fixed
manufacturing costs# A0-;#;;; in this instance. 5n contrast# the company would break even under
absorption costing# although nothing was sold to customers. This is an extreme example of what
has been called Yselling fixed manufacturing overhead to inventory.Y
" final note: Qe find it helpful to place the following comparisons on the board# keyed to the three
parts of this problem:
,. 3reakeven > f $sales%
-. 3reakeven > f $sales and production%
.. 3reakeven > f $; units sold and 40;#;;; units produced%# an extreme case
9-32 $0; min.% T3# A""-7-#% C'.(a$1 $ 2004.
This problem always generates active classroom discussion.
,. The treatment of fixed manufacturing overhead in absorption costing is affected primarily by
what denominator level is selected as a base for allocating fixed manufacturing costs to units
produced. 5n this case# is ,;#;;; tons per year# -;#;;; tons# or some other denominator level the
most appropriate baseI
Qe usually place the following possibilities on the board or overhead pro8ector and then ask
the students to indicate by vote how many used one denominator level versus another. 5ncidentally#
discussion tends to move more clearly if variable&costing income statements are discussed first#
because there is little disagreement as to computations under variable costing.
a. ariable&)osting 5ncome (tatement:
2003 2004 T'+#)3#r
9evenues $and contribution margin% A.;;#;;; A.;;#;;; AC;;#;;;
Fixed costs:
Hanufacturing costs A-B;#;;;
!perating costs 0;#;;; .-;#;;; .-;#;;; C0;#;;;
!perating income A $-;#;;;% A $-;#;;;% A $0;#;;;%
b. "bsorption&)osting 5ncome (tatement:
The ambiguity about the ,;#;;;& or -;#;;;&unit denominator level is intentional. 5F M!U Q5(+#
T+1 "H35=U5TM H"M 31 "!5D1D 3M =55N= T+1 (TUD1NT( " (/1)5F5)
D1N!H5N"T!9 Z11Z 5N "D"N)1.
"lternative ,. Use -;#;;; units as a denominatorF fixed manufacturing overhead per unit is
A-B;#;;; -;#;;; > A,0.
*&.-
9-32 $)ont7d.%
2003 2004 T'+#)3#r
9evenues A.;;#;;; A .;;#;;; AC;;#;;;
Hanufacturing costs at A,0 -B;#;;; && -B;#;;;
Deduct ending inventory ,0;#;;; && &&
)ost of goods sold ,0;#;;; ,0;#;;;\ -B;#;;;
Underallocated manuf. overhead&&
output level variance && -B;#;;; -B;#;;;
!perating costs 0;#;;; 0;#;;; B;#;;;
Total costs ,B;#;;; 0C;#;;; C0;#;;;
!perating income A,-;#;;; A$,C;#;;; % A$ 0;#;;; %
\ 5nventory carried forward from -;;. and sold in -;;0.
"lternative -. Use ,;#;;; units as a denominatorF fixed manufacturing overhead per unit is
A-B;#;;; ],;#;;; > A-B.
2003 2004 T'+#)3#r
9evenues A.;;#;;; A.;;#;;; AC;;#;;;
Hanufacturing costs at A-B 4C;#;;; && 4C;#;;;
Deduct ending inventory -B;#;;; && &&
)ost of goods sold -B;#;;; -B;#;;;\ 4C;#;;;
Underallocated manuf. overhead&&
output level variance && -B;#;;; &&
!verallocated manuf. overhead &&
output level variance $-B;#;;;% && &&
!perating costs 0;#;;; 0;#;;; B;#;;;
Total costs 0;#;;; C;;#;;; C0;#;;;
!perating income A-C;#;;; A$.;;#;;;% A $0;#;;;%
\5nventory carried forward from -;;. and sold in -;;0.
Note that operating income under variable costing follows sales and is not affected by
inventory changes.
Note also that students will understand the variable&costing presentation much more easily
than the alternatives presented under absorption costing.
-.
costing
able under vari
point 3reakeven
>
per ton margin on )ontributi
costs Fixed
>
A.;
A.-;#;;;
> ,;#CCD tons per year or -,#... for two years.
*&..
*&.0
9-32 $)ont7d.%
5f the company could sell CCD more tons per year at A.; each# it could get the extra A-;#;;;
contribution margin needed to break even.
Host students will say that the breakeven point is ,;#CCD tons per year under both
absorption costing and variable costing. The logical :uestion to ask a student who answers ,;#CCD
tons for variable costing is: YQhat operating income do you show for -;;. under absorption
costingIY 5f a student answers A,-;#;;; $alternative , above%# or A-C;#;;; $alternative - above%#
ask: Y3ut you say your breakeven point is ,;#CCD tons. +ow can you show an operating income on
only ,;#;;; tons sold during -;;.IY
The answer to the above dilemma lies in the fact that operating income is affected by both
sales and production under absorption costing.
=iven that sales would be ,;#;;; tons in -;;.# solve for the production level that will
provide a breakeven level of 6ero operating income. Using the formula in the chapter# sales of
,;#;;; units# and a fixed manufacturing overhead rate of A,0 $based on A-B;#;;; ? -;#;;; units
denominator level > A,0%:
Zet / > /roduction level
>
margin on contributi Unit
produced
Units
units
in sales
3reakeven
rate
overhead
manuf. Fixed
income
operating
Target
costs
fixed Total
1
1
1
]
1

,
_

,
_

,
_

,
_

,;#;;; tons >

.; A
% ;;; [ ,; $ ,0 A ; A ;;; [ .-; A P + +
A.;;#;;; > A.-;#;;; @ A,0;#;;; G A,0/
A,0/ > A,C;#;;;
/ > ,,#0-* units $rounded%
/roof:
=ross margin# ,;#;;; E $A.; G A,0% A,C;#;;;
!utput level variance#
$-;#;;; G ,,#0-*% E A,0 A,-;#;;;
Harketing and administrative costs 0;#;;; ,C;#;;;
!perating income A ;
*&.4
9-32 $)ont7d.%
=iven that production would be -;#;;; tons in -;;.# solve for the breakeven unit sales level.
Using the formula in the chapter and a fixed manufacturing overhead rate of A,0 $based on a
denominator level of -;#;;; units%:
Zet N > 3reakeven sales in units
N >
margin on contributi Unit
produced
Units
N
rate
overhead
manuf. Fixed
income
operating
Target
costs
fixed Total
1
1
1
]
1

,
_

,
_

,
_

,
_

N >
.; A
% ;;; [ -; N $ ,0 A ; A ;;; [ .-; A - + +
A.;N > A.-;#;;; @ A,0N G A-B;#;;;
A,CN > A0;#;;;
N > -#4;; units
/roof:
=ross margin# -#4;; E $A.; G A,0% A0;#;;;
!utput level H!+ variance A ;
Harketing and administrative costs 0;#;;; 0;#;;;
!perating income A ;
Qe find it helpful to put the following comparisons on the board:
ariable costing breakeven > f$sales%
> ,;#CCD tons
"bsorption costing breakeven > f$sales and production%
> f$,;#;;; and ,,#0-*%
> f$-#4;; and -;#;;;%
.. "bsorption costing inventory cost: 1ither A,0;#;;; or A-B;#;;; at the end of -;;. and
6ero at the end of -;;0.
ariable costing: Lero at all times. This is a ma8or criticism of variable costing and focuses
on the issue of the definition of an asset.
.. !perating income is affected by both production and sales under absorption costing.
*&.C
+ence# most managers would prefer absorption costing because their performance in any given
reporting period# at least in the short run# is influenced by how much production is scheduled near
the end of a period.
*&.D
9-33 $-4&.4 min.% C'.(ar&'$ '/ 8ara!"# *'&)$+ a$% a!&'r()'$
*'&)$+.
,. !perating income is a function of both sales and production under absorption costing#
whereas it is a function only of sales under variable costing. Therefore# inventory changes can have
dramatic effects on operating income under absorption costing. 5n this case# the severe decline in
inventory has resulted in enormous fixed costs from beginning inventory being charged against
-;;. operations.
-. The income statement deliberately contains an ambiguity about whether the fixed
manufacturing overhead of A,#;;;#;;; is the budgeted or actual amount. !f course# it must be the
budgeted amount# because the spending variance and the output level variance are shown
separately. Therefore:
> G
A0;;#;;; > A,#;;;#;;; G "llocated
"llocated > AC;;#;;;# which is C;O of denominator level
.. Note that the answer to $.% is independent of $-%. The difference in operating income of
A.,4#;;; $AC;;#;;; G A-B4#;;;% is explained by the release of A.,4#;;; of fixed manufacturing
costs when the inventories were decreased during -;;.:
7-#% 0a$2/.
A!&'r()'$ Vara!"# O8#r3#a%
C'&)$+ C'&)$+ $ I$8#$)'r1
5nventories:
December .,# -;;- A,#C4;#;;; A,#.-;#;;; A..;#;;;
December .,# -;;. D4#;;; C;#;;; ,4#;;;
9elease of fixed manuf. costs A.,4#;;;
The above schedule in this re:uirement is a formal presentation of the e:uation:
>
$A-B4#;;; G AC;;#;;;% > $A,4#;;; G A..;#;;;%
> G A.,4#;;;
*&.B
9-33 $)ont7d.%
"lternatively# the presence of fixed manufacturing overhead costs in each income statement
can be analy6ed:
"bsorption costing#
Fixed manuf. costs in cost of goods sold
$A0#4D4#;;; ^ A.#CC;#;;;% A *,4#;;;
/roduction&volume variance 0;;#;;;
,#.,4#;;;
ariable costing# fixed manuf. costs charged to
expense ,#;;;#;;;
Difference in operating income explained A .,4#;;;
"lthough it is not re:uired# the following supplementary analysis may clarify the relationships $all amounts
are at standard costs%:
A!&'r()'$ Vara!"#
C'&)$+ C'&)$+
5nventory# December .,# -;;- A,#C4;#;;; A,#.-;#;;;
)ost of goods manufactured\ .#;;;#;;; -#0;;#;;;
"vailable for sale 0#C4;#;;; .#D-;#;;;
5nventory# December .,# -;;. D4#;;; C;#;;;
)ost of goods sold A0#4D4#;;; A.#CC;#;;;
\)omputed from the other data# which are given.
0. a. "bsorption costing is more likely to lead to inventory buildups than variable costing.
Under absorption costing# operating income in a given accounting period is increased
because some fixed manufacturing overhead is accounted for as an asset $inventory%
instead of an expense $fixed cost written off during the current period%.
b. "lthough variable costing will counteract undesirable inventory buildups# other
measures can be used without abandoning absorption costing. 1xamples include budget
targets and nonfinancial measures of performance such as maintaining specific
inventory levels# inventory turnovers# delivery schedules# and e:uipment maintenance
schedules.
*&.*
9-34 $-4&.; min.% A")#r$a)8# %#$'.$a)'r-"#8#" *'$*#()&.
,.
D#$'.$a)'r-
L#8#"
C'$*#()
92%+#)#% 7-#%
0a$2/a*)2r$+
O8#r3#a%
(#r P#r'%
92%+#)#%
D#$'.$a)'r
L#8#"
92%+#)#% 7-#%
0a$2/a*)2r$+
O8#r3#a%
C'&) Ra)#
Theoretical capacity
/ractical capacity
Normal capacity utili6ation
Haster&budget utili6ation
$a% Kan.GKune -;;.
$b% KulyGDec. -;;.
A0-#;;;#;;;
0-#;;;#;;;
0-#;;;#;;;
-,#;;;#;;;
-,#;;;#;;;
4#-4C#;;;
.#4;;#;;;
-#B;;#;;;
,#,-;#;;;
,#CB;#;;;
A D.**
,-.;;
,4.;;
,B.D4
,-.4;
The differences arise for several reasons:
a. The theoretical and practical capacity concepts emphasi6e supply factors# while normal
capacity utili6ation and master&budget utili6ation emphasi6e demand factors.
b. The two separate six&month rates for the master&budget utili6ation concept differ because of
seasonal differences in budgeted production.
-. Theoretical capacity is based on the production of output at maximum efficiency for ,;;O of
the time.
/ractical capacity&&reduces theoretical capacity for unavoidable operating interruptions such
as scheduled maintenance time# shutdowns for holidays and other days# and so on.
For each of the three determinants of capacity in Zucky ZargerJs plant# practical capacity is
less than theoretical capacity:
9arr#"&
P#r H'2r
415
<'r:$+
H'2r&
P#r Da1
425
<'r:$+
Da1&
P#r Y#a
435
Ca(a*)1
445=415 > 425 > 435
Theoretical capacity
/ractical capacity
C;;
4;;
-0
-;
.C4
.4;
4#-4C#;;;
.#4;;#;;;
.. The smaller the denominator# the higher the amount of overhead costs capitali6ed for
inventory units. Thus# if the plant manager wishes to be able to Yad8ustY plant operating income by
building inventory# master&budget utili6ation or possibly normal capacity utili6ation would be
preferred.
*&0;
9-35 $.; min.% O(#ra)$+ $*'.# #//#*)& '/ a")#r$a)8# %#$'.$a)'r-
"#8#" *'$*#()& 4*'$)$2a)'$ '/ Pr'!"#. 9-345.
,. (olution 1xhibit *&.4 reports the operating income for each denominator&level concept. )omputations include:
D#$'.$a)'r-
L#8#"
C'$*#()
Vara!"#
0a$2/a*)2r$+
C'&)?
92%+#)#% 7-#%
0a$2/a*)2r$+
O8#r3#a%
C'&) Ra)#
T')a"
0a$2/a*)2r$+
C'&)&
Theoretical capacity
/ractical capacity
Normal capacity
A0C..;
0C..;
0C..;
A D.**
,-.;;
,4.;;
A40.-*
4B..;
C,..;
\
A,-;#.B;#;;; ? -#C;;#;;; > A0C..; per barrel
The total fixed manufacturing overhead variance $spending variance plus production&volume
variance% for each denominator&level concept is:
$a% Theoretical capacity: A0;#C.-#;;; G $AD.** E -#C;;#;;;%
A0;#C.-#;;; G A-;#DD0#;;; > A,*#B4B#;;; U
$b% /ractical capacity: A0;#C.-#;;; G $A,-.;; E -#C;;#;;;%
A0;#C.-#;;; G A.,#-;;#;;; > A *#0.-#;;; U
$c% Normal utili6ation: A0;#C.-#;;; G $A,4.;; E -#C;;#;;;%
A0;#C.-#;;; G A.*#;;;#;;; > A ,#C.-#;;; U
5llustration of operating income differences:
/ractical G Theoretical: A,.#B0B#;;; G A,.#;0C#;;; > A B;-#;;;
Normal G /ractical: A,0#00B#;;; G A,.#B0B#;;; > A C;;#;;;
Normal G Theoretical: A,0#00B#;;; G A,.#;0C#;;; > A,#0;-#;;;
The difference in operating income across the three denominator&level concepts is due solely to
differences in fixed manufacturing overhead included in the ending -;;#;;; barrels of inventory:
Theoretical capacity: -;;#;;; E A D.** > A,#4*B#;;;
AB;-#;;; difference
/ractical capacity: -;;#;;; E A,-.;; > A-#0;;#;;;
AC;;#;;; difference
Normal capacity: -;;#;;; E A,4.;; > A.#;;;#;;;
-. =iven the data in this :uestion# the theoretical capacity concept reports the lowest operating
income and thus $other things being e:ual% the lowest tax bill for -;;.. Zucky Zarger benefits by
having deductions as early as possible. The theoretical capacity denominator&level concept
maximi6es the deductions for manufacturing costs.
*&0,
9-35 $)ont7d.%
.. The 59( may restrict the flexibility of a company in several ways.
a. 9estrict the denominator&level concept choice.
b. 9estrict the cost line items that can be expensed rather than inventoried.
c. 9estrict the ability of a company to use shorter write&off periods or more accelerated
write&off periods for inventoriable costs.
d. 9e:uire proration or allocation of variances to represent actual costs and actual capacity
used.
SOL;TION E@HI9IT 9-35
T3#'r#)*a"
Ca(a*)1
Pra*)*a"
Ca(a*)1
N'r.a"
;)"Aa)'$
9evenues $ACB E -#0;;#;;;%
)ost of goods sold:
3eginning inventory
ariable manufacturing costs#
A0C..; E -#C;;#;;;
Fixed manufacturing overhead costs#
AD.**# A,-# A,4 E -#C;;#;;;
)ost of goods available for sale
1nding inventory#
A40.-*# A4B..;# AC,..; E -;;#;;;
Total cost of goods sold $at budgeted costs%
"d8ustment for variances
A,C.#-;;#;;;
;
,-;#.B;#;;;
-;#DD0#;;;
,0,#,40#;;;
,;#B4B#;;;
,.;#-*C#;;;
,*#B4B#;;;
a
A,C.#-;;#;;;
;
,-;#.B;#;;;
.,#-;;#;;;
,4,#4B;#;;;
,,#CC;#;;;
,.*#*-;#;;;
*#0.-#;;;
a
A,C.#-;;#;;;
;
,-;#.B;#;;;
.*#;;;#;;;
,4*#.B;#;;;
,-#-C;#;;;
,0D#,-;#;;;
,#C.-#;;;
a
)ost of goods sold
=ross margin
!ther costs
!perating income
,4;#,40#;;;
,.#;0C#;;;
;
A ,.#;0C#;;;
,0*#.4-#;;;
,.#B0B#;;;
;
A ,.#B0B#;;;
,0B#D4-#;;;
,0#00B#;;;
;
A ,0#00B#;;;
a
(ee the answer to re:uirement , for computation. The variances are the difference between actual fixed
manufacturing overhead costs and fixed manufacturing overhead costs allocated to products. Thus# the variances
are the sum of the fixed overhead spending variance and the production&volume variance.
*&0-
*..C$-; min.% D'B$Bar% %#.a$% &(ra".
,. 3udgeted variable manufacturing costs per unit A-;;
"llocated fixed manufacturing overhead costs per unit ,;;
a

3udgeted total manufacturing costs per unit .;;
Harkup $,;;O E A.;;% .;;
3udgeted selling price AC;;
a
A,#;;;#;;; ? ,;#;;; units > A,;; per unit
-. 3udgeted variable manufacturing costs per unit A-;;
"llocated fixed manufacturing overhead costs per unit ,-4
b

3udgeted total manufacturing costs per unit .-4
Harkup $,;;O E A.-4% .-4
9evised budgeted selling price AC4;
b
A,#;;;#;;; ? B#;;; units > A,-4 per unit
.. )onsidering that the market is highly competitive# raising the selling price# in an attempt to
recover fixed manufacturing overhead costs# will make /ismo )ompany less competitive. /ismo7s
higher selling price would likely make it lose its customers to the competitors. This is the classic
syndrome of the start of a downward demand spiral. /ismo )ompany should use its practical
capacity to allocate fixed manufacturing overhead costs. 5f an upturn is expected# /ismo should
keep its excess capacity. !therwise# it should either lease or get rid of the excess capacity in order
to bring down its fixed manufacturing overhead costs to the demand level.
*&0.
9-37 $-;&.4 min.% E//#*)& '/ %#$'.$a)'r-"#8#" *'$*#() *3'*#.
,. Normal capacity utili6ation. =ivens denoted\
A*)2a" C'&)&
I$*2rr#%
415
Sa.# 92%+#)#%
L2.( S2.
4a& $ S)a)* 92%+#)5
R#+ar%"#&& '/
O2)(2) L#8#"
425
7"#-!"# 92%+#)C
Sa.# 92%+#)#%
L2.( S2.
4a& $ S)a)* 92%+#)5
R#+ar%"#&& '/
O2)(2) L#8#"
435
A""'*a)#%C
92%+#)#% I$(2)
A""'B#% /'r
A*)2a" O2)(2)
> 92%+#)#% Ra)#
445
A,.;#;;; A,-;#;;;\ A,-;#;;;\
D;#;;; hrs.\ E A-.;;
a
> A,0;#;;;
A,;#;;; U\ A-;#;;; F\
(pending variance Never a variance /rodn. volume variance
>
G A-;#;;; > $A,-;#;;; G _%
_ > A,0;#;;;
>
> A- per machine&hour
Denominator level >
> C;#;;; machine&hours
*&00
9-37 4)ont7d.%
-. /ractical capacity. =ivens denoted\
A*)2a" C'&)&
I$*2rr#%
415
Sa.# L2.( S2.
4a& $ S)a)* 92%+#)5
R#+ar%"#&& '/
92%+#)#% O2)(2)
L#8#"
425
7"#-!"# 92%+#)C
Sa.# L2.( S2.
4a& $ S)a)* 92%+#)5
R#+ar%"#&& '/
92%+#)#% O2)(2)
L#8#"
435
A""'*a)#%C
92%+#)#% I$(2)
A""'B#% /'r
A*)2a" O2)(2)
> 92%+#)#% Ra)#
445
A,.;#;;; A,-;#;;;\ A,-;#;;;\
D;#;;;\ E A,.-;
a
> AB0#;;;
A,;#;;; U\ A.C#;;; U\
(pending variance Never a variance /rodn. volume variance
>
A.C#;;; > $A,-;#;;; G _%
_ > AB0#;;;
>
> A,.-; per machine&hour
Denominator level >
> ,;;#;;; machine&hours
.. To maximi6e operating income# the executive vice president would favor using normal capacity
utili6ation rather than practical capacity. QhyI 3ecause normal capacity utili6ation is a smaller
base than practical capacity# resulting in any year&end inventory having a higher unit cost. Thus#
less fixed manufacturing overhead would become a -;;. expense as part of the production&volume
variance if normal capacity utili6ation were used as the denominator level.
*&04
9-38 $.; min.% D#$'.$a)'r 8'"2.#, (r'%2*)'$ 8'"2.# 8ara$*#.
,. 92%+#)#% 92%+#)#% 92%+#)#% 7-#%
7-#% D#$'.$a)'r 0a$2/a*)2r$+
D#$'.$a)'r-L#8#" 0a$2/a*)2r$+ L#8#" 4$ O8#r3#a% Ra)#
Ca(a*)1 C'$*#() O8#r3#a% 0a*3$# H'2r&5 P#r 0a*3$#-H'2r
415 425 435 445 = 425 D 435
Theoretical capacity A,;#4;;#;;; -#,;;#;;; A4.;
/ractical capacity ,;#4;;#;;; ,#4;;#;;; D.;
Normal capacity utili6ation ,;#4;;#;;; ,#.,-#4;; B.;
Haster&budget capacity
utili6ation ,;#4;;#;;; ,#;;;#;;; ,;.4
-.
/roduction volume variance > G E
Theoretical capacity: /roduction volume variance > $-#,;;#;;; G ,#,;;#;;;% A4.;
> A4#;;;#;;; U
/ractical capacity: /roduction volume variance > $,#4;;#;;; G ,#,;;#;;;% E AD.;
> A-#B;;#;;; U
Normal capacity utili6ation: /roduction volume variance > $,#.,-#4;; G ,#,;;#;;;% E AB
> A,#D;;#;;; U
Haster budget capacity utili6ation: /roduction volume variance > $,#;;;#;;; G ,#,;;#;;;% E A,;.4
> A,#;4;#;;; F
*&0C
9-39 $-; min.% C'&) a""'*a)'$, %'B$Bar% %#.a$% &(ra".
,. >
A,.4; >
3udgeted denominator level >
> -#*-;#;;; meals
Q+H is using budgeted usage as its denominator level for calculating the budgeted fixed costs per
meal in -;;0.
-. "lternative denominator levels include:
a. )apacity available. The data in the problem note that the facility can serve .#C4;#;;;
meals a year. Qith this denominator level# there will be budgeted unused capacity#
which could be recorded as a separate line in the cost report for the (anta Honica
facility.
b. 3udgeted usage of capacity. Qith the -;;0 budgeted usage of -#*-;#;;; meals# the
fixed costs charge is A,.4; per meal. The marketplace is signaling that Q+HJs own
central food&catering facility is not providing value for the costs charged. 5f Kenkins
decides to raise prices to recover fixed costs from a declining demand base# he will
likely encounter the downward demand spiral:
92%+#)#%
D#$'.$a)'r
415
Vara!"# C'&)
(#r 0#a"
425
7-#% C'&)
(#r 0#a"
E4,380,000 D 415
435
T')a" C'&)
(#r 0#a"
445
.#C4;#;;;
-#*-;#;;;
-#44;#;;;
-#;;;#;;;
A..B;
..B;
..B;
..B;
A,.-;
,.4;
,.D-
-.,*
A4.;;
4..;
4.4-
4.**
Kenkins might adopt a contribution margin approach# which means viewing the A..B; variable
cost as the only per&unit cost and the A0#.B;#;;; as a fixed cost. "lternatively# Kenkins could use
practical capacity to cost the meals and work to reduce costs of unused capacity.
*&0D
9-39 $)ont7d.%
.. Three factors managers should consider in pricing decisions:
a. )ustomers. Kenkins is facing customers who are dissatisfied with both the cost and the
:uality of the meal service. Three of the ,; hospitals have already elected to use an
outside canteen service.
b. )ompetitors. For the three hospitals terminating use of the (anta Honica facility# at
least one competitor is more cost&effective. The seven remaining hospitals likely will be
very interested in how this competitor performs at the three hospitals.
c. )osts. Kenkins should consider ways to reduce both the variable costs per meal and the
fixed costs.
9-40 $-; min.% C'&) a""'*a)'$, !2%+#)#% ra)#&, #)3*& 4*'$)$2a)'$ '/ Pr'!"#.
9-395.
,. +ospitals are charged a budgeted variable cost rate and an allocation of budgeted fixed
costs. 3y overestimating budgeted meal counts# the denominator of the budgeted fixed cost rate is
larger# and hence the amount charged to individual hospitals is lower. )onsider -;;0 where the
budgeted fixed cost rate of A,.4; is computed as follows:
> A,.4; per meal
(uppose in -;;0# hospital administrators YinflatedY their budgeted meal count by -;O: The
budgeted fixed cost rate for -;;0 rate would have been
> A,.-4 per meal
+ence# by deliberately overstating budgeted meal count demand# they could reduce the costs
charged per meal in -;;0. The use of budgeted meals as the denominator means the central food&
catering facility bears the risk of demand overestimates.
-. 1vidence that could be collected include:
$a% 3udgeted meal&count estimates and actual meal&count figures each year for each hospital
controller. !ver an extended time period# there should be a si6able number of both underestimates
and overestimates. )ontrollers could be ranked on both their percentage of overestimation and the
fre:uency of their overestimation.
$b% Zook at the underlying demand estimates by patients at individual hospitals. 1ach hospital
controller has other factors $such as hiring of nurses% that give insight into their expectations of
future meal&count demands. 5f these factors are inconsistent with the meal&count demand figures
provided to the central food&catering facility# explanations should be sought.
*&0B
9-40 $)ont7d.%
.. $a% +ighlight the importance of a corporate culture of honesty and openness. Q+H
could institute a )ode of 1thics that highlights the upside of individual hospitals providing honest
estimates of demand $and the penalties for those who do not%.
$b% +ave individual hospitals contract in advance for their budgeted meal count.
Unused amounts would be charged to each hospital at the end of the accounting period. This
approach puts a penalty on hospital administrators who overestimate demand.
$c% Use an incentive scheme that has an explicit component for meal&count forecasting
accuracy. 1ach meal&count Rforecasting errorS would reduce the bonus by A;.;4. Thus# if a hospital
bids for -*-#;;; meals and actually uses -;;#;;; meals# its bonus would be reduced by
A;.;4 E $-*-#;;; G -;;# ;;;% > A0#C;;.
9-41 $C; min.% A!&'r()'$, 8ara!"#, a$% )3r'2+3(2) *'&)$+.
,.
$a% >
hours standard -; vehicles .#;;;
;;; # 4;; # D A

>
> A,-4 per standard assembly hour or A-#4;;
per vehicle
$b% Direct materials per unit A C#;;;
Direct manufacturing labor per unit ,#B;;
ariable manufacturing overhead per unit -#;;;
Fixed manufacturing overhead per unit -#4;;
Total manufacturing cost per unit A,-#.;;
*&0*
9-41 $)ont7d.%
-. "mounts in thousands. A!&'r()'$ C'&)$+
6a$2ar1 7#!r2ar1 0ar*3
9evenues $A,C#;;; E -#;;;F -#*;;F .-;;%
)ost of goods sold
3eginning inventory
ariable manufacturing costs $A*.B E .#-;;F -#0;;F .B;;%
Fixed manufacturing costs $A-.4 E .#-;;F -#0;;F .#B;;%
)ost of goods available for sale
Deduct ending inventory $A,-.. E ,#-;;F D;;F ,#.;;%
)ost of goods sold $at standard cost%
"d8ustment for manuf. variances
a
Total cost of goods sold
=ross margin
Harketing costs
!perating income
5nventory Details $Units%
3eginning inventory
/roduction
=oods available for sale
(ales
1nding inventory
5nventory Details $A,-#.;; per unit%
3eginning inventory $A,-#.;; per unit%
1nding inventory $A,#;;;s%
A.-#;;;
;
.,#.C;
B#;;;
.*#.C;
,0#DC;
-0#C;;
4;; F
-0#,;;
D#*;;
;
A D#*;;
;
.#-;;
.#-;;
-#;;;
,#-;;
A ;
A,0#DC;
A0C#0;;
,0#DC;
-.#4-;
C#;;;
00#-B;
B#C,;
.4#CD;
,#4;; U
.D#,D;
*#-.;
;
A *#-.;
,#-;;
-#0;;
.#C;;
-#*;;
D;;
A,0#DC;
A B#C,;
A4,#-;;
B#C,;
.D#-0;
*#4;;
44#.4;
,4#**;
.*#.C;
-#;;; F
.D#.C;
,.#B0;
;
A,.#B0;
D;;
.#B;;
0#4;;
.#-;;
,#.;;
A B#C,;
A,4#**;
C'.(2)a)'$ '/ 9'$2& 6a$2ar1 7#!r2ar1 0ar*3
!perating income
E ;.4O
AD#*;;#;;;
A .*#4;;
A*#-.;#;;;
A0C#,4;
A,.#B0;#;;;
A C*#-;;
a
/roductionGvolume variances > $Denomination level G /roduction% E 3udgeted rate
Kanuary: $.#;;; G .#-;;% E A-#4;; per vehicle > A4;;#;;; F
February: $.#;;; G -#0;;% E A-#4;; per vehicle > A,#4;;#;;; U
Harch: $.#;;; G .#B;;% E A-#4;; per vehicle > A-#;;;#;;; F
*&4;
9-41 $)ont7d.%
.. "mounts in thousands Vara!"# C'&)$+
6a$2ar1 7#!r2ar1 0ar*3
9evenues
ariable )osts
3eginning inventory
ariable manuf. costs $A*.B; E .#-;;F -#0;;# .#B;;%
)ost of goods available for sale
Deduct ending inventory $A*.B; E,#-;;F D;;# ,#.;;%
ariable )!=(
ariable marketing costs
ariable costs $at standard cost%
"d8ustment for variances
Total variable costs
)ontribution margin
Fixed costs
Fixed manuf. overhead costs
Fixed marketing costs
Fixed costs $at standard cost%
"d8ustment for variances
Total fixed costs
!perating income
5nventory details $A*#B;; per unit%
3eginning inventory $units%
1nding inventory $units%
3eginning inventory $A;;;s%
1nding inventory $A;;;s%
A.-#;;;
;
.,#.C;
.,#.C;
,,#DC;
,*#C;;
;
,*#C;;
;
,*#C;;
,-#0;;
D#4;;
;
D#4;;
;
D#4;;
A 0#*;;
;
,#-;;
A;
A,,#DC;
A0C#0;;
,,#DC;
-.#4-;
.4#-B;
C#BC;
-B#0-;
;
-B#0-;
;
-B#0-;
,D#*B;
D#4;;
;
D#4;;
;
D#4;;
A,;#0B;
,#-;;
D;;
A,,#DC;
A C#BC;
A4,#-;;
C#BC;
.D#-0;
00#,;;
,-#D0;
.,#.C;
;
.,#.C;
;
.,#.C;
,*#B0;
D#4;;
;
D#4;;
;
D#4;;
A,-#.0;
D;;
,#.;;
A C#BC;
A,-#D0;
C'.(2)a)'$ '/ 9'$2& 6a$2ar1 7#!r2ar1 0ar*3
!perating income
E ;.4O
A0#*;;#;;;
A -0#4;;
A,;#0B;#;;;
A 4-#0;;
A,-#.0;#;;;
A C,#D;;
*&4,
9-41 $)ont7d.%
0.
6a$2ar1 7#!r2ar1 0ar*3 T')a"
"bsorption&)osting 3onus
ariable&)osting 3onus
Difference
A.*#4;;
-0#4;;
A,4#;;;
A0C#,4;
4-#0;;
A $C#-4; %
AC*#-;;
C,#D;;
A D#4;;
A,40#B4;
,.B#C;;
A,C#-4;
The difference between absorption and variable costing arises because of differences in
production and sales:
6a$2ar1 7#!r2ar1 0ar*3 T')a"
/roduction
(ales
5ncrease $decrease% in inventory
.#-;;
-#;;;
,#-;;
-#0;;
-#*;;
$4;; %
.#B;;
.#-;;
C;;
*#0;;
B#,;;
,#.;;
Qith absorption costing# by building for inventory# +art can capitali6e A-#4;; of fixed
manufacturing overhead costs per unit. This will provide a bonus payment of A,-.4; $;.4O E
A-#4;;% per unit. !perating income under absorption costing will exceed that under variable costing
when production is greater than sales. !ver the three&month period# the inventory buildup is ,#.;;
units giving a difference of A,C#-4; $A,-.4; E ,#.;;% in bonus payments.
4. "mounts in thousands
Throughput )osting
6a$2ar1 7#!r2ar1 0ar*3
9evenues
Direct material cost of goods sold
3eginning inventory $AC E ;F,#-;;F D;;%
Direct materials $AC E .#-;;F -#0;;F .#B;;%
)ost of goods available for sale
Deduct ending inventory $AC E ,#-;;F D;;F,#.;;%
Total direct material cost of good sold
Throughput contribution
!ther costs
Hanufacturing
a
A.-#;;;
;
,*#-;;
,*#-;;
D#-;;
,-#;;;
-;#;;;
,*#CC;
A0C#0;;
D#-;;
,0#0;;
-,#C;;
0#-;;
,D#0;;
-*#;;;
,C#C-;
A4,#-;;
0#-;;
--#B;;
-D#;;;
D#B;;
,*#-;;
.-#;;;
-,#*0;
Harketing
Total other costs
!perating income
;
,*#CC;
A .0;
;
,C#C-;
A,-#.B;
;
-,#*0;
A,;#;C;
a
$A.#B;; .#-;;% @ AD#4;;#;;;
$A.#B;; -#0;;% @ AD#4;;#;;;
$A.#B;; .#B;;% @ AD#4;;#;;;
C'.(2)a)'$ '/ 9'$2& 6a$2ar1 7#!r2ar1 0ar*3
!perating income
E ;.4O
A.0;#;;;
A ,#D;;
A,-#.B;#;;;
A C,#*;;
A,;#;C;#;;;
A 4;#.;;
*&4-
9-41 $)ont7d.%
" summary of the bonuses paid is:
6a$2ar1 7#!r2ar1 0ar*3 T')a"
"bsorption )osting
ariable )osting
Throughput )osting
A.*#4;;
-0#4;;
,#D;;
A0C#,4;
4-#0;;
C,#*;;
AC*#-;;
C,#D;;
4;#.;;
A,40#B4;
,.B#C;;
,,.#*;;
C. "lternative approaches include:
$a% )areful budgeting and inventory planning#
$b% Use an alternative income computation approach to absorption costing $such as variable
costing or throughput costing%#
$c% Use a financial charge for inventory buildup#
$d% )hange the compensation package to have a longer&term focus using either an external
variable $e.g.# stock options% or an internal variable $e.g.# five&year average income%# and
$e% "dopt non&financial performance targetsGGe.g.# attaining but not exceeding present
inventory levels.
C3a()#r 9 I$)#r$#) E-#r*&#
The Internet exercise is available to students only on the Prentice Hall Companion Website
www.prenhall.comhorngren. !tudents can clic" on Cost #ccounting$ %%
th
ed.$ and access the
Internet &xercise 'or the chapter$ which lin"s to the Web site o' a company or organization. The
Internet &xercise on the Web will be updated periodically so that it is current with the latest
in'ormation available on the sub(ect organization)s Web site. # printout copy o' the Internet
exercise 'or this chapter as o' early *++* appears below.
The solution to the Internet exercise$ which will also be updated periodically$ is available to
instructors 'rom the Companion Website)s 'aculty view. To access the solution$ clic" on Cost
#ccounting$ %%
th
ed.$ ,aculty lin"$ and then register once to obtain your password through the
online 'orm. #'ter the initial registration$ you will have a personal login I- and password to use to
log in. # printout o' the solution to the Internet exercise 'or this chapter as o' early *++* 'ollows.
The exercise and solution provide instructors with an idea o' the content o' the Internet exercise 'or
this chapter.
I$)#r$#) E-#r*&#
The 3oeing )orporation and Dell )omputer )orporation both face the task of allocating fixed
manufacturing costs between inventory and cost of goods sold. =o to each companyJs home page
to learn more about its business and to access its -;;; annual reports. For 3oeing# go to
www.boeing.com# and click on the Yinvestor relationsY link. For Dell# go to www.dell.com and
click on the Yabout DellY link# followed by the Yinvestor relationsY link.
,a. )alculate gross margin# inventory turnover# and inventory as a percentage of total assets for
3oeing and Dell in ,*** and -;;;. Use cost of goods sold and ending inventory to calculate
inventory turnover.
*&4.
I$)#r$#) E-#r*&# $)ont7d.%
,b. Did the gross margins and inventory turnover ratios at each company improve in -;;;I
-. Qhat business factors account for DellJs significantly higher inventory turnover ratioI
.. For which company is the choice of absorption costing versus variable costing likely to be a
more important issue# and whyI
0a. 9ead footnotes , and * to 3oeingJs financial statements# the Y(ummary of (ignificant
"ccounting /oliciesY and Y5nventories.Y Describe the types of costs that 3oeing includes in
inventories. "re any costs in excess of estimated average production costs included in inventoryI
0b. Do these notes suggest that 3oeing uses variable costing or absorption costing to value
inventoryI QhyI
4. Qould the use of variable costing increase or decrease 3oeingJs inventory turnover ratioI
S'"2)'$ )' I$)#r$#) E-#r*&#
,a. The gross margins# inventory turnover# and inventory as a percentage of total assets are as
follows.
Dell 3oeing
-;;; ,*** -;;; ,***
=ross margin -;.DO --.4O ,0.BO ,,.4O
5nventory turnover\ 4,.. 4,.B C.0 D.B
5nventory'"ssets ..0O 0.;O ,C.-O ,B.,O
\ )ost of goods sold ' ending inventory
,b. DellJs gross margin decreased between ,*** and -;;;# while its inventory turnover remained
relatively constant. 3oeingJs gross margin improved between ,*** and -;;;# while its
inventory turnover deteriorated.
-. Dell7s build&to&order manufacturing process allows it to :uickly produce customi6ed
computer systems and to achieve rapid inventory turnover. 3oeing on the other hand
produces commercial and military aircraft# and satellites. These re:uire much longer
production times.
.. The choice of costing method will be a more important issue for 3oeing. 5nventory accounts
for more than ,CO of 3oeingJs total assets compared to less than 0O for Dell. 5n addition#
cost of goods sold accounts for a larger portion of 3oeings total costs. "ny overstatement of
inventory or cost of goods sold will have a proportionally larger financial statement impact.
*&40
I$)#r$#) E-#r*&# $)ont7d.%
0a. 3oeing includes direct engineering# production and tooling costs# and applicable overhead in
its inventoried costs for commercial aircraft and long&term contracts. "s of December .,#
-;;;# there were no significant costs in excess of estimated average production costs included
inventory.
0b. "verage costs include fixed and variable production costsF thus the notes suggest that 3oeing
uses absorption costing to value its ending inventory.
4. Under a variable costing approach# fixed manufacturing costs would be treated as a period
cost. Thus ending inventory would be lower. )ost of goods sold would be higher resulting in
higher $improved% inventory turnover ratio.
C3a()#r 9 V%#' Ca&#
The video case can be discussed using only the case writeup in the chapter. #lternatively$
instructors can have students view the videotape o' the company that is the sub(ect o' the case. The
videotape can be obtained by contacting your Prentice Hall representative. The case .uestions
challenge students to apply the concepts learned in the chapter to a speci'ic business situation.
<HEELED COACH INVENTORY COSTING AND CAPACITY ANALYSIS
1. 92%+#)#% 92%+#)#% 7-#%
92%+#)#% 7-#% D#$'.$a)'r 0a$2/a*)2r$+
D#$'.$a)'r-L#8#" 0a$2/a*)2r$+ L#8#" O8#r3#a% C'&)
Ca(a*)1-C'$*#() O8#r3#a%FY#ar 4I$ V#3*"#&5 Ra)# P#r V#3*"#
Theoretical )apacity A-#;;;#;;; . shifts E A,#B.,.4;
D vehicles E
4- weeks >
,#;*- vehicles
/ractical )apacity A-#;;;#;;; . shifts E A-#CCC.CD
4 vehicles E
4; weeks >
D4; vehicles
Normal )apacity A-#;;;#;;; , shift E AB#;;;.;;
Utili6ation 4 vehicles E
4; weeks >
-4; vehicles
Haster&3udget )apacity A-#;;;#;;; , shift E A,;#;;;.;;
Utili6ation 0 vehicles E
4; weeks >
-;; vehicles
V%#' Ca&# $)ont7d.%
*&44
-. Vara!"# 92%+#)#% 7-#% T')a"
D#$'.$a)'r-L#8#" 0a$2/a*)2r$+ 0OH 0a$2/a*)2r$+
Ca(a*)1-C'$*#() C'&)FV#3*"# C'&) FV#3*"# C'&)F V#3*"#
Theoretical capacity A0;#;;; A,#B.,.4; A0,#B.,.4;
/ractical capacity A0;#;;; A-#CCC.CD A0-#CCC.CD
Normal capacity
utili6ation A0;#;;; AB#;;;.;; A0B#;;;.;;
Haster&budget capacity
utili6ation A0;#;;; A,;#;;;.;; A4;#;;;.;;
.. 5f Qheeled )oach does not match the price and loses the business to HedTechnix# its
budgeted fixed manufacturing overhead costs would now be spread over a budgeted volume
of ,*; $not -;;% vehicles# at a rate of A,;#4-C $A-#;;;#;;;',*; vehicles% instead of A,;#;;;.
HedTechnix could continue to undercut Qheeled )oach7s prices and steal more customers#
further reducing the number of units over which Qheeled )oach can allocate its budgeted
fixed manufacturing overhead costs. This will contribute to a downward demand spiral that
may present larger problems in the future. Qheeled )oach is probably best off matching the
A0D#;;; price that exceeds variable manufacturing costs per vehicle and# in time# working to
reduce fixed manufacturing costs.
*&4C