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CHAPTER13

STANDARDCOSTINGANDVARIABLECOSTING
131JITandCostingMethods
Throughputcostingismostcompatiblebecauseitpenalizesproduction
inexcessofsales.Variablecostingdoesnotpenalizeexcessproduction,
whileabsorptioncostingactuallyrewardsoverproduction.
Throughputcostingexpenseseverythingexceptmaterialcostasthose
costsareincurred.Itexpensesmaterialcostswhenmaterialgoesinto
production.Thus,startingtomakesomethinggivesrisetoexpense,which
encouragesmanagerstoproduceonlywhentheycanselltheproduct.
Absorptioncostingrewardshighproductionbecauseitcapitalizesfixed
productioncostsininventory,thuspostponingtheirappearanceintheincome
statementuntilproductsaresold.
132UseofCostingMethods
Theconstructioncompanyisleastlikelytousestandardcostsbecause
itdoesnotmakestandardproducts.Suchacompanycould,andprobablydoes,
budgetcostsformajorprojects,butthesearenotstandards.Anautomaker
usesstandardcostsbothforcontrolandbecauseitcouldnotpossiblyuse
actualornormalprocesscostingbecauseofproductdiversity.Joborder
costingwouldbeprohibitivelycostly.Aprocessorofflourcoulduseactual
ornormalcosting,butwouldbenefitfromthecontrolusesofstandards.
133ProductCostPeriodCost
Classifyingacostaseitherproductorperiodtellslittleaboutthe
costitselfbutratherdescribeshowwetreatitforreportingpurposes.
Identifyingacostasaproductcostresultsinitsbeingreportedasan
expenseintheperiodinwhichtheproductissold.Identifyingacostasa
periodcostresultsinitsbeingreportedasanexpenseintheperiodin
whichitisincurred.Thedistinctionbetweenperiodandproductcostshas
norelevancetodecisionmakingexcept,perhaps,inconnectionwithcapital
budgetingdecisionswheretheperiodofexpensereportingfortaxpurposesis
relevanttothedeterminationoffuturecashflows.
134CostingMethodsandZeroInventories
Allthreemethodswillgivethesameresults.Totalexpenseswill
equaltotalcostsincurred,includingpurchasesofmaterialsandcomponents.
135CostingMethodsandCashFlows
Throughputcostingwillprobablybetheclosestbecausetheflowof
costsparallelstheirincurrence.Absorptioncostingwillhavetheleast
closerelationshiptocashflow.

131

136FundamentalsofAbsorptionandVariableCosting(15minutes)
1.
Sales,18,000x$50
$900,000
Standardcostofsales,18,000x$30
540,000
Standardgrossmargin

360,000
Sellingandadministrativeexpenses
300,000
Income

$60,000
2.
Sales,
$900,000
Standardvariablecostofsales,18,000x$10180,000
Standardgrossmargin,contributionmargin720,000
Fixedcosts,$400,000+$300,000
700,000
Income

$20,000
Thecostofsalessectionsoftheincomestatementfocusattentionon
inventories.
AbsorptionVariable

Beginninginventory

$0$0
Variableproductioncosts
200,000200,000
Fixedproductioncosts
400,0000
Totalavailable
600,000200,000
Endinginventory,2,000unitsat$30,$1060,00020,000
Costofsales
$540,000$180,000
Becauseactualproductionequalledthelevelusedtosetthestandard,there
isnovolumevariance.Youmightaskhowmuchincomethecompanyshouldearn
permonthifitcontinuestosell18,000units.Theansweris$20,000,
becausethecompanycannotindefinitelymake2,000unitsmorethanitsells.
137FundamentalsofAbsorptionandVariableCosting(15minutes)
1.
Sales,22,000x$50
Standardcostofsales,22,000x$30
Standardgrossmargin

Sellingandadministrativeexpenses
Income

$1,100,000
660,000
440,000
300,000
$140,000

2.
Sales,22,000x$50

$1,100,000
Standardvariablecostofsales,22,000x$10220,000
Standardgrossmargin,contributionmargin880,000
Fixedcosts,$400,000+$300,000
700,000
Income
$180,000
Thecostofsalessectionsoftheincomestatementagainfocusattentionon
inventories.
AbsorptionVariable
Beginninginventory,135
$60,000$20,000
Variableproductioncosts200,000200,000
Fixedproductioncosts400,0000
Totalavailable660,000220,000
Endinginventory00
Costofsales
$660,000$220,000
132

Becauseactualproductionagainequalledthelevelusedtosetthestandard,
thereisnovolumevariance.
138BasicStandardCostingAbsorptionandVariable(25minutes)
IncomeStatementsVariableCosting

MarchApril
Salesat$7percase$700,000$700,000
Costofsales:
Beginninginventory:
30,000x$390,000
Productioncosts:
130,000x$3390,000
90,000x$3_______270,000
Total390,000360,000
Endinginventory:
30,000x$390,000
20,000x$3________60,000
Variablecostofsales300,000300,000
Contributionmargin400,000400,000
Fixedcosts:
Production300,000300,000
Sellingandadministrative60,00060,000
Totalfixedcosts360,000360,000
Income$40,000$40,000
IncomeStatementsAbsorptionCosting

MarchApril
Sales,at$7percase$700,000$700,000
Costofsales:
Beginninginventory:
30,000x($3+$2)*150,000
Productioncostsapplied:
Variable130,000x$3390,000
90,000x$3270,000
Fixedcostsapplied:
130,000x$2260,000
90,000x$2________180,000
Total650,000600,000
Endinginventory:
30,000x$5150,000
20,000x$5________100,000
Standardcostofsalesat$5500,000500,000
Volumevariance:
$300,000$260,00040,000U
$300,000$180,000________120,000U
Actualcostofsales540,000620,000
Grossmargin160,00080,000
Sellingandadministrative60,00060,000
Income$100,000$20,000
*Standardfixedoverheadperunitis$2($300,000totalfixedmanufacturing
costdividedby150,000unitsatpracticalcapacity).
2.B&Yshouldearnabout$40,000permonth,thevariablecostingincome.
Absorptioncostingincomedependsonproduction,whichovertimemust
133

approximatesales.Asinventoriesstabilize,incomewillapproach$40,000,
thevariablecostingequilibriumamount.
Thisanswerdoesnotrelyonthecompany'susingabsorptioncostingor
variablecosting.Inthelongrun,anymethodwillgivethesameresult.
(Youmightwanttopointoutthatvariablecostingisnotacceptablefortax
purposes,soincomedifferencescannotrisefrominvestingtaxsavings,as
canhappenwithLIFO.)
NotetotheInstructor:Youcandothisexercisewithoutthedetailsof
thecostofsalessection,asshownbelow.Thecostofsalessectioncanbe
usedtoshowhowthecostsflowandwhyincomesturnoutthewaytheydo,but
itisnotnecessary.
IncomeStatementsVariableCosting

MarchApril
Sales,at$7percase$700,000$700,000
Variablecostofsalesat$3300,000300,000
Contributionmargin400,000400,000
Fixedcosts:
Production300,000300,000
Sellingandadministrative60,00060,000
Totalfixedcosts360,000360,000
Income$40,000$40,000
IncomeStatementsAbsorptionCosting

MarchApril
Sales,at$7percase$700,000$700,000
Standardcostofsalesat$5500,000500,000
Volumevariance:
$300,000$260,00040,000U
$300,000$180,000_________120,000U
Actualcostofsales540,000620,000
Grossmargin160,00080,000
Sellingandadministrative60,00060,000
Income$100,000$20,000
NotetotheInstructor:Becausethisexerciseisquitestraightforward
anduncomplicatedbyvariancesforvariablecosts,itprovidesabasisfor
drawingattentiontotheessentialdifferencesbetweenvariableand
absorptioncosting.Youmay,forexample,wishtoaskthestudentsifthey
canexplainthedifferencesbetweentheincomesunderthetwomethods.The
explanationmightproceedasfollows:
Explanationofthedifferencesinincomeinthetwomonths

MarchApril
Differencestobeexplained:
Incomeundervariablecosting$40,000$40,000
Incomeunderabsorptioncosting100,00020,000
Differencetobeexplained:
Variablecostingincomesmaller$60,000
Variablecostingincomelarger$20,000
Priormonth'sfixedcostsdeferredto
currentmonthbyinclusioninthe
beginninginventory:
30,000x$2060,000
Currentmonth'sfixedcostsdeferredto
thenextmonthbyinclusioninthe
endinginventory:
30,000x$260,000
134

20,000x$240,000
Differenceinincomeduetofixed________________
costsininventory$60,000$20,000
139ActualCostingIncomeStatements(1520minutes)
1.
JanuaryFebruary
Sales,18,000x$30,22,000x$30$540,000$660,000
Costofsales:
Beginninginventory040,000
Productioncosts:
Variable,20,000x$10200,000200,000
Fixed200,000200,000
Totalavailableforsale400,000440,000
Lessendinginventory*40,0000
Costofsales360,000440,000
Grossmargin180,000220,000
Sellingandadministrativeexpenses40,00040,000
Income$140,000$180,000
Inventory,$400,000/20,000=$20perunit,times2,000units=$40,000.
ThereisnoinventoryattheendofFebruary,sonocalculationisneeded.
2.
JanuaryFebruary
Sales,18,000x$30,22,000x$30$540,000$660,000
Costofsales,variablecostsat$10/unit180,000220,000
Contributionmarginat$20360,000440,000
Fixedcosts,$200,000+$40,000240,000240,000
Income$120,000$200,000
Thecostofgoodssoldsectionsundervariablecostingappearbelow.
JanuaryFebruary
Beginninginventory$020,000
Variableproductioncosts,20,000x$10200,000200,000
Totalavailableforsale200,000220,000
Lessendinginventory,2,000x$1020,0000
Costofsales$180,000$220,000
3.
JanuaryFebruary
Sales,18,000x$30,22,000x$30$540,000$660,000
Costofsales,materialcostat$6xproduction120,000120,000
Throughput420,000540,000
Othercosts,$80,000+$200,000+$40,000320,000320,000
Income$100,000$220,000

1310StandardFixedCostandVolumeVariance(15minutes)
1.(a)(b)

NormalPractical
Budgetedfixedmanufacturingcosts$900,000$900,000
Dividedbycapacitymeasure225,000300,000
Equalsstandardfixedcostperunit$4$3

135

2.(a)(b)
Standardfixedcostperunit$4$3
Timesnumberofunitsproduced240,000240,000
Fixedoverheadappliedtoproduction$960,000$720,000
Lessbudgetedfixedoverhead900,000900,000
Volumevariance(unfavorable)$60,000($180,000)
Alternatively,thecalculationscouldbemadeusingthedifferences
betweenactualproductionandthevolumeusedtosetthestandardfixedcost.
VolumeUsedtoActualStandardVolume
SetStandardProductionDifferencexFixedCost=Variance
(a)225,000240,000(15,000)x$4$60,000F
(b)300,000240,00060,000x$3180,000U
1311Relationships(2025minutes)

1.(a)$10perunit$10,000favorablevariance/1,000unitsabovenormal
production
(b)$200,00020,000unitsx$10
2.(b)$60,00020,000unitsx$3
(c)17,000units$9,000unfavorablevariance/$3perunit=3,000units
belownormalof20,000
3.(a)$2perunit$40,000/20,000
(d)$4,000unfavorable(20,00018,000)x$2
4.(a)$7perunit$140,000/20,000
(c)22,000units$14,000favorablevariance/$7perunit=2,000units
morethannormalof20,000
1312EffectsofChangesinProductionStandardVariableCosting(15
minutes)

Production
40,000units41,000units
Sales(40,000x$10)$400,000$400,000
Variablecostofgoodssold:
Variableproductioncosts
40,000x$3$120,000
41,000x$3$123,000
Endinginventory
0x$30
1,000x$33,000
Variablecostofgoodssold
40,000x$3120,000120,000
Contributionmargin280,000280,000
Fixedproductioncosts200,000200,000
Income$80,000$80,000

136

NotetotheInstructor:Weaskedforincomestatementsforbothlevels
ofproductiontoallowyoutohighlighthowincreasesinvariablecost
occurringbecauseofincreasesinproductionaredeferredininventory,
thereforehavingnoeffectonincome.Moststudentsshouldseethatincome
willbethesamenomatterwhatproductionis.Youmightthereforereiterate
thatincomecanbecomputedaswedidasearlyasChapter2.
Salesvariablecostsfixedcosts=income
(40,000x$10)(40,000x$3)$200,000=$80,000
1313EffectsofChangesinProductionStandardAbsorptionCosting(1520
minutes)

Production
40,000units41,000units
Sales(40,000x$10)$400,000$400,000
Costofgoodssold:
Variableproductioncosts$120,000$123,000
Appliedfixedproductioncosts
40,000x$5200,000
41,000x$5________205,000
Costofgoodsavailableforsale320,000328,000
Endinginventory
0x$80
1,000x$8________8,000
Costofgoodssold(40,000x$8)320,000320,000
Standardgrossprofit(40,000x$2)80,00080,000
Volumevariance,favorable(1,000x$5)05,000
Income$80,000$85,000
NotetotheInstructor:Weaskedfordetailsofthecostofsales
sectionsothatyoucanshowhowincreasesinproductionleadtoincreasesin
appliedfixedcostswithacorrespondingincreaseinendinginventoryanda
morefavorable(orlessunfavorable)volumevariance.The1,000unit
increaseinproductionleadstoanincreaseinthefixedcostsininventory
of$5,000,whichisalsotheincreaseinincome.
1314"NowWaitaMinuteHere."(20minutes)
Thisassignmentshowstherelationshipsofincometosalesand
production.
Sales10,000Sales10,000Sales10,001Sales9,999
Prod.10,000Prod.10,001Prod.10,001Prod.10,001

Salesat$10$100,000$100,000$100,010$99,990
Costofsalesat$770,00070,00070,00769,993
Standardgrossmargin30,00030,00030,00329,997
Volumevariance06F6F6F
Actualgrossmargin$30,000$30,006$30,009$30,003
Thehighestprofitiswithsalesandproductionat10,001,butthe
lowestiswithsalesandproductionat10,000.Salesof9,999with
productionof10,001givesahigherprofitthansalesof10,000with
productionof10,000.Salesof10,000withproductionof10,001givesthe
secondbestprofit.Inotherwords,productionincreasesincomemorethan
doessales.Thecompanyincreasesitsprofitby$6foreachadditionalunit
itproduces,whilesellinganadditionalunitgains$3($10$7),and
producingandsellinganotherunitgains$9,the$6forproducingandthe$3
forselling.

137

1315AllFixedCostCompany(2530minutes)
Thisproblemshowstheeffectsonbothincomeandthebalancesheetof
thetwocostingmethods.Thereconcilingfactorbetweenincomesinboth
yearsisthe$80,000absorptioncostinginventory,increasein20X2,decrease
in20X3.
1.20X220X3
Sales,120,000x$6$720,000$720,000
Costofsales:
Beginninginventory$0$120,000
Costsappliedat$4600,000360,000
Totalavailable600,000480,000
Endinginventoryat$4120,0000
Standardcostofsalesat$4480,000480,000
Standardgrossmargin240,000240,000
Volumevariance100,000F
140,000U
Actualgrossmarginandprofit$340,000$100,000
Volumevariancesare$600,000$500,000and$360,000$500,000.
2.Balancesheets

20X220X3
Cash=cumulativesales$720,000$1,440,000
Inventory,30,000x$4120,0000
Plant,net2,000,0001,500,000
Totalassets$2,840,000$2,940,000
Stockholders'equity($2,500,000+$340,000)$2,840,000
($2,840,000+$100,000)$2,940,000
3.
Sales$720,000$720,000
Fixedcosts500,000500,000
Profit$220,000$220,000
Balancesheets
Cash=cumulativesales$720,000$1,440,000
Plant,net2,000,0001,500,000
Totalassets$2,720,000$2,940,000
Stockholders'equity($2,500,000+$220,000)$2,720,000
($2,720,000+$220,000)$2,940,000
1316BasicAbsorptionCosting(1520minutes)

April
Sales,9,000x$100$900,000
Standardcostofsales,9,000x$65585,000
Standardgrossmargin,9,000x$35315,000
Volumevariance*80,000F
Actualgrossmargin395,000
Sellingandadministrativeexpenses280,000
Profit$115,000
*
138

Actualproduction12,000
Normalactivity10,000
Difference2,000
Standardfixedcost$40
Volumevariance,favorable$80,000
Anexpandedcostofgoodssoldsectionappearsasfollows.
Beginninginventory$0
Variableproductioncosts,12,000x$25300,000
Fixedproductioncosts,12,000x$40480,000
Total,12,000x$65780,000
Lessendinginventory,3,000x$65195,000
Standardcostofsales,9,000x$65$585,000
Notethatthevolumevarianceisalsothedifferencebetweenapplied
fixedoverheadof$480,000andbudgetedfixedoverheadof$400,000.

May
Sales,11,000x$100$1,100,000
Standardcostofsales,11,000x$65715,000
Standardgrossmargin,11,000x$35385,000
Volumevariance*40,000U
Actualgrossmargin345,000
Sellingandadministrativeexpenses280,000
Profit$65,000
*
Actualproduction9,000
Normalactivity10,000
Difference1,000
Standardfixedcost$40
Volumevariance,unfavorable$40,000
Beginninginventory,3,000x$65$195,000
Variableproductioncosts,9,000x$25225,000
Fixedproductioncosts,9,000x$40360,000
Availableforsale,12,000x$65780,000
Lessendinginventory,1,000x$6565,000
Standardcostofsales,11,000x$65$715,000
NotetotheInstructor:Youmightwishtopointoutthatprofitdropped
by$50,000,whilesalesincreased22.1%(from9,000to11,000units).You
mightremindstudentsthatChapter2showedhowincomeincreasesmorerapidly
thansaleswhenacompanyhasfixedcosts.Amanagerlookingatthese
statementsmustwonderwhytheincreaseinincomelaggedthatofsaleswhen
thecoststructureremainedthesame.Thenextexerciseinthisseries
allowsyoutoshowhowvariablecostingalleviatesthisproblem.
1317BasicVariableCosting(Continuationof1316)(1520minutes)
1.

April
Sales,9,000x$100$900,000
Standardvariablecostofsales,9,000x$25225,000
Contributionmargin,9,000x$75675,000
Fixedcosts:
Manufacturing$400,000
Sellingandadministrative280,000
139

Totalfixedcosts680,000
Loss($5,000)
Anexpandedcostofgoodssoldsectionshows
Beginninginventory$0
Variableproductioncosts,12,000x$25300,000
Lessendinginventory3,000x$2575,000
Standardcostofsales9,000x$25$225,000

May
Sales,11,000x$100$1,100,000
Standardvariablecostofsales,11,000x$25275,000
Contributionmargin,11,000x$75825,000
Fixedcosts:
Manufacturing$400,000
Sellingandadministrative280,000
Totalfixedcosts680,000
Profit$145,000
Anexpandedcostofgoodssoldsectionshows
Beginninginventory,3,000x$25$75,000
Variableproductioncosts,9,000x$25225,000
Total,12,000x$25300,000
Lessendinginventory,1,000x$2525,000
Standardcostofsales,11,000x$25$275,000
2.Jaspershouldearnabout$145,000permonth,thevariablecostingincome.
Absorptioncostingincomedoesnotreflectlongrunearningpowerwhen
productionandsalesdiffer.Overthelongrun,salesandproductionwould
havetoapproximateoneanother,bringingtotalincometothevariable
costingequilibriumamount.
NotetotheInstructor:Inconnectionwiththepreviousexercise,you
mightwishtoshowhowincomeisaffectedunderthetwocostingmethods.
Usingvariablecosting,weseethefollowing.
Lossat9,000units($5,000)
Contributionmarginon2,000unitsat$75150,000
Incomeat11,000units$145,000
Incomeunderabsorptioncostingismorecomplicated.Bothsalesand
productionaffectresults.Thefollowinganalysismightbeuseful.
Incomeat9,000units$115,000
Lessinventoryeffect,(12,0009,000)x$40120,000
Lossat9,000unitsifproductionequalssales($5,000)
Incomeat11,000units$65,000
Plusinventoryeffect,(11,0009,000)x$4080,000
Incomeifproductionequalssales$145,000
1318ThroughputCosting(Continuationof1316)(15minutes)
Costofsalesisnowthecostofmaterialsusedinproduction,andallother
costsareexpensed.Materialcostis$15perunit,sodirectlaborand
variableoverheadare$10($25$15).

April
Sales,9,000x$100$900,000
Costofsales,12,000x$15180,000
1310

Margin720,000
Operatingexpenses:
Directlaborandvariableoverhead,12,000x$10$120,000
Fixedmanufacturing400,000
Sellingandadministrativeexpenses280,000800,000
Loss($80,000)

May
Sales,11,000x$100$1,100,000
Standardvariablecostofsales,9,000x$15135,000
Margin965,000
Operatingexpenses:
Directlaborandvariableoverhead,9,000x$10$90,000
Manufacturing400,000
Sellingandadministrative280,000770,000
Profit$195,000
Thedifferencesamongthethreemethodsare,asalways,differencesin
inventories.Thetablebelowsummarizesthedifferences.Absorptionand
variablecostingtreatonlyoneelement,fixedproductioncosts,differently.
Throughputcostingtreatsallelementsdifferentlyfromtheothertwomethods
exceptthatvariablecostingalsoexpensesfixedproductioncostsas
incurred.

OtherVariableFixed
MaterialsProductionCostsProductionCosts
AbsorptioncostingXXX
VariablecostingXXY
ThroughputcostingZYY
X=treatasproductcost,Y=expenseasincurred,Z=expenseasusedin
production

1319EffectofMeasureofActivity
(Continuationof1316)(1520
minutes)
Standardfixedcostis$16perunit,$400,000/25,000,andtotalstandard
costis$41.

April
Sales,9,000x$100$900,000
Standardcostofsales,9,000x$41369,000
Standardgrossmargin,9,000x$59531,000
Volumevariance*128,000U
Actualgrossmargin403,000
Sellingandadministrativeexpenses280,000
Profit$123,000
*Actualproduction12,000
Practicalcapacity20,000
Difference(8,000)
Standardfixedcost$16
Volumevariance,unfavorable($128,000)
Anexpandedcostofgoodssoldsectionappearsasfollows.
Beginninginventory$0
Variableproductioncosts,12,000x$25300,000
1311

Fixedproductioncosts,12,000x$16192,000
Total,12,000x$41492,000
Lessendinginventory,3,000x$41123,000
Standardcostofsales,9,000x$41$369,000

May
Sales,11,000x$100$1,100,000
Standardcostofsales,11,000x$41451,000
Standardgrossmargin,11,000x$59649,000
Volumevariance*(176,000)U
Actualgrossmargin473,000
Sellingandadministrativeexpenses280,000
Profit$193,000
*
Actualproduction9,000
Practicalcapacity20,000
Difference(11,000)
Standardfixedcost$16
Volumevariance,unfavorable($176,000)
Beginninginventory,3,000x$41$123,000
Variableproductioncosts,9,000x$25225,000
Fixedproductioncosts,9,000x$16144,000
Availableforsale,12,000x$41492,000
Lessendinginventory,1,000x$4141,000
Standardcostofsales,11,000x$41$451,000

Thedifferencesareinthestandardcosts,affectingbothinventoryand
costofgoodssold.Usingpracticalcapacitygivesalowerstandardcostof
salesbecausethestandardcostislower,butitgiveshigher(more
unfavorable)volumevariancesbecausethebasisforsettingthestandardis
higher.IncomewashigherinApril,andlowerinMay,thanwhenthecompany
usednormalcapacity.Ifproductionexceedssales,incomewillbehigherfor
themethodthathasthehigherunitcost,andviceversa.Thisrelationship
worksthesameasthatbetweenvariablecostingandabsorptioncosting,and
forthesamereason.
1320AbsorptionCosting(1520minutes)
NotetotheInstructor:Thisproblemanditssequelincludevariable
costvariances,afixedoverheadbudgetvariance,andavolumevariance.
1.
Sales,90,000x$400$36,000,000
Standardcostofsales,90,000x$25022,500,000
Standardgrossmargin,90,000x$15013,500,000
Volumevariance*$600,000U
Fixedoverheadspendingvariance*130,000F
Variablecostvariances**50,000F420,000U
Actualgrossmargin13,080,000
Sellingandadministrativeexpenses10,550,000
Profit$2,530,000
*
ActualFixedOverheadBudgetedFixedOverheadAppliedFixed
Overhead96,000x
$150
$14,870,000$15,000,000$14,400,000
$130,000F$600,000U
BudgetvarianceVolumevariance
1312

**
ActualVariableCostStandardVariableCost
96,000x$100
$9,550,000$9,600,000
$50,000F
Variableoverheadvariances
Wecannotdeterminehowmuchofthevariablecostvariancerelatesto
spendingandhowmuchtoefficiency.
Anexpandedcostofgoodssoldsectionappearsasfollows.

Beginninginventory$0
Variableproductioncosts,96,000x$1009,600,000
Fixedproductioncosts,96,000x$15014,400,000
Total,96,000x$25024,000,000
Lessendinginventory,6,000x$2501,500,000
Standardcostofsales,90,000x$250$22,500,000
1321VariableCosting(1520minutes)
NotetotheInstructor:Youmightwishtoignorethefixedoverhead
budgetvariance.Weshoweditbecauseitisaneconomicvariance.Moreover,
studentstendtoforgetthatcompaniesusingvariablecostingstillplanand
controlfixedcosts.
1.
Sales,90,000x$400$36,000,000
Standardcostofsales,90,000x$1009,000,000
Standardvariablemanufacturingmargin,90,000x$30027,000,000
Variablecostvariances50,000F
Variablemanufacturingmargin27,050,000
Fixedcosts:
Budgetedmanufacturingcosts$15,000,000
Budgetvariance130,000F
Sellingandadministrative10,550,000
Totalfixedcosts25,420,000
Profit$1,630,000
Anexpandedcostofgoodssoldsectionappearsasfollows.
Beginninginventory$0
Variableproductioncosts,96,000x$1009,600,000
Lessendinginventory,6,000x$100600,000
Standardcostofsales,90,000x$100$9,000,000
Thedifferenceinincomesbetweenthisandthepreviousexerciseisthe
$900,000fixedcostsintheendinginventory(6,000x$150).
1322InterpretingResults(15minutes)
1.February,35,000units;March,16,000units
FebruaryMarch
Volumevariance=$6xdifferencebetweenactual$60,000F$54,000U
productionand25,000units
Dividedby$6equalsdifferencebetweenactual
productionand25,000units(under)10,000(9,000)
1313

Normalcapacity25,00025,000
Production35,00016,000
2.Theresultsthatthepresidentbelievesstrangeoccurbecauseabsorption
costingdefersfixedproductioncostsininventory,sothatinperiodsof
highproduction,profitwillbehigherthaninperiodsoflowproduction,
salesbeingthesame(oreven,ashere,withhighersalesinthelow
productionperiod).
Itisnotthevolumevariancepersethatcausestheresults,as
studentsoftenthink.Rather,itisthedeferraloffixedcostsin
inventory.
3.Incomestatementsusingvariablecosting

FebruaryMarch
Sales$480,000$680,000
Variablecostofsales48,00068,000
Contributionmargin432,000612,000
Fixedcosts270,000270,000
Income$162,000$342,000
Variablecostofsales:Unitvolumes=24,000and34,000,fromrevenue/$20
sellingprice.Wecanuseeithermonthtofindstandardvariablecostof
sales,inseveralways.Perhapsthemostobviousis
Februarystandardcostofsales$192,000
DividedbyFebruarysales24,000
Standardcostofsales$8
Lessstandardfixedcostof$6=standardvariablecost$2
Fixedcosts=$120,000sellingandadministrativeplus$150,000fixed
productioncosts(25,000x$6).
Thevariablecostingincomestatementspresentthepicturemuchbetter.
Profitsroseby$180,000($342,000$162,000),accompanyinga10,000unit
salesincrease.Contributionmarginis$18perunit,$20$2.

1323IncomeDeterminationAbsorptionCosting(2025minutes)
Standardcostcalculations:

Standardfixedcostperunit:
Fixedproductioncosts$960,000
Productionbasis80,000=$12perunit
Standardfixedcostperunit:
Fixedproductioncosts$960,000
Productionbasis120,000=$8perunit

Withthe$8standardvariablecost($880,000/110,000),thetotalstandard
costsare$20and$16.
80,000unit120,000unit

BasisBasis
Sales,90,000units$2,700,000$2,700,000
Standardcostofsales1,800,0001,440,000
Volumevariance:
$960,000$1,320,000360,000F
1314

$960,000$880,000__________80,000U
Actualcostofgoodssold1,440,0001,520,000
Grossprofit1,260,0001,180,000
Sellingandadministrativecosts250,000250,000
Income$1,010,000$930,000
Anexpandedcostofsalessectionshowsthefollowing.
Productioncosts:
Variable(110,000x$8)$880,000$880,000
Fixed:
110,000x$121,320,000
110,000x$8__________880,000
Total2,200,0001,760,000
Lessendinginventory:
20,000x$20400,000
20,000x$16320,000
Standardcostofsales$1,800,000$1,440,000
NotetotheInstructor:Youmightwishtoshowthatthe$80,000
differencebetweenthetwoincomesisthe$4differenceinstandardfixed
costmultipliedbythe20,000unitchangeininventory.
1324IncomeDeterminationVariableCosting(Continuationof1323)(1520
minutes)
Sales$2,700,000
Costofgoodssold:
Variableproductioncosts(110,000x$8)$880,000
Lessendinginventory(20,000x$8)160,000
Standardcostofsales720,000
Standardvariablemanufacturingmargin1,980,000
Fixedcosts:
Production$960,000
Sellingandadministrative250,0001,210,000
Income$770,000
NotetotheInstructor:Youmightwishtoshowthatthedifference
betweenincomehereandinthepreviousexerciseisthefixedcostsin
inventory.
80,000unitbasis120,000unitbasis
Fixedcostsinendinginventory:
20,000x$12$240,000
20,000x$8$160,000
Addvariablecostingincome770,000770,000
Absorptioncostingincome$1,010,000$930,000
1325Relationships(1520minutes)
1.(c)$240,000
Sales(80,000x$10)$800,000
Variablecostofgoodssold(80,000x$4)320,000
Contributionmargin,variablecosting($10$4)480,000
Fixedcosts240,000
Income,variablecosting$240,000
(b)70,000units
Incomeundervariablecosting(partc)$240,000
Incomeunderabsorptioncosting(given)210,000
1315

Differenceinincome,absorptioncostinglower$30,000
Dividedbyperunitfixedcostusedunder
absorptioncosting($240,000/80,000)$3
Equalschangeininventory10,000units
Becauseabsorptioncostingincomeislower,theinventorychangeisnegative
(inventorydeclines),sothatproductionmusthavebeen10,000unitslower
thansales.
2.(a)50,000units
Incomeundervariablecosting$60,000
Addfixedcosts240,000
Equalscontributionmargin$300,000
Dividedbycontributionmarginperunit$6
Equalssales,inunits50,000
(b)70,000units
Incomeunderabsorptioncosting$120,000
Lessincomeundervariablecosting60,000
Equalsincomedifferenceduetoinventorychange,
absorptioncostinghigher$60,000
Dividedbyperunitfixedcost,absorption$3
Equalsinventorychange20,000units
Becauseabsorptioncostingincomeishigher,theinventorychangeispositive
(inventoryincreases),sothatproductionmusthavebeen20,000unitshigher
thansales.
3.(c)$120,000
Totalcontributionmargin[60,000x($10$4)]$360,000
Lessfixedcosts240,000
Income,variablecosting$120,000
(d)$105,000
Incomeundervariablecosting$120,000
Inventorychange(60,00055,000)5,000
Timesfixedcostperunit$3
Equalsthedifferencebetweenincomeunder
variableandunderabsorptioncosting15,000
Absorptioncostingincome$105,000
(Thedifferenceissubtractedbecauseabsorptioncostingincomeislowerthan
variablecostingincomewheninventorydecreases,whichisthecasehere.)
NotetotheInstructor:Somestudentshavegreatdifficultywithallor
partsofthisassignment,butthosewhounderstandthetwocostingmethods
andtherelationshipsamongsales,production,andincomeshouldbeableto
completetheproblemsuccessfullywithlittledifficulty.Acriticalstepis
torecognizethatthedifferencebetweenincomesunderthetwocosting
methodswillrelatetochangesininventoryand,morespecifically,tothe
changeinfixedcostsininventory.Hence,animportantfirstcalculationis
the$3perunitfixedcost.
Wehavefoundthatstudentswhoattacktheassignmentmethodicallyhave
takenoneoftwoapproaches.Onegroupexpressesincomeundereachmethodin
formulafashion,toseetherelationships.Thus,

1316

Income,variable=(unitsalesxunitcontributionmargin)fixedcosts
costing
=(unitsalesx($10$4)$240,000
Income,absorption=variablecostingincome+/(inventorychangex
costingperunitfixedcost)
=variablecostingincome+/(inventorychange
x$3)
Thesecondgroup,perhapslessinventivebutwithanunderstandingofthe
calculationofthevolumevariance,willworktowardtheanswersbyfilling
inthedetailsofincomestatementsreflectingeachmethod.
1326AllFixedCompany(20minutes)
1.Absorptioncosting

MayJuneJuly
Unitsales9,00010,00011,000
Unitproduction11,00010,0009,000
Salesat$5$45,000$50,000$55,000
Beginninginventory04,0004,000
Appliedfixedcostsat$222,00020,00018,000
Availableforsale22,00024,00022,000
Lessendinginventoryat$24,0004,0000
Standardcostofsalesat$218,00020,00022,000
Standardgrossmarginat$327,00030,00033,000
Volumevariance*2,000F02,000U
Profit$29,000$30,000$31,000
*$20,000appliedfixedproductioncostsor([actualunits10,000]x
$2).
NotetotheInstructor:Thisexercisehighlightsthedifferences
betweenabsorptioncostingandvariablecosting.Intherequiredformat,
withsimplenumbers,itiseasytoseeseveralimportantrelationships.
Appliedfixedproductioncostsandthevolumevarianceaddupto$20,000,
budgetedfixedcosts.Thatis,allfixedcostsgothroughthecalculationof
income,withtheamountsdeferredininventory(beginningandending)being
thedifferencebetweenabsorptioncostingandvariablecosting.Thus,the
differenceinincomeinthefirstmonthwillbe$4,000(absorptionover
variable),zerointhesecondmonthbecausethereisnochangein
inventories,and$4,000inthethirdmonth(variableoverabsorption).Itis
alsoworthnotingthattotalexpensesontheincomestatementequalstandard
costofsalesplus/minusthevolumevariance,$16,000($18,000$2,000)in
May,$20,000inJune,and$24,000($22,000+$2,000)inJuly.
2.Variablecosting

MayJuneJuly
Salesat$5$45,000$50,000$55,000
Fixedcosts20,00020,00020,000
Profit$25,000$30,000$35,000
Becausetherearenovariablecosts,profitissimplysales$20,000.
1327StandardCostingAbsorptionandVariable(2030minutes)
1.$32$15+$6+$11Variableoverhead=$2x0.50=$1.Fixed
overhead=$500,000/50,000=$10,or($500,000/25,000DLH)x0.50DLHper
1317

unitofproduct.Totalstandardvariableproductioncostsare$22.
2.
Sales(40,000x$40)$1,600,000
Standardcostofsales:
Appliedvariableproductioncosts(45,000x$22)$990,000
Appliedfixedproductioncosts(45,000x$10)450,000
Availableforsale(45,000x$32)1,440,000
Endinginventory(5,000x$32)160,000
Standardcostofsales(40,000x$32)1,280,000
Standardgrossmargin[40,000x($40$32)]320,000
Volumevariance[(45,00050,000)x$10]50,000U
Actualgrossmargin270,000
Sellingandadministrativeexpenses200,000
Income$70,000

3.
Sales(40,000x$40)$1,600,000
Standardvariablecostofsales:
Appliedvariableproductioncosts(45,000x$22)$990,000
Endinginventory(5,000x$22)110,000
Standardvariablecostofsales(40,000x$22)880,000
Standardvariablegrossmargin[40,000x($40$22)]720,000
Fixedproductioncosts$500,000
Sellingandadministrativeexpenses200,000
Totalfixedcosts700,000
Income$20,000
Alternatively,incomeissimply[40,000x($40$22)]$700,000=$720,000
$700,000=$20,000.
1328AbsorptionCostingandVariableCosting(2025minutes)
1.$40,$600,000/15,000
2.Incomestatement
Sales,14,000x$90$1,260,000
Standardcostofsales,14,000x$65910,000
Standardgrossmargin,14,000x$25350,000
Volumevariance*40,000F
Actualgrossmargin390,000
Sellingandadministrativeexpenses160,000
Profit$230,000
*
Actualproduction16,000
Normalactivity15,000
Difference1,000
Standardfixedcost(requirement1)$40
Volumevariance,favorable$40,000
Anexpandedcostofgoodssoldsectionfollows.

1318

Beginninginventory,3,000x$65$195,000
Variableproductioncosts,16,000x$25400,000
Fixedproductioncosts,16,000x$40640,000
Totalavailable,19,000x$651,235,000
Lessendinginventory,5,000x$65325,000
Standardcostofsales,14,000x$65$910,000
3.Incomestatement,variablecosting
Sales,14,000x$90$1,260,000
Standardvariablecostofsales,14,000x$25350,000
Contributionmargin,14,000x$65910,000
Fixedcosts:
Manufacturing$600,000
Sellingandadministrative160,000
Totalfixedcosts760,000
Profit$150,000
Anexpandedcostofgoodssoldsectionfollows.

Beginninginventory,3,000x$25$75,000
Variableproductioncosts,16,000x$25400,000
Totalavailable,19,000x$25475,000
Lessendinginventory,5,000x$25125,000
Standardcostofsales,14,000x$25$350,000
1329AbsorptionCostingandVariableCostingVariances(1520minutes)
1.$3perunit,$900,000/300,000;totalstandardcostis$9,$3+$6
2.
ActualFixedOverheadBudgetedFixedOverheadAppliedFixed
Overhead
$3x290,000
$910,000$900,000$870,000
$10,000U$30,000U
BudgetvarianceVolumevariance
$40,000U
Totalfixedoverheadvariances
Totalactualvariablecosts$1,715,000
Totalstandardvariablecosts(290,000x$6)1,740,000
Variablecostvariances25,000F
Fixedoverheadvariances40,000U
Totalvariances$15,000U
3.
Sales(270,000x$20)$5,400,000
Standardcostofsales(270,000x$9)$2,430,000
Variances15,000U
Costofsales2,445,000
Grossmargin2,955,000
Sellingandadministrativeexpenses800,000
Income$2,155,000
4.
Sales(270,000x$20)$5,400,000
Standardcostofsales(270,000x$6)$1,620,000
Variablecostvariances25,000F1,595,000
1319

Grossmarginandcontributionmargin3,805,000
Fixedcosts($800,000+$910,000)1,710,000
Income$2,095,000
1330BudgetedIncomeStatements(20minutes)
1.Absorptioncostingincomestatement
Sales,37,000x$70$2,590,000
Standardcostofsales,37,000x$401,480,000
Standardgrossmargin,37,000x$301,110,000
Volumevariance*25,000U
Actualgrossmargin1,085,000
Sellingandadministrativeexpenses:
Variable,37,000x$8$296,000
Fixed600,000896,000
Profit$189,000
*Budgetedproduction39,000
Normalactivity40,000
Difference1,000
Standardfixedcost$25
Volumevariance,unfavorable$25,000
Anexpandedcostofgoodssoldsectionappearsasfollows.
Variableproductioncosts,39,000x$15$585,000
Fixedproductioncosts,39,000x$25975,000
Totalavailable,39,000x$401,560,000
Lessendinginventory,2,000x$4080,000
Standardcostofsales,37,000x$40$1,480,000
2.Incomestatement,variablecosting
Sales,37,000x$70$2,590,000
Standardvariablecostofsales,37,000x$15555,000
Variablemanufacturingmargin,37,000x$552,035,000
Variablesellingand
administrativeexpenses,37,000x$8296,000
Contributionmargin,37,000x$47*1,739,000
Fixedcosts:
Manufacturing$1,000,000
Sellingandadministrative600,0001,600,000
Profit$139,000
*$70$15$8=$47contributionmargin
Anexpandedcostofgoodssoldsectionfollows.
Variableproductioncosts,39,000x$15$585,000
Lessendinginventory,2,000x$1530,000
Standardcostofsales,37,000x$15$555,000
The$50,000differenceinincome($189,000$139,000)isexplainedby
thefixedoverheadintheendinginventory($25x2,000pairs).
1331AnalysisofResults(Continuationof1330)(30minutes)
1.Absorptioncostingincomestatement

1320

Sales,40,000x$70$2,800,000
Standardcostofsales,40,000x$401,600,000
Standardgrossmargin,40,000x$301,200,000
Volumevariance*25,000F
Actualgrossmargin1,225,000
Sellingandadministrativeexpenses:
Variable40,000x$8$320,000
Fixed600,000920,000
Profit$305,000
*
Actualproduction41,000
Normalactivity40,000
Difference1,000
Standardfixedcost$25
Volumevariance,favorable$25,000
Anexpandedcostofsalessectionappearsbelow.
Variableproductioncosts,41,000x$15$615,000
Fixedproductioncosts,41,000x$251,025,000
Totalavailable,41,000x$401,640,000
Lessendinginventory,1,000x$4040,000
Standardcostofsales,40,000x$40$1,600,000
2.Incomestatement,variablecosting
Sales,40,000x$70$2,800,000
Standardvariablecostofsales,40,000x$15600,000
Variablemanufacturingmargin,40,000x$552,200,000
Variablesellingand
administrativeexpenses,40,000x$8320,000
Contributionmargin,40,000x$471,880,000
Fixedcosts:
Manufacturing$1,000,000
Sellingandadministrative600,0001,600,000
Profit$280,000
Anexpandedcostofgoodssoldsectionfollows.
Variableproductioncosts,41,000x$15$615,000
Lessendinginventory,1,000x$1515,000
Standardcostofsales,40,000x$15$600,000
3.Thevariablecostingincomestatementsprovideabetterbasisfor
analyzingresults.Incomechangespurelyasafunctionofthechangein
sales.Thehigherincome(actualversusbudgeted)underabsorptioncosting
isdueinparttoincreasedproduction,whereundervariablecostingitis
duesolelytoincreasedsales.Becausegoodsmustbesoldtoincreaseprofit
(atleastatsomepointtheymustbesold),variablecostingprovidesa
betterbasisforevaluatingresults.
1332AnalysisofIncomeStatementStandardCosts(25minutes)
1.(a)24,000units,volumevariance/applicationrate=$8,000/$2=4,000
unitsovernormalactivityof20,000units
(b)$7,000favorable
Standarduseofmaterials(24,000x16)384,000
1321

Materialsused370,000
Usebelowstandard14,000
Materialusevarianceat$0.50perpound$7,000
(c)$10,000unfavorable,totalunfavorablevarianceof$3,000+the
favorableusevariancecalculatedinpartb.
(d)$12,000favorable
Standardhours(24,000x2hours/unit)48,000
Actualhours47,000
Hoursabovestandard1,000
Varianceat$12perhour$12,000
(e)$8,000unfavorable,totalfavorablelaborvarianceof$4,000the
$12,000favorableefficiencyvariancefrompartd
(f)$1,000favorable,1,000hoursunderstandardfrompartdx$1
standard
variableoverheadrateperhour
(g)$3,000unfavorable,totalunfavorablevariableoverheadvarianceof
$2,000+thefavorableefficiencyvariancefrompartf
(h)$37,000
Totalbudgetedfixedoverhead
$2standardratex20,000units$40,000
Fixedoverheadspendingvariance,favorable3,000
Actualfixedoverhead$37,000
2.Variablecostingincomestatement
Sales(20,000x$50)$1,000,000
Standardvariablecostofsales(20,000x$34)680,000
Standardgrossmargin320,000
Variances:
Materials$3,000U
Labor4,000F
Variableoverhead2,000U1,000U
Actualgrossmargin319,000
Fixedcosts:
Production$37,000
Sellingandadministrative230,000267,000
Income$52,000
Notethattheincomesareeasilyreconciled:
Increaseininventory(24,00020,000)4,000
Multipliedby$2standardfixedcost$2
Differenceinincomes($60,000$52,000)$8,000
1333ConversionofAbsorptionCostingStatementfromNormaltoPractical
Capacity(Continuationof1332)(1520minutes)
1.$1.60($40,000/25,000)
2.
Sales$1,000,000
Standardcostofsales(20,000x$35.60)*712,000
Standardgrossprofit288,000
Variances:
Materials$3,000U
Labor4,000F
Variableoverhead2,000U
1322

Fixedoverheadbudget3,000F
volume**1,600U400F
Actualgrossprofit288,400
Sellingandadministrativeexpenses230,000
Income$58,400
*$34+$1.60
**$1.60x(25,00024,000)=$1,600unfavorable
NotetotheInstructor:Youmightaskstudentswhethertheycan
reconcileincomeherewiththatin1331.Thedifferenceinincomesof
$1,600($60,000$58,400)isthedifferenceinunitfixedcosts($2.00
$1.60)multipliedbytheincreaseof4,000units.
Fixedcostsinendinginventoryat$2($2x4,000)$8,000
Fixedcostsinendinginventoryat$1.60($1.60x4,000)6,400
Differenceinincomes($60,000$58,400)$1,600
1334ReconcilingIncomesAbsorptionCosting(20minutes)
1.
Sales(214.0x$20)$4,280.0
Standardcostofsales(214.0x$9)1,926.0
Standardgrossmargin2,354.0
Volumevariance*50.0U
Actualgrossmargin2,304.0
Sellingandadministrativeexpenses1,800.0
Income$504.0
*(220.0210.0)x$5=$50UAlternatively,
Budgetedfixedmanufacturingcost(220x$5)$1,100
Appliedfixedmanufacturingcost(210x$5)1,050
Unfavorablevolumevariance$50
Therewasnofixedoverheadbudgetvariance,norvariablecostvariances.
Budgetedvariablecostsfor210,000unitsare$840,000,whichequalledactual
variablecosts.

2.
Memorandum

To:LynnMaffett
From:Student
Subj:Operatingresults
Date:Today
Thedifficultywithinterpretingourresultsisthatweuseabsorption
costing.Underabsorptioncosting,ourincomedependspartlyonproduction.
Theoriginalbudgetassumedthatwewouldproduce220thousandunits,butwe
actuallyproducedonly210thousandunits.Wethereforedeferred$50
thousandlessfixedcostthanoriginallyplanned[(220210)x$5].
Theeffectofthechangeinproductionisgreaterthanthatofthechange
insales.Areconciliationoftheincomesis:
Standardgrossmargin,actualresults(214.0x$11)$2,354.0
Standardgrossmargin,budgetedresults(211.5x$11)2,326.5
Difference(2.5x$11)$27.5
Lessdifferenceinfixedoverheaddeferral50.0
Differenceinincomes$22.5

1323

NotetotheInstructor:Thedifferenceinvolumevariances(between
budgetedandactual)equalstheactualvolumevariancebecausethebudgeted
amountwaszero.Notethathadtherebeenabudgetedvolumevariance,it
wouldbenecessarytousethedifferencesinvolumevariances,nottheactual
amount.
Itisworthpointingoutthatthebudgetedincomestatementshowsincome
higherthanthecompanycanmaintainatthatlevelofsales,whichreflects
productioninexcessofsales.Thecompanycannotcontinueforlongto
produceinexcessofsales.Thesequeltothisassignmentusesvariable
costingandshowsthatproductiondoesnotaffectincomeusingthatmethod.

1335ReconcilingIncomesVariableCosting(Continuationof1334)(15
minutes)
1.Budgetedincomestatement
Sales(211.5x$20)$4,230.0
Standardcostofsales(211.5x$4)846.0
Contributionmargin3,384.0
Fixedcosts($1,800+$1,100)*2,900.0
Income$484.0
*220x$5,from1333
Actualincomestatement

Sales(214.0x$20)$4,280.0
Standardcostofsales(214.0x$4)856.0
Contributionmargin3,424.0
Fixedcosts2,900.0
Income$524.0
2.Thedifferenceinincomesof$40thousand($524$484)issimplythe
additionalcontributionmarginfromselling2,500moreunits.
Additionalvolume2,500
Timescontributionmargin($20$4)$16
Additionalcontributionmargin$40,000
Thechangeinproductionisirrelevant,asisthelevelofproduction,so
thatthevariablecostingincomestatementsgiveaclearerpictureofthe
economicsituationthandotheabsorptioncostingstatements.
1336AnalyzingIncomeStatements(1520minutes)
1.StatementAwaspreparedusingvariablecosting,statementBusing
absorptioncosting.Wecandeterminethisseveralways:(1)productioncosts
arehigherinstatementBbecausefixedcostsareincluded;(2)ending
inventoryishigherinstatementBbecauseofthefixedcostsincludedin
inventory;(3)"othercosts"arehigherinstatementAbecauseofthe
inclusionoffixedcostsasadirectchargeoffintheincomestatement.
2.(a)$900,000,thedifferencebetweenproductioncostsinthetwo
statements
(b)$300,000,theamountshownas"othercosts"instatementB

1324

(c)30,000units.Sinceonethirdofproductioncostsareincludedin
endinginventoryinbothstatementsand20,000unitsweresold,20,000is
twothirdsofproduction.Also,thevariablecostingstatementshows
$1,800,000inproductioncosts(mustbeonlyvariablecosts);sincevariable
costperunitis$60,productionmusthavebeen30,000units
($1,800,000/$60).
(d)Endinginventoryis10,000units(productionof30,00020,000
sold).Inventorycostis$60perunitundervariablecosting,whichisgiven.
Underabsorptioncosting,$90perunitisthecost($900,000/10,000units).
3.Thereisnocorrectanswertothisquestion.Ifoneacceptstheview
thatsalesmanagersaremostlikelytopreferabsorptioncostingbecauseof
theneedto"cover"allcosts,thenthesalesmanagerwouldprobablyhave
preparedtheabsorptioncostingstatement,thecontrollerthevariable
costingstatement.(Itmightalsobearguedthatthecontrollerwouldprefer
thesimplerandmoredirecttreatmentthatvariablecostingaffords,though
thisisonlyouropinion.)Otherswouldassumethattheabsorptioncosting
statementwaspreparedbythecontroller,onthetheorythatthecontroller
wouldbeinfluencedbythedemandsoffinancialaccounting.Stillothers
mightsuggestthattheemphasison"coveringallcosts"ismorelikelyto
comefromthecontroller,orthatthedesiretoshowthebestpicturewould
probablybeconsistentwiththeoptimismofthesalesforceratherthanthe
conservatismoftheaccountingpersonnel.Perhapsthisisagoodplaceto
discuss(andmaybedestroy)somestereotypes.

1325

1337ConversionofIncomeStatement(1520minutes)
IncomeStatement,MorganDivision
Sales(33,100x$40)$1,324,000
Variablecostofsales(33,100x$15)496,500
Contributionmargin[33,100x($40$15)]827,500
Fixedcosts:
Manufacturing$480,000
Sellingandadministrative276,300756,300
Income$71,200
Calculations
Sales33,100units,$1,324,000/$40perunit
Variablecostperunit$15
Absorptioncostofsales$893,700
Dividedbysales,inunits33,100
Equalsabsorptioncostperunit$27
Lessfixedcostperunit12
Equalsvariablecostperunit$15
Fixedproductioncosts$480,000
Volumevariance,unfavorable$21,600
Dividedbyfixedcostperunit$12
Equalsvolumeofproductionlessthan
volumeusedtosetfixedcostperunit1,800
Addproduction38,200
Equalsvolumeusedtosetfixedcostperunit40,000
Timesfixedcostperunit$12
Equalsbudgetedfixedcosts$480,000
NotetotheInstructor:Youmightwanttoremindyourstudentsthat
theycanchecktheiranswersbydeterminingthedifferencetheyshouldexpect
tofindbetweenabsorptioncostingincomeandvariablecostingincome.After
calculatingsalesof33,100units,youknowthedifferencebetweenproduction
andsales.
Sales,calculated33,100units
Production,given38,200
Difference,changeininventory(increase)5,100units
Timesfixedcostperunit,given$12
Equalsdifferenceinincome$61,200
Subtractedfromabsorptioncostingincome,given132,400
Equalsvariablecostingincome,asabove$71,200
Variablecostingincomeislowerthanabsorptioncostingincomebecausesome
fixedcosts($61,200)arecarriedforwardintothenextperiodthroughthe
increaseininventory.Youmayalsowanttoremindyourstudentsthatthey
donotneedtoknowthenumberofunitsininventoryateitherthebeginning
ortheendofthequarter;alltheyneedtoknowisthechangeininventory.

1326

1338EffectsofCostingMethodsonBalanceSheet(30minutes)
1.McPhersonCompany
BudgetedIncomeStatementfor20X2
Sales(100,000units)$1,000,000
Costofsales:
Beginninginventory$200,000
Productioncosts:
Fixed300,000
Variable750,000
Total$1,250,000
Endinginventory*630,000
Costofsales620,000
Grossprofit380,000
Otherexpenses:
Variable$50,000
Fixed50,000
Total100,000
Income$280,000
*Fixedmanufacturingcosts$300,000
Dividedbyproductionof150,000units
Equalsstandardfixedcostperunit$2.00
Variablecostperunit5.00
Totalcostperunit$7.00
Timesnumberofunitsininventory:
Beginninginventory40,000
Production150,000
Availableforsale190,000
Sales100,000

90,000
Equalsendinginventory$630,000

McPhersonCompany
ProFormaBalanceSheet
December31,20X2
AssetsEquities
CashandreceivablesCurrentliabilities$240,000
$400,000$250,000$150,000Longtermbankloan460,000
Inventory630,000Stockholders'equity
Totalcurrentassets780,000($760,000+$280,000)1,040,000
Fixedassets,net960,000__________
Total$1,740,000Total$1,740,000
2.Currentassets=$780,000=3.25
Currentliabilities$240,000

Totaldebt=$700,000=67.3%
Owners'equity$1,040,000
3.Yesandno.Sincetheuseofabsorptioncostingdoesenablethecompany
tomeettherequirements,itisdefactohelpful.Moststudentswillsee
thatthecompanyisprobablyinaworsesituationbecauseitscashis
$250,000lowerandithasinventoryequalto90%of20X2sales.Suchalarge
amountmightbehardtosell.

1327

1339CVPAnalysisandAbsorptionCosting(20minutes)
1.
Sales,82,000unitsat$40$3,280,000
Standardvariablecostofsalesat$241,968,000
Contributionmargin1,312,000
Fixedcosts800,000
Profit$512,000
2.Theresultsintheincomestatementheredonotdependonproduction,
onlyonsales.Themanageristhereforebetterabletoseewhethershemet
herobjectives,andifnot,whynot.Here,thedifferencebetweenthe
originalobjectiveofa$480,000profitandtheactual$512,000is2,000
unitsatacontributionmarginof$16,for$32,000.
Youmightwishtoshowthefollowingreconciliationofincomes.
Variablecosting$512,000
Absorptioncosting440,000
Difference$72,000
Explainedby:
Sales82,000
Production70,000
Difference12,000
Timesstandardfixedcostperunit$6
Differenceinincomes$72,000
Youmightalsowishtoshowthefollowingderivationsfortheincome
statement,eventhoughstudentsneednotanalyzethatstatementtocomplete
theassignment.
Totalfixedcosts$800,000
Fixedmanufacturingcosts,75%oftotal$600,000
Dividedby100,000units=standardfixedcostperunit$6
Plusvariablecost24
Standardcostperunit$30
Productionvariancesof$180,000=(100,00070,000)x$6,allvolume
variance.
1340StandardCostingActivityBasedOverheadRates(25minutes)
1.$0.15perpartand$64.80permachinehour
PartrelatedMachinerelated
Budgetedoverhead$1,200,000$6,480,000
Measureofactivity8,000,000parts100,000MH
Rates$0.15$64.80
2.
Parts(given)$27.50
Partrelatedoverhead(11x$0.15)1.65
Machinerelatedoverhead(0.15x$64.80)9.72
Totalstandardcost$38.87
3.Wecancalculatebudgetandvolumevariancesforeachoverheadelement.

1328

PartrelatedOverhead

ActualBudgetApplied
($1,200,000/12)60,000x$1.65
$105,300$100,000$99,000
$5,300$1,000
UnfavorablebudgetvarianceUnfavorablevolumevariance
$6,300
Unfavorabletotalvariance
MachinerelatedOverhead

ActualBudgetApplied
($6,480,000/12)60,000x$9.72
$542,230$540,000$583,200
$2,230$43,200
UnfavorablebudgetvarianceFavorablevolumevariance
$40,970
Unfavorabletotalvariance
NotetotheInstructor:Thisassignmentillustratesstandardcost
calculationswithmorethanonebasisforapplyingoverhead,theunderlying
principleofwhichwehavedevelopedsinceChapter3,mostrelevantlyfor
thispurposeinChapters12and13.

1341PreparingIncomeStatements(30minutes)
1.Incomestatements

MarchFebruary
Sales$1,256.8$1,452.4
Standardvariablecostofsales510.3580.5
Variablecostvariances*18.5U17.2U
Variablecostofsales528.8597.7
Contributionmargin728.0854.7
Fixedcosts:
Production299.8305.2
Sellingandadministrativeexpenses406.4412.6
Totalfixedcosts706.2717.8
Profit$21.8$136.9

*February$7.1+$6.9+$3.2=$17.2;March$8.4+$7.8+$2.3=$18.5
2.$6.5favorableinMarch,$11.9unfavorableinFebruary.

MarchFebruary
Totaloverheadvariance$8.9F$15.8U
Variableoverheadvariance2.3U3.2U
Fixedoverheadvariance$11.2F$12.6U
Actualfixedoverhead$299.8$305.2
Budgetedfixedoverhead304.5304.5
Budgetvariance$4.7F$0.7U

1329

Volumevariance$11.2$4.7$6.5F
$12.6$0.7$11.9U
NotetotheInstructor:Thisassignmentislessstraightforwardthan
othersofthesametype.Italsoofferstheopportunitytopursuesuch
questionsas:
1.WasproductionhigherinFebruaryorinMarch?Marchbecauseofthe
favorablevolumevariance.
2.Wasproductionabovetheamountusedtosetstandardfixedcostsin
FebruaryorinMarch?YesinMarch,favorablevolumevariance.Noin
February,unfavorablevolumevariance.

1342IncorporatingVariancesintoBudgets(30minutes)
1.
MaterialsVariances
Pricevariance:
Standardquantityrequiredforplannedproduction
24,000unitsx3gallonsperunit72,000
Additionalquantityexpectedtobeused,10%ofstandard7,200
Totalmaterialsexpectedtobeused79,200
Expectedpricesavingsonmaterials:
Standardcostpergallon$3
Expectedsavingspergallon5%$0.15
Expectedfavorablevariance$11,880
Usevariance:
Additionalquantityexpectedtobeused,fromabove7,200gals.
Standardcostpergallon$3
Expectedunfavorablevariance$21,600
LaborVariances
Ratevariance:
Standardquantityoflaborrequired(24,000units
x2hrs.perunit)48,000hrs.
Expectedsavingsinhours,4%ofstandard1,920
Expectedactualhours46,080
Expectedexcesslaborrate:
Standardcostperhour$10
Expectedincrease6%$0.60
Expectedunfavorablevariance$27,648
Efficiencyvariance:
Expectedsavingsinhours,fromabove1,920hrs.
Standardcostperhour$10
Expectedfavorablevariance$19,200
VariableOverheadVariances
Spendingvariance:
Expectedhoursoflabor,seecomputationoflabor
variances,above46,080hrs.
Expectedexcessspending:
Standardcostperhour$12
Expectedincrease5%$0.60
Expectedunfavorablevariance$27,648
1330

Efficiencyvariance:
Expectedsavingsinlaborhours,seecomputation
oflaborvariance,above1,920hrs.
Standardcostperhour$12
Expectedfavorablevariance$23,040
2.
VinerCompany
BudgetedIncomeStatement
fortheYear20X1
Sales(20,000unitsx$100)$2,000,000
Costofsales,atstandard(20,000unitsx$53)1,060,000
Grossprofit,atstandard940,000
Lessmanufacturingvariances:(favorable)
Materialprice($11,880)
Materialuse21,600
Laborrate27,648
Laborefficiency(19,200)
Variableoverheadspending27,648
Variableoverheadefficiency(23,040)
Total22,776
Grossprofit917,224
Fixedcosts:
Manufacturing300,000
Sellingandadministrative400,000700,000
Incomebeforetaxes$217,224
NotetotheInstructor:Severalpointsaboutthisproblemareworth
specialnote.
1.Variancesshouldbecomputedusingproductionratherthansalesfigures.
Somestudentsmaynothaveseenthisatfirst.
2.Theanticipatedwageincreaseshouldprobablyhavebeenincorporatedin
thestandardsincetheincreaseiscertain.Tobringthispointtolight,
youmightaskthestudentsforrecommendations.Totheextentthattheother
anticipatedvarianceshavebeenexperienced,thequestionofthecurrentness
ofstandardsisalsorelevant.
3.Thestudentsmaywantto(oryoumightpromptthemto)bringupthe
questionwhethervariancesshouldbeallocatedbetweentheunitssoldandthe
unitsremainingonhand.Therearenobeginninginventoriessowecanbe
surethattheendinginventoryisequaltoatleasttheexcessofproduction
oversales(4,000units).Sinceweknowthatatleastonestandard(labor
rate)isclearlyoutofdate,thereisanargumentforassigningsomeofthe
variancefromthisstandardtotheendinginventory.
4.Youcouldpointoutthatthebudgetedmaterialpricevariancehasbeen
computedundertheassumptionthatmaterialspurchaseswillequalmaterial
used.Ifthecompanyplansachangeinitsmaterialsinventory,thevariance
ascomputedwouldbeinerror.Youmightwishtodiscusswhateffecta
plannedchange(increaseordecrease)wouldhaveonthevariance.
1343CostsandDecisions(20minutes)
Memorandum

To:Mr.Beatty
From:Student
1331

Subj:Specialorder
Date:Today
Ihavepreparedthefollowinganalysisshowingthatwedidincrease
profitsasaresultofacceptingthespecialorder.Pleaseexaminethe
comparativeincomestatementsthatusevariablecosting.

WithoutActual,With
SpecialOrderSpecial
Order
Totalsales$2,500,000$2,620,000
Standardvariablecostofgoodssoldat$101,000,0001,100,000
Contributionmargin1,500,0001,520,000
Fixedcosts($6x130,000)780,000780,000
Subtotal,manufacturingmargin720,000740,000
Sellingandadministrativeexpenses710,000710,000
Income$10,000$30,000
Thestatementsshowthatthesaleprovidedpositivecontributionmargin.
Theincomestatementsyoushowedmereflectnoincreaseinproductiontomeet
theorder.Thustheeffectofthesaleonexpensesrecognizedduringthe
periodwas$160,000,the10,000unitsatthestandardcostof$16each.Had
weincreasedproductionby10,000units,wewouldhavedeferred$60,000
(10,000x$6)fixedoverheadininventory,whichwouldhaveproducedincome
of$90,000forthestatementshowingactualresults.
WithSpecialOrder
andIncreasedProduction
Sales$2,620,000
Standardcostofsales1,760,000
Standardgrossprofit860,000
Volumevariance(10,000x$6)60,000U
Actualgrossprofit800,000
Sellingandadministrativeexpenses710,000
Income$90,000
Thisstatementshowsthattheadditionalrevenuemorethancoveredthe
variablecoststhatwouldhavebeenincurredhadtheadditionalunitsbeen
produced.However,producingthemmightnothavebeenawisedecision;the
firmapparentlythoughtitbettertofilltheorderfrominventory.
Dependingontheprospectsforsellingtheexistinginventory,itmighthave
beenwisetohavesoldtheunitsatanypricethatcouldbegotten,even
belowvariablecost.Thatwouldbewisebecausevariablecostsfor
productionalreadyonhandaresunkcostsasfarasthoseunitsare
concerned.Thus,ifthechoicewere"sellat$2ordon'tsellthematall,"
thesaleat$2wouldbebeneficial.
NotetotheInstructor:IncomestatementsfollowingGAAPwouldshow
thewisdomofsuchasalebecausetheinventorycouldnotbecarriedat$16
perunitstandardcostiftheunitshadlittleornomarketvalue.(If$12
isthebestavailablepricenow,theinventoryshouldbewrittendown.)The
followingpointsarerelevant.
1.Theresultsshowndependontheuseofabsorptioncosting,whichmight
notalwaysreflectthewisdomofdecisions.
2.Becauseinventorywasoverstocked,andthecompanydidnotproduce
additionalunits,thepriceof$12isadequate.Apricebelowvariablecost
isappropriateifitwerethebestavailablepriceforunitsalready
1332

produced.

1344ActualversusStandardCosts

MultipleProducts(35minutes)
1.Standardcostforeachmodel:

#108#380#460
Directlaborhoursrequired0.50.81.5
Directlaborat$8perhour$4.00$6.40$12.00
Variableoverheadat$7perhour3.505.6010.50
Fixedoverheadat$15perhour*7.5012.0022.50
Materialsasgiven12.0014.0018.00
Totalstandardcostperunit$27.00$38.00$63.00
*$90,000/6,000hours.
2.Inventoryoffinishedgoodsis$55,400($16,200+$26,600+$12,600).

#108#380#460
Unitsonhand(productionminussales)600700200
Standardcostperunit$27$38$63
Inventoryamounts$16,200$26,600$12,600
3.IncomestatementforApril
Sales($84,000+$90,000+$85,000)$259,000
Standardcostofsales:
#108$27x2,400$64,800
#380$38x1,80068,400
#460$63x1,00063,000196,200
Standardgrossprofit62,800
Fixedcostvariances:
Budgetvariance($92,000$90,000)2,000U
Volumevariance*10,500U12,500
Actualgrossprofit50,300
Sellingandadministrativeexpenses28,000
Income$22,300
*Thevolumevarianceis700directlaborhoursat$15perhour.Actualand
standarddirectlaborhourswere5,300,computedasfollows,
#1083,000unitsx.5perunit1,500
#3802,500unitsx.8perunit2,000
#4601,200unitsx1.5perunit1,800
Totalhours5,300
NotetotheInstructor:Classdiscussioncandevelopalongthelines
oftherelativeeaseofapplicationofstandardcosting(asopposedtothe
actualcostsysteminprevioususe)aswellasitsadvantagesforcost
controlandplanning.Allocatingcostsbasedonrelativematerialcostsdoes
notprovidegooddata.Inthethreemodelstheratiosofmaterialcostsdo
notcorrespondtodirectlaborratiosanditisdirectlaborhourswithwhich
variableoverhead(aswellasdirectlabor)isvariable.Hence,relative
materialcostisapoormeasureofactivity.

1333

1345IncomeStatementsandBalanceSheets(35minutes)
1.MicroCook
20X3IncomeStatements(000s)

JanuaryJuneJulyDecemberTotal

Sales$9,000(30,000x$300)$12,000(40,000x$300)$21,000
Costofsales:
Beg.inv.225675225
Productioncosts:
Variable5,760(32,000x$180)7,560(42,000x$180)13,320
Appliedfixed1,440(32,000x$45)1,890(42,000x$45)3,330
Total7,42510,12516,875
Endinginventory675(3,000x$225)1,125(5,000x$225)1,125
Costofsales6,750(30,000x$225)9,00015,750
Grossprofit2,2503,0005,250
Underabsorbedor
overabsorbed
overhead360(8,000x$45)(90)(2,000x$45)270
S&Aexpenses
Variableat10%9001,2002,100
Fixed1,2001,2002,400
Total2,4602,3104,770
Income(loss)($210)$690$480
2.MicroCook
BalanceSheets
(InThousands)
June30,20X3December31,
20X3
Cash*$140$780
Inventory6751,125
Plantandequipment(beginningless$400
and$800)2,6002,200
Totalassets$3,415$4,105
Commonstock$3,000$3,000
Retainedearnings(beginningbalanceless
$210loss,plus$690profit)4151,105
Totalequities$3,415$4,105
*Cashbalances

June30December31
Beginningbalance$400$140
Sales9,00012,000
Available9,40012,140
Disbursements:
Variableproductioncosts5,7607,560
Fixedproductioncosts
$1,800$400depreciation1,4001,400
Sellingandadministrative2,1002,400
Totaldisbursements9,26011,360
Endingbalance$140$780

1334

1346PricingDispute(1520minutes)
1.
Sales[(100,000x$5)+(10,000x$4.50)]$545,000
Costofgoodssoldatstandard:
Beginninginventory,given$80,000
Variableproductioncosts,given250,000
Fixedproductioncosts,given150,000
Costofgoodsavailableforsale480,000
Endinginventory(10,000x$4)40,000
Costofgoodssoldatstandard440,000
Standardgrossprofit105,000
Volumevariance(20,000x$1.50)$30,000F
Sellingandadministrativeexpenses50,00020,000
Income$85,000
Thisincomestatement,andtheonegivenintheproblem,containmore
datathanarenecessary.Itwouldbesufficienttoshowstandardcostof
salesat$4perunit.Thecompanydoesshow$5,000moregrossprofitthanit
didbeforeconsideringtheorder,whichis$0.50perunitfor10,000units.
2.ThecontrollerofPhelanCompanycouldwellarguethatthe$4.50price
provides$2ingrossprofit,consideringthevariablecostofproduction
($2.50)astheonlyproductcost.Thus,$3perunit($2.50variablecost
plus$.50grossprofit)wouldbetherockbottomprice.Theproblemisthe
meaningof"grossprofit."BecauseCalligerisCompanydidnotproducethe
additional10,000units,itsgrossprofitandincomeincreasedby$5,000,
whichistheamountallowableundertheagreement.Hadthecompanyproduced
anadditional10,000units,itsincomestatement(abbreviated)wouldhave
appearedasfollows:
Sales$545,000
Standardcostofgoodssold(110,000x$4)440,000
Standardgrossprofit105,000
Volumevariance(30,000x$1.50)$45,000F
Sellingandadministrativeexpenses50,0005,000
Income$100,000
Grossprofitatstandardcostwouldstillbeonly$5,000higher,but
incomewouldincreaseby$20,000overthatshownintheproblem.The
increaseisthecontributionmarginof$2perunit($4.50$2.50).
AttheveryleastthecontrollerofPhelanCompanywouldarguethatthe
standardfixedcostperunitisbasedontoolowanactivitylevel.The
standardisbasedon80,000unitsbecausethevolumevarianceis20,000units
favorableatproductionof100,000units.Eveniftheactualfixedcostper
unitbasedonproductionof100,000unitsisused,whichis$1.20perunit
($1.50x80,000=$120,000fixedproductioncost/100,000units=$1.20),the
appropriatepricewouldbe$4.20.
NotetotheInstructor:Onepurposeofthisproblemistoshowthatthe
meaningsoftermssuchas"cost"and"grossprofit"arenotfixedand
constant.GiventhewayCalligerisCompanycomputesitsgrossprofit,the
$4.50pricedoesprovideagrossprofitandincomeof$5,000.Ifan
additional10,000unitshadbeenproduced,thecompany'sgrossprofitat

1335

standardwouldstillhavebeenincreasedby$5,000,itsincomeby$20,000,as
theincomestatementaboveshows.
PerhapsthemoralisthatthePhelanCompanyshouldhavespecifiedthe
meaningof"grossprofit"moreclearlythanitdid.
1347PredeterminedOverheadRatesMultipleProducts(20minutes)
1.Thepredeterminedoverheadrateperdirectlaborhouris$6($300,000
budgetedfixedcostsdividedby50,000directlaborhoursatnormal
activity).Thestandardcostsarecomputedfromthisfigureasfollows.
Model84Model204Model340
Directlaborhoursrequired0.500.801.50
Predeterminedfixedoverheadrate$6.00$6.00$6.00
Standardfixedcostperunit$3.00$4.80$9.00
2.
Model84Model204Model340
Variableproductioncostsperunit$4.00$7.00$11.00
Standardfixedcostperunit3.004.809.00
Totalinventorycostperunit$7.00$11.80$20.00
Endinginventoryinunits
(productionminussales)5,0004,0002,000
Endinginventoryindollars$35,000$47,200$40,000
SalmonCompany
IncomeStatementfor20X1
Sales($250,000+$280,000+$450,000)$980,000
Costofsalesatstandard:
Model84(25,000x$7)$175,000
Model204(20.000x$11.80)236,000
Model340(18,000x$20)360,000771,000
Standardgrossprofit209,000
Volumevariance,favorable(seebelow)85,200
Actualgrossprofit294,200
Sellingandadministrativeexpenses140,000
Income$154,200
Thevolumevariancecanbecalculatedineitheroftwoways.Themethod
illustratedinthechapterisperhapsslightlysimpler.
Model84Model204Model340
Production30,00024,00020,000
Standardfixedcostperunit$3.00$4.80$9.00
Totalfixedcostsapplied$90,000$115,200$180,000
Totalforthethreeproductsis$385,200,whichis$85,200morethan
budgeted.
NotetotheInstructor:Youmaywishtoillustratethecomputation
basedondirectlaborhoursandthepredeterminedoverheadrateof$6per
hour.
Model84Model204Model340
Production30,00024,00020,000
Directlaborhoursrequired0.500.801.50
Directlaborhoursworked15,00019,20030,000
Totaldirectlaborhoursworkedwere64,200(15,000+19,200+30,000),
1336

whichis14,200morethanthe50,000hoursusedtosetthepredetermined
rate.
Actualhours64,200
Hoursatnormalactivity50,000
Difference14,200
Predeterminedrate$6
Favorablevolumevariance$85,200
1348ComprehensiveReview,Budgeting,OverheadApplication(75minutes)
1.Budgetedincomestatement
Sales(880,000x$20)$17,600,000
Costofsales[880,000x($6.50+$3.50)]8,800,000
Grossprofit8,800,000
Underabsorbedoverhead*(100,000x$3.50)$350,000
Variablesellingcosts($2unit)1,760,000
Fixedsellingandadministrativeexpenses5,550,0007,660,000
Profitbeforetaxes1,140,000
Incometaxesat40%456,000
Netincome$684,000
*$3,500,000/$3.50=1,000,000unitbaseforoverheadapplication.
Productionof900,000unitsis100,000fewerthanthebase.
2.Theeasiestwaytoapproachthispartistodevelopdatafortheendof
thefourthquarter.Thesedatawillalsobeusedfortheproformabalance
sheet.
Salesinfourthquarter(880,000x30%x$20)$5,280,000
Dividedby3equalsmonthlysales1,760,000
Multipliedby2givesaccountsreceivableat
yearend$3,520,000
Cashreceipts
Beginningaccountsreceivable$2,800,000
Plussales17,600,000
Subtotal20,400,000
Lessendingaccountsreceivable3,520,000
Cashreceipts$16,880,000
Cashdisbursementsforcommissions

SalesinDecember(1/3offourthquarter)$1,760,000
At10%commissionrate($2/$20),endingbalance$176,000
Beginningliability,beginningbalancesheet$120,000
Commissionsearned,incomestatement1,760,000
Subtotal1,880,000
Endingbalanceofliability,above176,000
Cashdisbursementsforcommissions$1,704,000
Cashdisbursementsdirectlabor
Productioninfourthquarter210,000
Directlaborcostat$2.00$420,000
Percentageunpaidatquarterend10%
Accruedpayrollatyearend$42,000
1337

Beginningaccrual,openingbalancesheet$64,000
Wagesearned(900,000unitsx$2.00perunit)1,800,000
Subtotal1,864,000
Accrualatyearend,above42,000
Cashdisbursementsdirectlabor$1,822,000

Paymentsforrawmaterials
Purchasesin1stmonthoffourthquarter(795,000/3)265,000lbs.
Priceperpound$0.80
Accountspayableatyearend$212,000
Beginningaccountspayable,openingbalancesheet$240,000
Purchases(3,382,000lbs.x$0.80perlb.)2,705,600
Subtotal2,945,600
Endingaccountspayable,above212,000
Cashdisbursementsformaterials$2,733,600
Cashdisbursementsfortaxes
Yearendaccrual($456,000x25%)$114,000
Beginningaccrual,openingbalancesheet$80,000
Expenseforyear,perincomestatement456,000
Subtotal536,000
Yearendaccrual,above114,000
Cashdisbursementstaxes$422,000
Cashbudget
Beginningbalance$840,000
Receipts16,880,000
Totalavailable17,720,000
Disbursements
Materials2,733,600
Directlabor1,822,000
Othermanufacturingcosts:
Fixed($3,500,000$1,900,000)1,600,000
Variable[($6.50$3.20$2.00=$1.30)
x900,000]1,170,000
Sellingandadministrative:
Commissions1,704,000
Other5,550,000
Taxes422,000
Dividends300,000
Plantandequipmentpurchases2,100,000
Totaldisbursements17,401,600
Balanceatyearend$318,400
3.
RulandCompany
ProFormaBalanceSheet
December31,20X2
(InThousandsofDollars)
AssetsEquities
1338

Cash(cashbudget)$318.4Accountspayable$212.0
Accountsreceivable3,520.0Accruedcommissions176.0
Inventoryfinishedgoods*1,660.0Accruedpayroll42.0
Inventorymaterials*249.6Accruedtaxes114.0
Plantandequipment18,300.0Longtermdebt4,000.0
Accumulateddepreciation(10,300.0)Commonstock7,000.0
Retainedearnings**2,204.0
Total$13,748.0Total$13,748.0
*Inventories:

DollarsUnits
Finishedgoods,beginningofyear$1,460,000146,000
Production,$10perunit9,000,000900,000
Availableforsale10,460,0001,046,000
Costofsales,perincomestatement8,800,000880,000
Endinginventory$1,660,000166,000
Rawmaterials,beginningofyear$424,000530,000
Purchases2,705,6003,382,000
Available3,129,6003,912,000
Usedinproduction(900,000x4x$.80)2,880,0003,600,000
Endinginventory$249,600312,000
**Beginningbalanceof$1,820,000plus$684,000netincomeless$300,000
dividend
Youcouldalsopreparetheproformabalancesheetbeforethecash
budgetbycalculatingtheendingbalancesintheassetandequityaccounts,
exceptforcash,andpluggingcash.Thecashfigurecanthenbecheckedfor
accuracywhenthecashbudgetisprepared.
4.Themajordifferenceswouldbeinthefinishedgoodsinventoriesand
retainedearnings.Eachwouldbelowerby$581,000,theamountoffixedcost
intheinventory(166,000x$3.50).Thisanswerassumesthatthecompany
wouldstillhavepaidincometaxesbasedonabsorptioncostingincome.If
variablecostingwereacceptablefortaxpurposes,thedifferenceinretained
earningswouldbereducedbyalowertaxliability.
1349StandardCostsandPricing(3035minutes)
1.$2,740,000
Totalmanufacturingcost[$7,680,000+(2,400,000x$4.25)]$17,880,000
Dividedby2,400,000hours=hourlyrate$7.45
Multipliedby1.50=hourlyprice$11.175
Revenues(2,400,000x$11.175)$26,820,000
Manufacturingcosts17,880,000
Grossmargin8,940,000
Sellingandadministrativeexpenses6,200,000
Profit$2,740,000
Inthiscase,standardfixedcostperhouris$3.20($7,680,000/2,400,000).
2.$4,015,000
Totalmanufacturingcosts[$7,680,000+(3,000,000x$4.25)]$20,430,000
Dividedby3,000,000hours=hourlyrate$6.81
Multipliedby1.50=hourlyprice
$10.215
1339

Revenues(3,000,000x$10.215)$30,645,000
Manufacturingcosts20,430,000*
Grossmargin10,215,000
Sellingandadministrativeexpenses6,200,000
Profit$4,015,000
Inthiscase,standardfixedcostperhouris$2.56($7,680,000/3,000,000).
3.Therealissueisthelikelylevelofsalesatspecificpricesprice
volumerelationshipsnotthevolumetousetocomputestandardcosts.
Becauseofthecompany'spricingformula,thelowerthevolumeusedtoset
prices,thehigherthepricesitwillset,sothatagivenlevelofsales
willtendtobelessachievableaslongasthereisarelationshipbetween
pricesandvolume.But,simplyusingaparticularhigherlevelofvolumeto
setpricesdoesnotguaranteethatthosepriceswillproducesalesatthat
level.
Quitepossibly,asthetreasurersays,the$11.175price(requirement1)
willmeanalossofsales.Butfromwhatstartingpoint?Salesat3,000,000
hours?At2,400,000hours?Thecontroller'scommentssuggestanexpected
saleslevelofsomethinglessthan3,000,000(largeunderappliedoverheadat
thatlevel).Wouldapriceof$10.215(requirement2)raisesales
expectationstothe3,000,000hourlevel?

If3,000,000hoursisthebasisforstandardcost,thepriceissetat
$10.215perhour,andsalesofonly2,400,000hoursmaterialize,incomewill
be$436,000[2,400,000x($10.215$4.25)$7,680,000$6,200,000].From
earlierchaptersweknowthatatanygivensalesvolume,thehigherprice
(andcontributionmargin)willproducemoreprofit.Hence,theissuehereis
whetherthelowerpricewillproducesufficientvolumetooffsetthedecline
incontributionmargin.Inthisparticularcase,toproducethesametotal
contributionmarginundereitherprice,thesalesvolumeatthelowerprice
mustbeapproximately16%greaterthanatthehigherprice.
($10.215$4.25)X=($11.175$4.25)Y
X/Y=1.16
X=requiredvolume,inhours,atlowerprice
Y=requiredvolume,inhours,athigherprice
Theavailablefactsareinsufficienttoallowdetermininganappropriate
price(and,hence,absorptionbasis).

1350ProductCostingMethodsandCVPAnalysis(30minutes)
1.152,000units($630,000+$434,000)/($16$7$2).Variableproduction
costsof$7perunitare$1,330,000/190,000.
2.123,500units.Grossprofitusingthe$3predeterminedoverheadrate
($630,000/210,000)is$6($16$7$3)andvariablesellingcostsare$2.
Thecompanywillhaveunderabsorbedoverheadof$60,000[(210,000190,000)
x$3]andsothenet$4perunit($6$2)mustcoverfixedsellingand
administrativecostsof$434,000plusthe$60,000underabsorbedoverhead,a
totalof$494,000.Thisamount,whendividedby$4,gives123,500.As
proof:
Sales(123,500x$16)$1,976,000
Productioncosts:
Variable$1,330,000
Fixed($3x190,000)570,000
1340

Total1,900,000
Lessendinginventory(66,500unitsat$10)665,0001,235,000
Grossprofit741,000
Less:
Underabsorbedoverhead60,000
Variablesellingcosts247,000
Fixedsellingandadministrativeexpenses434,000741,000
Income$0
3.Theanswersdifferintheamountoffixedcoststhatwouldbeincluded
intheendinginventoryunderabsorptioncosting.Theendinginventory
containsfixedcostsof$199,500($3x66,500units).Thesecostswouldbe
chargedtotheincomestatementundervariablecosting,requiringthatmuch
additionalcontributionmargin.Atthecontributionmarginof$7perunit
($16$7$2),thedifferenceinunitsis28,500($199,500/$7),whichis
thedifferencebetweenthebreakevenpoints(152,000123,500=28,500).
4.Theanswertorequirement2wouldbethesame.Thebeginninginventory
wouldbe$100,000at$10perunit.Theendinginventorywouldbe76,500
units,whichis10,000unitsand$100,000higherthancurrently.Therefore,
costofsaleswouldbethesameandsowouldunderabsorbedoverhead.

NotetotheInstructor:Thisproblemillustratesoneoftheassumptions
ofbreakevenandcostvolumeprofitanalysiseitherthatvariablecosting
isusedorthatinventoriesdonotchange.Someextensionsoftheproblem
aretoaskaboutthebreakevenpointifproductionweretobe220,000units,
inwhichcaseoverheadwouldbeoverabsorbedby$30,000andbreakevenwould
fallto101,000units[($434,000$30,000)/$4].Or,acomparisonofincomes
at152,000units,absorptioncostingandvariablecosting,orat123,500
unitscaneasilybedone.At152,000units,thebreakevenpointunder
variablecosting,absorptioncostingwouldshowthefollowing,atproduction
of190,000.
Sales(152,000x$16)$2,432,000
Costofsalesat$101,520,000
Grossprofitat$6912,000
Underabsorbedoverhead(20,000x$3)$60,000
Variablesellingcosts(152,000x$2)304,000
Fixedsellingandadministrativeexpenses434,000798,000
Income$114,000
The$114,000incomeisthefixedcostsintheendinginventory,38,000units
(190,000152,000)at$3.
Amajorpointofthisproblem,then,isthatifproductionisknown,the
overabsorbedorunderabsorbedfixedcostsaretreatedlikefixedcostsin
costvolumeprofitcalculations.But"fixedcosts"includeonlysellingand
administrativecostsplusunderabsorbedoverheadorlessoverabsorbed
overhead,andthedivisoris:
Sellingpricevariableproductionfixedproductionvariable
costscostsperunitsellingcosts
ratherthancontributionmargin.
1351CostingMethodsandEvaluationofPerformance(25minutes)
1.WallaceDivisionIncomeStatement,SecondQuarter
Sales(25,000units)$2,500,000
1341

Costofsales:
Beginninginventory(10,000units)$625,000
Productioncostsapplied(50,000x$62.50)*3,125,000
Availableforsale3,750,000
Lessendinginventory(35,000x$62.50)*2,187,500
Standardcostofsales1,562,500
Standardgrossprofit937,500
Volumevariance**125,000F
Grossprofit1,062,500
Sellingandadministrativeexpenses500,000
Income$562,500
*Variablecostperunitof$50+fixedcostperunitof$12.50($500,000/
40,000)=$62.50totalcostperunit
**$12.50x(50,00040,000)=$125,000favorable
2.TheincomestatementforthesecondquarterreflectsBoroff'sskillat
selectingastrategythatmakesherperformanceappearbetterthanitwould
ifshepursuedamorereasonableproductioninventorypolicy.Anadvocateof
absorptioncostaccountingwouldarguethatabuildupofinventorypriorto
anexpectedheavysellingperiodcreatesvaluesthatshouldberecognizedin
thecostassignedtoinventory.Suchabuildupisnotthecasehere;Boroff
hasnoexpectationofincreasingsalestobolsterherdecisiontodouble
productionforthesecondquarter.
Thedivisionnowhaswhatseemstobeexcessiveinventoryif10,000
unitshasbeensufficienttomeetdemandinthepast.Boroffhasmadeabad
decision,butherperformanceimproveswhenmeasuredbyincomedetermined
underabsorptioncosting.
Theuseofvariablecostingwouldeliminatethepossibilityofsuch
manipulationsasBoroffperformed.Anotherwayofproceedingistokeepthe
presentcostingmethodbutrequirethatmanagersjustifylargeincreasesin
production.Thecompanycouldalsodiscouragethebuildupofunneeded
inventorybychargingthemanagersaspecifiedamountorpercentageon
inventoryaboveapresetlevel.Suchachargewouldoffset,atleast
partially,thetendencytotakeactionssuchasBoroff's.
WithrespecttoBoroff'sfitnessforthepresidency,theprevailing
answerisprobablygoingtobeno.Onemightalsowonderifsheisoneof
theleadingcandidatesbecauseofapparentgoodperformanceinthepast.
1352CostingMethodsandPerformanceEvaluation(2530minutes)
1.Thisassignmentisdifficult,withlimitedinformationandseveral
irrelevancies.Theexplanationofresultsisthatproductionchangedgreatly
amongthethreemonthsandsothereforedidthevolumevariance.Becausethe
volumevarianceisnotshownseparately,itmustbecalculatedfromthecost
ofsalesfiguresandtheadditionalinformation.Theclueisthatproduction
inAprilwasequaltothenormalproductionusedtosetthestandardfixed
costat$9.InApril,then,costofsalesequalsthetotalstandardcostper
unitbecausethereisnovolumevariance.Sellingpriceis$20perunit,
whichgivessalesinunitsof22,000inApril($440,000/$20).Standardtotal
costisthen$12($264,000/22,000).Thisgivesastandardvariablecostof
$3($12$9).Productionvolumeandvolumevariancesforthemonthsare
calculatedbelow.

MarchMay
Salesvolume($sales/$20perunit)18,00028,000
Standardcostofsalesat$12perunit$216,000$336,000
1342

Costofsalesshownonstatements198,000381,000
Volumevariance(unfavorable)$18,000
($45,000)
Dividedbystandardfixedcostperunitof$9
=volumeabove(below)normalactivity,25,000units2,000
(5,000)
Actualproduction27,00020,000
Partoftheexplanation,then,isthevolumevariance,whichinApril
waszero,butwhichinMarchgaveaboosttoincomeof$18,000andinMaya
dropinincomeof$45,000,inrelationtowhatincomewouldhavebeenif
25,000unitshadbeenproducedeachmonth.
Also,"otherexpenses"changedwithsalesvolume,suggestingthatthere
isavariablecomponent.Theseexpensesincreasedfrom$142,000inMarchto
$150,000inApril,andto$162,000inMay.Thechangesgivea10%ofsales
dollars($2perunit)variablecomponentand$106,000fixedamountcalculated
asfollows.
ForMarchtoApril,
Changeincost=$8,000=10%
Changeinsales$80,000
and,forApriltoMay,$12,000=10%
$120,000
Doneinunits,theresultwillshowa$2variablecostperunit.Atany
volume,thefixedcomponentwillbecomputedas$106,000.InMarch,variable
costsare$36,000($360,000x10%,or18,000x$2),whichwhensubtracted
fromthetotalcostof$142,000leaves$106,000.
2.Incomestatementsusingvariablecostingfollow.

MarchAprilMay
Sales$360,000$440,000
$560,000
Variablecosts($3productionplus$2other)
(volumesof18,000,22,000,and28,000)90,000110,000
140,000
Contributionmarginat$15perunit270,000330,000
420,000
Fixedcosts($225,000production*plus
$106,000other)331,000331,000
331,000
Income(loss)($61,000)($1,000)$
89,000
*$9perunitx25,000units
Youmightpointoutthatthechangeininventoryovertheperiod(4,000
units,computedbelow)timesthe$9standardfixedcostperunitexplainsthe
$36,000differencebetweentheseriesofincomescomputedunderthetwo
alternativeapproaches.

Income
UnitsofVariableAbsorption

SalesProductionCostingCosting
March18,00027,000($61,000)$20,000
April22,00025,000(1,000)26,000
May28,00020,00089,00017,000
Totals68,00072,000$27,000$63,000
68,00027,000
1343

Inventoryincrease4,000
Differenceinincome(duetoinventoryincrease)$36,000
NotetotheInstructor:Oneofthemajorpointsofthiscaseis
behavioral:GannondoesnotwanttoexplaintoProgmanwhytheresultscame
outthewaytheydidandusesthereasoningthatgenerallyaccepted
accountingprinciplesforexternalreportingareusedtopreparetheinternal
statements.Itispossibletodiscussthemeritsofusingnormalabsorption
costingforinternalpurposeswithoutgettingintotherationaleforusing
absorptioncostingforexternalpurposes.
Additionally,thecasegivesthedatainrelativelycompactform,which
shouldgivethestudentsanideahowdifficultitcanbetointerpretincome
statementsevenwithoutintroducingalargenumberofcategoriesonthe
statement.
AstothequestionwhetherProgmanhasturnedthedivisionaround,it
couldbearguedthathehas,basedontheresultsusingvariablecostingand
assumingthathehashadlittleopportunitytoimplementhispoliciesand
procedures.Incomecomputedonavariablecostingbasishasincreasedby
$150,000fromalossof$61,000toaprofitof$89,000.Weneedmore
informationtodecidewhetherthecornerhadinfactbeenturned,including
informationaboutseasonality(whetherAprilandMayarehighsalesmonths),
andaboutpastperformance.Itwouldalsobeimportanttoknowwhetherthe
apparentimprovementhasbeenpurchasedattheexpenseofreducedlongterm
prospectsforthedivisionorthecompany.

1353CostingMethodsandProductProfitability(30minutes)

Neithermanagerrecognizedthedifferingtimerequirementsfor
differentvalves.Therelativeprofitabilitiesareasfollows.
101271013410156
Contributionmarginperunit$4$6$9
Numberproducedinonehour1084
Contributionmarginperhour$40$48$36
Theorderofprofitabilitydoesnotdependonthecontributionmargin
perunitinsituationswherealloutputcanbesoldandthereisafixed
resource.The10156istheleastprofitableproductandshouldbemadeonly
uptothecommittedrequirements.The10127shouldalsobemadeupto
commitments,andallexcesshoursshouldbedevotedto10134.
Inthiscase,theallocationsuggestedbyEmersondoesnoharm,forif
theprofitabilityperhourofgrindingtimeiscomputedonafullcostbasis,
thesamesequenceofprofitabilityismaintained.
101271013410156
Profitperunit,Emerson'sexample$3.00$4.75$6.50
Hourlyproduction1084
Hourlyprofit$30.00$38.00$26.00
Thehourly"profits"areall$10lessthanhourlycontributionmargins,
whichisduetothe$10fixedcostperhour.Thereasonthatrelative
profitabilityisnotdistortedbythisallocationisthatthenumberofunits
usedtodeterminethefixedcostperunit,whichisonehour,isalsothe
numberofunitsusedtodeterminetheoutputbecausetheanalysisisdoneper
grindinghour.Becausethecompanycanuseallavailablegrindinghours,
giventhedemandfortheproducts,thehighestprofitperhourproductshould
bemadewiththediscretionarytimeavailable.
1344

Emersonwaswrongingivingthesellingpricesoftheproductsthat
wouldequalizetheirprofitability,exceptinthesensethatthepricesshe
gavewouldequalizeperunitprofit.Neitherperunitcontributionnor
contributionperhourwouldbeequalizedusinghermethod.Ifan"equitable
price"isonethatprovidesthecompanywiththesametotalprofitfor
whicheverproductismadeusingitsscarceresources,andifthe$38perhour
profitnowearnedon10134sisconsidered"fair,"thefollowingpriceswill
achievetheresult:
1012710156
Desiredhourlyprofit$38$38
Dividedbyhourlyproduction104
Equalsrequiredprofitperunit$3.80$9.50
Fullcost($5.00+$1.00)and($8.40+$2.50)6.0010.90
Requiredprice$9.80$20.40
Thesameresultsfollowfromusingtherequiredcontributionmarginof
$48perhourandignoringthefixedcosts.
1354Budgeting,CashFlow,ProductCosting,Motivation(35minutes)
Thebreakevenpointis1,406,250units.

Fixedcosts:
Manufacturing$6,000,000
Sellingandadministrative750,000
Total$6,750,000
Contributionmargin:
Sellingprice$12.00
Variablecosts:
Manufacturing4.80
Sellingandadministrative2.40
Total7.20
Contributionmargin$4.80
Breakeven($6,750,000/$4.80)1,406,250units
Thenewbreakevenpointis1,500,000units.
Fixedcostsold,asabove$6,750,000
newadvertisingcampaign450,000
Totalfixedcosts$7,200,000
Dividedbycontributionmarginperunit,asabove$4.80
Newbreakevenpoint1,500,000units
Because20X3salesare1,406,250units,andtheonlychangeincost
structureisanadditionaloutlayforadvertising($450,000),itshouldbe
immediatelyapparentthatreportedincomefortheyear20X8($420,000)is
peculiar.Salesareattheoldbreakevenpoint,fixedcostsareup,a
provisionhasbeenmadeforaprofitsharingpoolandincometaxes,andthe
companyisstillreportingaprofit.Adeclineinvariablecostscould
explainthisbutthevariablecostsperunitshownonthe20X3income
statementarethesameasintheprioryear.
Thenewbreakevenpoint,basedonthechangeinfixedcostsof
$450,000,is1,500,000units($7,200,000/$4.80perunit),or93,750units
morethanweresoldin20X3.Hence,theprofitreportedin20X3is
definitelypeculiar.Giventhedataregardingproductionandsalesinunits,
1345

andtheendinginventory,thenextstepistodeterminetheextenttowhich
fixedcostsininventoryarerelatedtothereportedprofitin20X3.
Fixedmanufacturingcostsare$6,000,000,foracapacityof1,875,000
units,givingaperunitfixedcost,basedonabsorptionatnormalcapacity,
of$3.20perunit.Sincetheendinginventorycontains468,750units,the
fixedcostininventoryis$1,500,000(468,750x$3.20).(Notethatthe
$3.20perunitfixedcostaddedtotheperunitvariablemanufacturingcost
of$4.80givestheinventorycostperunitof$8,asstatedintheproblem.)
The$1,050,000profitbeforeprofitsharingandtaxesin20X3isnow
understandable.
Contributionshortofbreakeven
(1,500,000units1,406,250units)x$4.80($450,000)
Currentcostscarriedinendinginventory
(468,750x$3.20)1,500,000
Reportedprofit$1,050,000
Havingdeterminedthatthe20X3profitisaresultofdeferringfixed
costsininventory,thequestionsofcontinuedprofits,distributionofthe
profitsharingpool,andeventhepaymentofthedeclareddividendare
particularlyinteresting.Considerthecashforecastforthecomingyear.
Variablecostsifproductionandsales
aremaintainedatpresentlevels:
Manufacturing$9,000,000
Selling3,375,000
Total12,375,000
Taxestobepaid420,000
Dividendstopay200,000
Totaloutlayswithoutprovisionforadditional
advertising,outofpocketfixedcosts,
orprofitsharingpool12,995,000
Sales,ifallcollected16,875,000
Cashavailableformeetingoutofpocket
fixedcostsandprofitsharingdistribution
profitsharingpool$3,880,000
Fixedcosts(someofwhichmustbecashcosts)6,750,000
Maximumpossibleshortfall$2,870,000
Sincethetotalfixedcostsarenotidentifiedastocashcostsandnoncash
costs,wecannotdeterminewhetherthe$3,880,000issufficienttocovercash
costs.Itisunlikelythattherewillbesufficientcashflowtopaythe
dividend,thetaxes,andthedistributionfromthepool.
Ofcourse,wecannotpredictwhatsaleswillbein20X4.Wecan,
however,suggestthatdiscontinuanceofthesalescampaignshouldbe
consideredcarefully.Withanoutlayof$450,000,salesincreasedby206,250
units,bringingacontributionmarginof$990,000.Thus,$1spenton
advertisingreturned$2.20incontribution.Forthepotentialforfuture
reportedprofitswecanpointoutthatifinventoriesremainatcurrent
levels,earningfutureprofitsdependsonsalesreachinglevelshigherthan
inthecurrentyear.
Itseemsclearfromthecasethatthecompanyhasnosystemfor
implementingthemanagementfunctionsofplanningandcontrol.Asystemof
comprehensivebudgetingencouragestheinterrelatingofestablishedgoals.
Hadsuchasystembeeninforce,theproductionplanwouldhavebeen
1346

identifiedasoutoflinewithsalesforecasts.Theindependentactionof
thepresidentfurtherunderscorestheabsenceofcoordinationatthehighest
levelsofthefirm.
Thereisnoevidencethattheprofitsharingplan,withitsmonetary
incentive,hascontributedtoefficiency,costreduction,orareturnto
profitableoperations.Fixedcostsremainedunchanged,asdidperunit
variablecosts,andthe"profitable"operationshavebeenexplainedearlier.
Ifinflationhadbeensignificantduringtheyearandthecompanymanagedto
maintaincostlevelsequaltolastyear's,theplanmighthavebeen
successful.
Theproblemsofmotivatingemployeescannotberesolved,accordingto
mostcurrentorganizationalbehaviorexperts,simplybyprovidingmonetary
incentives.Wedonotknowenoughinthiscasetoidentifyallofthe
problemsthatmightprevailatthiscompany,butatleastwecannotethat
thebeliefsofthechiefexecutiveareclearlyconsideredasparamount.If
hispersonalbeliefsaboutmotivationcannotbeshakenbythoroughdiscussion
withhispeers(attherecentseminar),itseemsunlikelythattheywillbe
influencedbycommentsoflowerlevelexecutivesinhisowncompany.
Fromtheindependentactionofthepresidentinurgingproductionwithout
limitsandsalesatamaximumeffort,andgiventhecommentsofthe
executives,itappearsthatcommunicationwiththepresidentisbasically
oneway.Thatis,theproductionandsalesmanagersmightwellhaveforeseen
theresultsoftheuncoordinatedeffortsbutwereunabletodiscussthiswith
theseniorofficer.Giventhattheexecutives'performancesweregoingtobe
measured(andrewarded)basedontheirabilitytofollowtheseniorofficer's
instructions,itshouldnotbesurprisingthattheyfollowedthe
instructions.
Thecommentsamongthelowerlevelexecutivesatthetimeofthelast
directors'meetingalsoidentifyaseldomdiscussedbutnotuncommon
problemnepotism.Thispracticecancreatemotivationproblemswith
unrelatedemployees(includingexecutives).Thereare,ofcourse,somegood
effectsthatmaycomefromthispractice.Forexample,employeesmaytakea
proprietaryinterestinthefirm.
Onefinalnotewithrespecttomotivation.Despitetheapparentlackof
successoftheprofitsharingplan,itisobviousthatmanagementshouldgo
aheadwiththedistributionbecausefailingtodosowouldcreateevenmore
seriousproblems.

1347