CHAPTER 3

PREDETERMINED OVERHEAD RATES, FLEXIBLE BUDGETS,

AND ABSORPTION/VARIABLE COSTING
QUESTIONS
1. Although both variable and mixed costs change in total with activity measure
changes,thedifferenceisthatvariablecostschangeindirectproportiontosuch
activitychangesandmixedcostsdonot.Sinceamixedcosthasbothafixedand
variablecomponent,thecostperunitatdifferentactivitylevelsisnotconstantasit
iswithavariablecost.
2.

No,thesearenotalwaysthebestpointsofobservation.First,thepointsmustbe
within the relevant range of activity. Second, to be useful, the points must be
reflectiveoftheentiredatasetofobservationpoints.Ifthehighandlowpointsdo
notmeetthesetwoconditions,alternativepointsshouldbeselected.

3.

There are several reasons for using predetermined overhead rates. First, the
companydoesnotneedtowaittoassignoverheadcoststoproductsorservicesuntil
theendoftheperiodwhenactualcostsareknown.Second,suchrates eliminate
overhead cost fluctuations that have nothing to do with volume levels. Third,
predeterminedoverheadratesprovideameanstocontroldistortionsinproductcosts
caused by changes in volume between or among periods, and the resulting
product/servicecostchangescausedbydifferencesinfixedcostperperiod.

4.

Departmentaloverheadrates aresuperiortoplantwideoverheadrates inthat

overheadapplicationbasescanbeidentifiedthatmoreaccuratelyreflectthecauses
ofcostsineachdepartment.Ineffect,useofdepartmentalratespermitmorecost
driverstobeidentifiedandusedasallocationbases.
Separationofvariableandfixedcostsallowsmanagerstomakedecisionsthatrely
onknowledgeofcostbehavior.Forexample,somedecisionsrequirethatamanager
identifycoststhatwillchangeifaparticulardecisionalternative(suchaswhetherto
manufactureandselladditionalunits)isimplemented.Totalvariablecostresponds
differentlyfromtotalfixedcosttomanagerialactions.Useofatotaloverheadrate
doesnoteasilyallowmanagerstodeterminetheimpactofsuchdifferences.

5.

The two differences between absorption and variable costing relate to the
treatmentoffixedfactoryoverheadandthepresentationofcosts/expensesonthe
incomestatement.Absorptioncostingtreatsfixedfactoryoverheadasaproductcost
andallocatesittotheunitsproducedduringtheperiod;variablecostingtreatsfixed
overheadasaperiodexpenseandchargesthefullamountincurredtotheincomeof
theperiod.Absorptioncostingpresentscostsontheincomestatementinfunctional
categorieswithoutregardtocostbehavior;variablecostingpresentscostsonthe
41
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Chapter 3

42

incomestatementfirstasproductorperiod,secondlybycostbehavior(variableor
fixed),andpossiblybyfunctionalcategories.
Theunderlyingcauseofthedifferencebetweenabsorptionandvariablecostingis
foundinthedefinitionofanasset.Assetcostshouldincludeallcostsnecessaryto
getanitemintoplaceandreadyforsaleoruse.Absorptioncostingconsidersfixed
overheadtobeinventoriable(partofassetcost)becauseproductscouldnotbemade
without the basic manufacturing capacity represented by fixed overhead cost.
Variable costing proponents, however, believe that fixed overhead is not
inventoriablebecauseitisincurredregardlessofwhetherproductionoccursornot.
Thecorrectanswercannotbedeterminedbecausebothpositionshavelogicaland
rationalargumentstosupportthem.
6.

Functionally classifying a cost refers to classification based on where the cost

was incurred (production, selling, or administrative area) and for what purpose
(wages, salaries, utilities, etc.). Behaviorallyclassifyingacostreferstoclassification
basedonthereactionthatthecosthastoachangeinunderlyingactivity(suchas
productionorsalesvolume)and,thus,asvariableorfixed.Acompanyisconcerned
aboutbehavioralclassificationbecause(aslongasthecompanyisoperatinginthe
relevantrangeofactivity)variablecostswillchangeinadirectrelationshipwith
changesinsomeunderlyingactivitymeasure,butfixedcostswillremainconstant.If
variableandfixedcostsarecombinedandshownmerelyasfunctionalcategories,
managementwillnotbeabletoseehoweachfunctionalcategoryofcostwillchange
withchangesinactivity.

7.

Absorptioncostingisrequiredforexternalreporting.Therationaleisthatfixed
manufacturingoverheadistraditionally viewed as aproductcost,andthus,itshould
beaddedtovariableproductioncostandassignedtoinventory.Thetotalcostper
unitwillbeshownasanexpenseonlyintheperiodinwhichtherelatedproductsare
sold.

8.

Useofmonetary,quantitativeinformationvariesgreatlybetweenexternaland
internal users. External users emphasize profitability potential; internal users
emphasizeinformationthathelpsmakesales,production,andcapitalexpenditure
decisions.
Bothabsorptionandvariablecostinghaveaplaceindecisionmaking.Accountants
anddecisionmakersneedtounderstandtheapplicationsandlimitationsofthetwo
techniqueswithinthecontextofpast,present,andfuturecostinformationneeds.No
matterwhichtypeofcostingafirmuses,thefirmstotalrevenuemustcoverall
costsbothvariableandfixedandalsogenerateasatisfactoryprofitifafirmisto
surviveinthelongrun.
The methods of cost accumulation and cost presentation used for reporting are
determinedbywhatisacceptabletothepartiesforwhomthereportsareintended.
External reporting is guided by the characteristics of reliability, uniformity, and
consistency. Internal reporting is guided by flexibility in helping managers with
planning,controlling,decisionmaking,andperformanceevaluations.
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Chapter 3

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43

44

9.

Chapter 3

Whenproductionexceedssalesvolume,absorptioncostingincomewillbehigher
than variablecosting incomebecause some ofthe fixedfactory overhead incurred
duringtheperiodwillbedeferredintoinventoryratherthanappearingontheincome
statement.Sincenofixedoverheadisinventoriedundervariablecosting,therewillbea
largerexpenseontheincomestatementundervariablecostingthanunderabsorption
costing.
Whenproductionislessthansalesvolume,someofthefixedoverheaddeferredin
previousperiodswillbechargedagainstincomeaspartofcostofgoodssoldunder
absorptioncostinginadditiontoallofthecurrentperiodfixedoverhead.Thus,there
will be a higher income statement charge under absorption costing than under
variable costing (which will only expense the current period fixed overhead).
Therefore, under this circumstance, absorption costing income will be less than
variablecostingincome.

10.

Theregressionmethodhasthemajoradvantageofusingallpointsinthedataset
todeterminethefixedandvariablecostelementsofthemixedcosts.This isin
contrasttothehighlowmethod,whichusesonlytwopointsinthedataset. It is
possible that the use of only two points could include outliers, if they are not
recognized as such by the user.

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Chapter 3

45

EXERCISES
11. a. (1)
Atanylevel,thevariablecostis$2permachinehour.Sincefour
hours are needed to make one unit, the variable rate is $8 per unit. At
productionof10,000units,thefixedrateis$325,00010,000or$32.50per
unit.
(2)
Atanylevel,thevariablecostis$2permachinehour.At
productionof10,000units,thefixedratepermachinehour=$32.504=
$8.125permachinehour.
b.

(1) Combinedrate=$8+$32.50=$40.50perunit
(2) Combinedrate=$2+$8.125=$10.125perunit
c.
Atactualproductionof11,000unitsandapplyingOHon
unitsofproduction:

Expected=
Actual
Applied
VOH(11,000$8) $88,000
(11,000$8)=$ 88,000
FOH
325,000 (11,000$32.50)= 357,500
12.

Under/Over
Applied
$0
32,500overapp.
a. Applied

VOH=900$8=$7,200
AppliedFOH=900$32.50=$29,250
c. VOH:ActualVOHAppliedVOH=$7,500$7,200=$300underapplied
FOH:ActualFOHAppliedFOH=$26,500$29,250=$2,750overapplied
13.

a. Expected
overhead=($42,90012)+($678,000)
=$514,800+$468,000
=$982,800
Predeterminedoverheadrate=$982,80078,000=$12.60perDLH
Overheadperunit=$12.601.5hoursperunit=$18.90

b.
Manufacturing
Overhead
Variousaccounts
WorkinProcessInventory(6,390$12.60)
ManufacturingOverhead
c.

128,550
128,550
80,514
80,514

6,390DLHs1.5=4,260unitsshouldhavebeen

produced
14.

a. Jan.$180,0002.50=$450,000
Feb.$165,0002.50=$412,500
Mar.$170,0002.50=$425,000
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46

Chapter 3

b. Jan.ActualApplied=$440,000$450,000=
Feb.ActualApplied=$420,400$412,500=
Mar.ActualApplied=$421,000$425,000=
Totalforquarter

$10,000overapplied
$7,900underapplied
$4,000overapplied
$6,100overapplied

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Chapter 3

47

15. a.($600,400+$199,600)(10,000+40,000)=$800,00050,000=$16.00perDLH
b. ($600,400+$199,600)(76,000+4,000)=$800,00080,000=$10.00perMH
c. Assembly:$600,40076,000=$7.90perMH
Finishing:$199,60040,000=$4.99perDLH
d. Overheadassignedusinganswerfrom(a):1$16.00=$16.00
Overheadassignedusinganswerfrom(b):5$10.00=$50.00
Overheadassignedusinganswerfrom(c):(5$7.90)+(1$4.99)
=$39.50+$4.99=$44.49
16. a. ManufacturingOverhead
CostofGoodsSold
b. ManufacturingOverhead
WorkinProcessInventory
FinishedGoodsInventory
CostofGoodsSold
WIP
FG
CGS
Total

66,000
66,000
66,000

$384,000 384,0001,200,000=32%
96,000 96,0001,200,000=8%
720,000 720,0001,200,000=60%
$1,200,000

21,120
5,280
39,600
0.32$66,000= $21,120
5,280
0.08$66,000=
0.60$66,000= 39,600

c. Themethodin(b)wouldbemoreappropriateinthisinstancebecauseofthe
amount.Overappliedoverheadis5.5percentofthetotalbalancesinallofthe
accountscontainingoverhead,sotocloseitdirectlytocostofgoodssoldwould
causeadistortionofthecostsremainingininventoryandcostofgoodssold.
17. a. Predeterminedoverheadrate=AppliedoverheadActualDLHs
=$120,0005,000=$24.00perDLH
b.

Overhead is underapplied by ($121,500 $120,000) or $1,500

c. Becausetheamountofunderappliedoverheadisonlyabout0.5percentoftotal
productioncostsforthemonth,theunderappliedbalancecouldbeclosedonlyto
CostofGoodsSoldwithoutdistortingproductcosts.Thejournalentrywouldbe
asfollows:
CostofGoodsSold
ManufacturingOverhead

1,500
1,500

18. a.
UsingtheinformationintheWIPInventoryaccount,therateis$20,000
$10,000or200percentofdirectlaborcost.
b. The amount ($40,000) should be prorated because it is large
relativetothebalancesinWorkinProcessInventory,FinishedGoodsInventory,
andCostofGoodsSold.

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48

Chapter 3

c.
$520,000)=$3,846
FinishedGoodsInventory:
CostofGoodsSold:
Total

WorkinProcessInventory:$40,000($50,000
$40,000($200,000$520,000)=15,385
$40,000($270,000$520,000)=20,769
$40,000

d. Adebitbalanceinthemanufacturingoverheadaccountcanbethe
resultofseveralcausesincluding:(1)payinghigherpricesthanbudgetedforthe
resourcescomprisingactualoverhead,(2)usingmoreoverheadresourcesthan
attachedtoinventoryforactualoutput,(3)producingatlesscapacitythanthe
plannedlevelofactivityuponwhichthepredeterminedoverheadratewasbased,
or(4)acombinationofthepriorthreecauses.
19. a.
The choice of capacity measure affects the amount of under or
overappliedoverheadonlyforfixedoverheadcosts.Becausethetotalamountof
overhead that is expected to be incurred is unaffected by the volume of
production(aslongasitiswithintherelevantrange), theperunitcostoffixed
overheadvariesinverselywiththelevelofactualproduction.Iftheactualcapacity
differsdramaticallyfromthecapacitychosentoallocateoverhead,theresultislikely
tobelargeamountsofunderoroverappliedfixedoverhead.Ifactualcapacityis
significantlybelow(above)thecapacityusedtodevelopthefixedoverheadrate,the
result is likely to be a significant amount of underapplied (overapplied) fixed
overhead.
b. Expected capacity would likely result in the least amount of
underoroverappliedoverheadbecauseexpectedcapacityreflectsthemostlikely
levelofcapacityutilizationfor2013.
c. If Milltown is in a cyclical industry, it might choose normal
capacitytoallocateoverheadcosts.Normalcapacityisbasedonaconsideration
oflongtermactivitythatcanaccommodateanentirecycleinanindustry.The
annualcapacityreflectstheaverageofthelongtermactivitylevel.
20. a.
VOHrate(canbecalculatedateitherlevel):$1,250,000100,000MHs
=$12.50perMHor$1,875,000150,000MHs=$12.50perMH
b.

FOHrate:$1,440,000180,000=$8.00perMH

c.
Expectedcapacity=2/3180,000=120,000MHs
FOHrate:$1,440,000120,000=$12.00perMH
d.
At110,000MHs:
TotalVOHapplied=110,000$12.50=$1,375,000
TotalFOHapplied(practicalcapacityrate):110,000$8.00=$880,000
TotalFOHapplied(expectedcapacityrate):110,000$12.00=$1,320,000
TotalOHapplied(practical)($1,375,000+$880,000)
ActualOH
UnderappliedOH

$2,255,000
(2,710,000)
$(455,000)

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Chapter 3

49

TotalOHapplied(expected)($1,375,000+$1,320,000)
$2,695,000
ActualOH
(2,710,000)
UnderappliedOH
$(15,000)
MHs
TotalCost = VariableCost + FixedCost
21.
a.
Highactivity
34,000 $12,200
$5,440
$6,760
Lowactivity
31,000 11,720
4,960
6,760
Differences
3,000 $480
Variablerate=$4803,000MHs=$0.16perMH
Highactivityvariablecost=34,000$0.16=$5,440
Lowactivityvariablecost=31,000$0.16=$4,960
Fixedcostathighactivity=$12,200$5,440=$6,760
Fixedcostatlowactivity=$11,720$4,960=$6,760
Budgetformula:TC=FC+VC(X)
TC=$6,760+$0.16MH
b.

$11,760

TC = $6,760 + $0.16(31,250) = $6,760 + $5,000 =

ShipmentsReceived
60
35
25

22. a.
Highactivity
Lowactivity
Differences

CostofReports
$202
142
$60

Variablecost=$6025=$2.40
Fixedcost(highpoint)=$202(60$2.40)=$58
y=$58+$2.40X
b.

y=$58+($2.4072)

y=$230.80
c. Themostsignificantproblemisthat72shipmentsisfarlargerthan
thelargestnumberofshipmentsinthedatausedtodeveloptheequation.Thus,72
maybeoutsideoftherelevantrangefortheequation.Otherconcernsarethose
associatedwithuseofthehighlowmethodincludingonlytwoofthesevendata
pointswereusedtodeveloptheequation.
23.a.
Highactivity
Lowactivity
Differences

MHs TotalCost = VariableCost + FixedCost

9,000 $880
$(1,620)
$2,500
3,000 1,960
(540)
2,500
6,000 $(1,080)

Variablerate=$(1,080)6,000MHs=$(0.18)perMH
Highactivityvariablecost=9,000$(0.18)=$(1,620)
Lowactivityvariablecost=3,000$(0.18)=$(540)
Fixedcostatlowactivity=$1,960$(540)=$2,500
Totalmaintenancecost=$2,500$0.18MH
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50

Chapter 3

b. Thevariablecostcomponentisnegative,whichimpliesthat,as
the number of machine hours increases, the amount of maintenance costs
declines.Sucharelationshipisimplausible.Oneexplanationthatwouldaccount
fortheperceivedinverserelationshipwouldbethatthecompanyperformsthe
maintenance chores when there is idle time available. As business activity
increases,lessandlesstimeisavailabletoperformmaintenanceactivities.
c. For a cost prediction formula to work effectively, a positive
relationshipbetweentheactivitymeasureandthecostpoolisnotrequired.Thus,
theformuladevelopedin(a)mightfunctioneffectively.However,onecannot
interprettheparametersofthemodel($0.18,$2,500)asvariableandfixedcosts,
respectively.
24. a.

Highactivity
Lowactivity
Differences

MHs
1,900
1,250
650

Total
Cost =
$1,160
900
$260

Variable
Cost
$760
500

Fixed
+ Cost
$400
400

Variablerate=$260650MHs=$0.40perMH
Costformula:y=$400+$0.40MH
b.
Variableutilitycost@$0.40perMH
Fixedutilitycost
Expectedtotalutilitycost

1,325 1,500 1,675

$530
$600
$670
400
400
400
$930
$1,000
$1,070

25. a.
Ifthepurposeistocontrolcosts,thecomparisonisinappropriate.Actual
costshouldbecomparedwithflexiblebudgetcostatthesamelevelofoutputas
thatoftheactualcostinthiscase17,600units(not16,000units).Aflexible
budgetformulaallowsthedeterminationofcostsatanylevelofactivity.
b.
Variablerate(b)(atanypoint)=$4(forexample,$80,000
20,000units)
Fixedamount(a)(given)=$32,000
Theflexiblebudgetfor17,600unitsis:
$70,400
Variable(17,600$4)
Fixed
32,000
Total
$102,400
Acomparisonwiththebudgetfollows:
Variable
Fixed
Total

Budget
$70,400
32,000
$102,400

Actual
$69,000
32,800
$101,800

Variances
$1,400F
800U
$600F

Thecompanydidwellcontrollingvariablecosts,butfixedcostswere$800over
thebudgetedamount.

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Chapter 3

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51

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Chapter 3

26.a.
Variablecosts:
Supplies@$4.00perDLH
Directlabor@$7.00perDLH
Utilities@$5.40perDLH
Fixedcosts:
Directlabor
Utilities
Rent
Advertising
Totalcost
b.CostperDLH

250

300

350

400

$1,000
1,750
1,350

$1,200
2,100
1,620

$1,400 $1,600
2,450 2,800
1,890 2,160

500
350
450
75
$5,475

500
350
450
75
$6,295

500
350
450
75
$7,115

$21.90

$20.98

$20.33

500
350
450
75
$7,935
$19.84

c.
$20.331.4=$28.46hourlycharge
$28.461.25hoursperrepair=$35.58or$36percustomerrepair
27. a. (18,00016,560)$22.00=1,440$22.00=$31,680
b.
$18.00=$25,920

(18,00016,560) ($22.00$4.00)=1,440

c.
Absorption costing would have produced the
highernetincomebecauseitwouldhaverequired$5,760(1,440$4.00)offixed
manufacturing overhead to be inventoried rather than to be charged against
income.
28. Thevariancebetweenvariableandabsorptionnetincomeiscausedbythedifference
intreatmentoffixedmanufacturingoverhead.
Fixedoverheadexpensed:
Variablecosting
Absorptioncosting[$500,000(21,00025,000)]
Netincomedifference

$500,000
(420,000)
$80,000

Thecompanysnetincomewouldhavebeen$80,000higherunderabsorption
costing.
29. a. Ingredients
Labor
Variableoverhead
Totalvariablecost
Dividedbyunits
Variablecostperunit
Totalvariablecost
Fixedoverhead
Totalcost
Dividedbyunits

$228,800
104,000
197,600
$530,400
104,000
$5.10
$530,400
98,800
$629,200
104,000

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Chapter 3

53

Absorptioncostperunit
b.
$5.10=$510,000
c.
$6.05=$605,000

$6.05
Variablecostofgoodssold=100,000
Absorptioncostofgoodssold=100,000

d.
Ending inventory (variable costing) =
4,000$5.10=$20,400
Endinginventory(absorptioncosting)=4,000$6.05=$24,200
e.
Fixed overhead charged to expense
(variablecosting)=$98,800
Fixedoverheadchargedtoexpense(absorptioncosting)=$95,000
30. a.

b.

IncomeVariablecosting
DeductincreaseinCGS[FOHoutofinventory($89,600)]
IncomeAbsorptioncosting
IncomeVariablecosting
AdddecreaseinCGS[FOHinventoried($83,000)]
IncomeAbsorptioncosting

$188,000
(76,800)
$111,200
$188,000
24,000
$212,000

31.a.(1)Fabios Fashions
IncomeStatement(AbsorptionCostingBasis)
FortheMonthEndedApril30,2013
Sales($14,400,000$144=100,000unitssold)
$14,400,000
(10,200,000)
Costofgoodssold($102100,000)
*
(1,275,000)
Productionvolumevariance($3042,500)
Grossmargin
$2,925,000
Fixedselling&administrativeexpenses
(2,400,000)
Incomebeforetaxes
$525,000
Totalproduction(100,000unitssold+7,500
unitsinventoried)
Expectedproduction
Unitscreatingvolumevariance
*

107,500
(150,000)
42,500

(2) Differencesinincomes=$300,000$525,000=$(225,000)
Thisamountisequaltotheincreaseininventoryof7,500units$30perunit
fixedoverheaddeferredinendinginventoryunderabsorptioncosting.
b. Caffrey should find the variable costing approach to income
determinationdesirableformanyreasons,includingthefollowing:
Variablecostingincomevarieswithunitssold,notunitsproduced.

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54

Chapter 3

Fixedmanufacturingoverheadcostsarechargedagainstrevenueintheperiod
inwhichtheyareincurred;consequently,manufacturingcostperunitdoes
notchangewithachangeinproductionlevel.
The contribution margin offers a useful tool for marketing decisions that
consider changes in relationships among costs, volume levels, and profit
figures.
(CMAadapted)

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Chapter 3

55

32.a. Budgetedfixedoverhead=$0.40100,000=$40,000
b. Actual(andbudgeted)fixedoverhead
Appliedfixedoverhead(45,000$0.40)
Underappliedfixedoverhead(absorption)

$40,000
18,000
$22,000

Thereisnounderappliedoroverappliedfixedoverheadundervariablecosting
becausefixedoverheadisnotappliedtounitsofproduct.
Directmaterial
Directlabor
Variableoverhead
Costperunit(variable)
Fixedoverhead
Costperunit(absorption)
d.Absorptioncostofgoodssold(48,750$5.60)
Plusunderappliedoverhead(55,000$0.40)
Adjustedcostofgoodssold
Sellingandadministrativecosts:
Variable(48,750$0.40)
Fixed
Totalexpense(absorption)
Variablecostofgoodssold(48,750$5.20)
Variablesellingexpenses(48,750$0.40)
Fixedoverhead
Fixedsellingandadministrativeexpenses
Totalexpense(variable)

$3.60
1.00
0.60
$5.20
0.40
$5.60
$273,000
22,000
$295,000
$19,500
150,000

169,500
$464,500
$253,500
19,500
40,000
150,000
$463,000

e. Incomeishigherundervariablecostingbecausethesaleslevelis
greaterthantheproductionlevel.Incomewillbehigherbythefixedoverheadper
unit($0.40)timesthechangeininventory(3,750unitdecline)or$1,500.
33. Each student will have a different answer, but the following points should be
addressed. Thedebatesurroundingtheuseofvariablecostingversus absorption
costingforvaluinginventoryhingesonwhethertheincurrenceoffixedoverhead
createsanasset.Acostincurredtocreateanasset,asopposedtoacostthatisan
expense of the period, must be capitalized and should not be charged against
revenues (expensed) until its related benefit is recognized in income. Since
inventoryisanasset,anycoststhatareincurredtocreatethatasset,includingfixed
overhead,shouldbeconsideredforcapitalization.Thisistheargumentforuseof
absorptioncosting.
However,proponentsofvariablecostingarguethattheincurrenceoffixedoverhead
relates more to the capacity to produce than to production. Accordingly, these
peoplearguethatfixedoverheadisnotdirectlyrelatedtoproductionsufficientlyto
beconsideredaninventoriablecost.

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Chapter 3

34.a.

x
50
44
40
35
53
58
60
340

y
$175
162
154
142
185
200
202
$1,220

xy
$8,750
7,128
6,160
4,970
9,805
11,600
12,120
$60,533

x2
2,500
1,936
1,600
1,225
2,809
3,364
3,600
17,034

x=340 7=48.57
y=$ 1,220 7=$ 174.29
xy n( x )( y) = $ 60,5337 (48.57)($ 174.29)= $ 1,276.14 =$ 2.45
b=
17,0347(48.57)(48.57)
520.69
x 2n(x)2
a= yb x=$ 174.292.45(48.57)=$ 55.29
y $55.29+$2.45(#ofshipments)

b.
y=$55.29+$2.45(165)=$459.54
Note that one would be cautious to use this prediction because 165 may be
substantiallygreaterthantherelevantrangeofactivity.
35.x
200
325
400
410
525
680
820
900
4,260

y
$300
440
480
490
620
790
840
900
$4,860

xy
$60,000
143,000
192,000
200,900
325,500
537,200
688,800
810,000
$2,957,400

x2
40,000
105,625
160,000
168,100
275,625
462,400
672,400
810,000
2,694,150

x=4,260 8=532.60
y=$ 4,860 8=$ 607.50
xy n( x )( y) = $ 2,957,4008 (532.50)( $ 607.50) = $ 369,450 =$ 0.87
b=
2,694,1508 (532.50)(532.50)
425,700
x 2n(x)2
a= yb x=$ 607.50$ 0.87(532.50)=$ 144.23
y $144.23+$0.87MH

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Chapter 3

57

PROBLEMS
36.a. OHrate=AllocatedoverheadActualhours
=($80,000+$16,000+$4,000)(8,000+1,600+400)
=$10.00perDLH
MH

b.

OHrate=$100,000(800+2,400+12,800)=$6.25per

c.
GW1:800$6.25=$5,000
GW4:2,400$6.25=$15,000
GW7:12,800$6.25=$80,000
d. Theoverheadallocationsdifferdramaticallybecausemostofthe
direct labor hours are expended on the production of GW1 and most of the
machine hours are expended on GW7. GW4 is allocated similar amounts of
overheadunderthetwoschemesonlybecauseitsproductionrequiresabalanceof
machineandlabortime.
Thebetterallocationcannotbedeterminedbasedontheavailableinformation.
However, identifying the better allocation requires that the costs comprising
overheadbeexaminedtodeterminewhethertheyaremorecloselyassociated
withlabortimeormachinetime.Alternatively,anoverheadallocationscheme
couldbedevisedthatwouldusetwooverheadrates:oneusingdirectlaborto
allocate the labordriven overhead costs and the other uses machine hours to
allocatethemachinedrivenportionofoverhead.
37.a.
Indirectmaterial
Indirectlabor
Utilities
Repairs&maintenance
Materialhandling
Depreciation
Rentonplantbuilding
Insuranceonplantbuilding
Totals

FixedCosts
$144,000
6,000
20,000
16,000
210,000
50,000
12,000
$458,000

VariableCosts
$2.00
2.50
0.04
0.34
0.12

$5.00

y=$458,000+$5X
b.
Capacitiescomputed:
Theoretical=50,000units
Practical=50,0000.80=40,000units
Normal=50,0000.800.80=32,000units
Expectedcapacity=30,000units
Overheadapplicationrates(perunit):
Theoretical:($458,00050,000)+$5=$14.16
Practical:($458,00040,000)+$5=$16.45
Normal:($458,00032,000)+$5=$19.31(rounded)
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58

Chapter 3

Expected:($458,00030,000)+$5=$20.27(rounded)

c.

Actualcost=$458,000+($535,000)=$633,000

Appliedoverhead:
Theoreticalrate:$14.1635,000=$495,600
Practicalrate:$16.4535,000=$575,750
Normalrate:$19.3135,000=$675,850
Expectedrate:$20.2735,000=$709,450
Under/Overappliedamounts:
Theoretical:
Practical:
Normal:
Expected:

Applied
$495,600
575,750
675,850
709,450

38.a.
Variablecosts:
Indirectmaterial
Indirectlabor
Factoryutilities
Machinemaintenance
Materialhandling
Machinedepreciation
Totalvariablecosts
Fixedcosts:
Factoryutilities
Machinemaintenance
Materialhandling
Buildingrent
Supervisorssalaries
Factoryinsurance
Totalfixedcosts

Actual
$633,000
633,000
633,000
633,000

(Under)OverappliedAmount
$(137,400)
(57,250)
42,850
76,450

Expected
72,000

Normal
76,000

Practical Theoretical
80,000
100,000

$180,000
216,000
1,440
36,000
8,640
2,160
$444,240

$190,000
228,000
1,520
38,000
9,120
2,280
$468,920

$200,000
240,000
1,600
40,000
9,600
2,400
$493,600

$250,000
300,000
2,000
50,000
12,000
3,000
$617,000

$3,000
10,000
8,000
12,000
72,000
6,000
$111,000

$3,000
10,000
8,000
12,000
72,000
6,000
$111,000

$3,000
10,000
8,000
12,000
72,000
6,000
$111,000

$6.17

$6.17

$6.17

$1.46

$1.39

$1.11

3,000
10,000
8,000
12,000
72,000
6,000
$111,000

VariableOHrateperunit
FixedOHrateperunit

$6.17
$1.54

VariableManufacturingOverhead

175,000

1
)
RawMaterial(Supplies)Inventory
Torecordindirectmaterialat$2.50perunit
produced
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175,000

Chapter 3

59

VariableManufacturingOverhead
WagesPayable(orCash)
Torecordindirectlaborat$3.00perunitproduced

210,000
210,000

VariableManufacturingOverhead
FixedManufacturingOverhead
UtilitiesPayable(orCash)
Torecordfactoryutilities

1,400
3,000

VariableManufacturingOverhead
FixedManufacturingOverhead
Cash(orSupplies)
Torecordfactorymaintenance

35,000
10,000
45,000

VariableManufacturingOverhead
FixedManufacturingOverhead
Cash
Torecordmaterialhandlingcharges

8,400
8,000

VariableManufacturingOverhead
AccumulatedDepreciation
Torecorddepreciationat$0.03perunitproduced

2,100

FixedManufacturingOverhead
Cash
Torecordbuildingrent

12,000

FixedManufacturingOverhead
SalariesPayable(orCash)
Torecordsupervisorssalaries

72,000

FixedManufacturingOverhead
Cash(orPrepaidIns.orIns.Payable)
Torecordfactoryinsurance
WorkinProcessInventory
VariableManufacturingOverhead
FixedManufacturingOverhead
Toapplyvariableandfixedmanufacturing
overheadtoWIP

4,400

6,000

539,700

Actualfixedoverhead

$111,000

Appliedfixedoverhead(70,000$1.54)
Underappliedfixedoverhead

107,800
$3,200

16,400

2,100

12,000

72,000

6,000

431,900
107,800

d. Use of expected capacity would create costs that would more

closelymatchactualproductioncosts.However,useofpracticalcapacitywould
helpindicatetomanagementthecostsofunusedcapacity.

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60

Chapter 3

39.a. Totaloverhead=$635,340+$324,000=$959,340
TotalMHs=72,000+9,300=81,300
OHrateperMH=$959,34081,300MH=$11.80perMH
Appliedoverhead=$11.8010.30=$121.54
b.
Fabrication:$635,34072,000
$88.20
MHs=$8.82perMH10
13.50
Finishing:$324,00048,000DLHs=$6.75perDLH2
TotalOHappliedperunitusingdepartmentalrates
$101.70
c.
Becauseeachdepartmentissodifferentinthetype
ofworkbeingperformed(machineintensivevs.laborintensive),plantwiderates
willnotaccuratelyattachoverheadcosts.
40. a.

(1)TotalDLHs=27,000+3,000=30,000
OHrateperDLH=$993,00030,000DLHs=$33.10perDLH
TotalMHs=2,100+65,800=67,900
OHrateperMH=$993,00067,900MHs=$14.62perMH
b.
Cutting:$385,50027,000DLHs=$14.28perDLH
Assembly:$607,50065,800MHs=$9.23perMH
c.

RW22SKI
Directmaterial
$34.85
120.00
DirectlaborCutting(6$20.00;4.8$20.00)
0.24
DirectlaborAssembly(0.03$8.00;0.05$8.00)
Totalcostotherthanoverhead
$155.09
(1)
Overhead(plantwide
rateusingDLHs)
199.59
(6.03$33.10;4.85$33.10)
Totalcost
$354.68
(2)

Totalcostotherthan

overhead
Overhead(plantwiderateusingMHs)
(5.96$14.62;9.45$14.62)
Totalcost
(3)

Totalcostotherthan
overhead
CuttingDepartmentoverhead
(6$14.28;4.8$14.28)
AssemblyDepartmentoverhead
(5.9$9.23;9.3$9.23)
Totalcost

SD45ROW
$19.57
96.00
0.40
$115.97
160.54
$276.51

$155.09

$115.97

87.14
$242.23

138.16
$254.13

$155.09

$115.97

85.68

68.54

54.46
$295.23

85.84
$270.35

c. Given that a competitor sells the similar product for $310,

management would probably conclude that production of RW22SKI was not

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Chapter 3

61

feasibleifthecostdeterminedfromaplantwideoverheadratebasedonDLHs
was used; competing on price would create a loss per unit. Using the cost
determinedfromaplantwideratebasedonMHs mightcausemanagementto
undercutthecompetitorspricesubstantially,believingthatasignificantprofit
margincouldbemade.Usingthecostdeterminedfromdepartmentalrates(which
isthemostaccurateofthethreecosts)wouldallowmanagementtomeetthe
competitionspricebutwouldprovideasmall5percentprofitmargin($310
$295.23 = $14.77; $14.77 $310 = 0.05). Possibly management needs to
determineiftheproductcouldbeproducedmoreefficiently.
$100,000
20,000
80,000
120,000
$320,000

41. a.Variableindirectlabor
Variableindirectmaterial
Variableutilities
Variableportionofothermixedcosts
TotalvariableOHcosts

TotalvariableOHcostsNumberofMHs=VariableOHrateperMH
$320,00050,000MHs=$6.40perMH
Fixedmachinerydepreciation
Fixedmachineryleasepayments
Fixedmachineryinsurance
Fixedsalaries
Fixedutilities
TotalfixedoverheadOHcosts

$62,000
13,000
16,000
75,000
12,000
$178,000

TotalfixedOHcostsNumberofMHs=FixedOHrateperMH
$178,00050,000MHs=$3.56perMH
VariableManufacturingOverhead

273,600

Variousaccounts
TorecordactualVOHcosts

273,600

FixedManufacturingOverhead
Variousaccounts
TorecordactualFOHcosts

185,680

WorkinProcessInventory(53,000MHs$6.40)
VariableManufacturingOverhead
ToapplyVOHtoproduction

339,200

WorkinProcessInventory(53,000MHs$3.56)
FixedManufacturingOverhead
ToapplyFOHtoproduction

188,680

185,680

339,200

188,680

ActualVOH

$273,600

ActualFOH

$185,680

AppliedVOH

339,200

AppliedFOH

188,680

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62

Chapter 3

OverappliedVOH

$65,600

OverappliedFOH

FixedManufacturingOverhead

$3,000

3,000

CostofGoodsSold
TocloseFOHatyearend

WIP
FG
CGS
Total

3,000

Balance

Proportion

$234,000
390,000
936,000
$1,560,000

$234,000$1,560,000
390,000$1,560,000
936,000$1,560,000

15 $65,600
25 $65,600
60 $65,600
100

VariableManufacturingOverhead
WorkinProcessInventory
FinishedGoodsInventory
CostofGoodsSold

Overapp.OH Adj.
$9,840
16,400
39,360
$65,600

65,600
16,400
39,360

9,840

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Chapter 3

63

42. a.Indirectmaterial:variable;ateitherlevel,$6.40peranimalday
Indirectlabor:mixed;$8,000+$12.00peranimalday
a 6,000days
$80,000
t
a (4,000)days
(56,000)
t
2,000
$24,000
$24,0002,000=$12peranimalday
Totalcost
Variable($126,000animaldays)
Fixed

$80,000
72,000
$8,000

Maintenance:mixed;$4,000+$1.60peranimalday
at
6,000days
$13,600
at (4,000)days (10,400)
2,000
$3,200
$3,2002,000=$1.60peranimalday
Totalcost
Variable($1.606,000animaldays)
Fixed

$13,600
(9,600)
$4,000

Utilities:variable;ateitherlevel,$2.00peranimalday
Allother:mixed;$2,400+$3.20peranimalday
at 6,000days
$21,600
at (4,000)days (15,200)
2,000
$6,400
$6,4002,000=$3.20peranimalday
Totalcost
Variable($3.206,000animaldays)
Fixed

$21,600
(19,200)
$2,400

Totalfixedcost=$8,000+$4,000+$2,400=$14,400
Totalvariablecost=$6.40+$12.00+$1.60+$2.00+$3.20=$25.20
TotalOHcostformula:$14,400+$25.20peranimalday
b.

$14,400($26.80$25.20)=9,000animaldays

c.

$26.809,000=$241,200

d. VOHrateremainsconstantat
FOHrate($14,40012,000)
TotalOHrateat12,000animaldays

$25.20
1.20
$26.40*

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64

Chapter 3

Thisrateassumesthat12,000daysisstillwithintherelevantrangeofactivity
and, therefore, novariable costs will change per unit and nofixed costs will
changeintotal.
*

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accessible website, in whole or in part.

Chapter 3

65

43.a.
Highactivity
Lowactivity
Differences

MHs
TotalCost
2,700 $13,160
(1,400) (9,000)
1,300 $4,160

VariableCost
$8,640
4,480

FixedCost
$4,520
4,520

Variablerate=$4,1601,300MHs=$3.20perMH
Highactivityvariablecost=2,700$3.20=$8,640
Lowactivityvariablecost=1,400$3.20=$4,480
Fixedcostatlowactivity=$9,000$4,480=$4,520
TotalR&Mcost=$4,520+$3.20MH
x

xy

x2

1,400
1,900
2,000
2,500
2,200
2,700
1,700
2,300

$9,000
10,719
10,900
13,000
11,578
13,160
9,525
11,670

1,960,000
3,610,000
4,000,000
6,250,000
4,840,000
7,290,000
2,890,000
5,290,000

16,700

$89,552

$12,600,000
20,366,100
21,800,000
32,500,000
25,471,600
35,532,000
16,192,500
26,841,00
0
$191,303,20
0

36,130,000

x=16,700 8=2,087.50
y=$ 89,552 8=$ 11,194
xy n( x )( y) = $ 191,303,2008(2,087.50)( $ 11,194 )= $ 4,363,400 =$ 3.44
b=
36,130,0008(2,087.50)(2,087.50)
1,268,750
x 2n(x)2
a= yb x=$ 11,193.25$ 3.44(2,087.50)=$ 4,012.25
y $4,012.25 + $3.44 MH
c.
Part(b)computationsprovidethebetteranswer.
Theleastsquaresregressionapproachtakesintoconsiderationalloftheavailable
dataandemploysamathematicalalgorithmtominimizethevariancearoundthe
fittedregressionline.
44.a.
Variablecosts:
Supplies

Directlabor
Overhead

550
$
2
,
2
0
0
6,600
55
0

DIRECTLABORHOURS
600
650
$
2
,
4
0
0
7,200
60
0

$
2
,
6
0
0
7,800
65
0

700
$2,800

8,400
700

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66

Chapter 3

Totalvariablecosts

VariablecostperDLH

Fixedcosts:
Overhead

FixedcostsperDLH

Totalcost
b.TotalcostperDLH

$
9
,
3
5
0
$
1
7
.
0
0

$10,20
0

$11,05
0

$11,900

$
1
7
.
0
0

$
1
7
.
0
0

$17.00

$ $
8 8,000
,
0
0
0
$
$
1
1
4
3
.
.
5
3
5
3
$17,35
$18,20
0
0
$
3
1
.
5
5

$
3
0
.
3
3

8
,
0
0
0
$
1
2
.
3
1
$19,05
0
$
2
9
.
3
1

$8,000

$11.43

$19,900
$28.43

c. Price=(1.45$29.31)+[0.4
(1.45$29.31)]=$59.50(rounded)

45.a.
Low
2,500
Productionoverheadcosts:
Variable
Fixed
Total

$10,125
95,400
$105,525

ACTIVITYINMHs
High
3,000
3,500
$12,150
95,400
$107,550

$14,175
95,400
$109,575

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Chapter 3

Installationoverheadcosts:
Variable
Fixed
Total

67

6,000

ACTIVITYINDLHs
7,000
8,000

$85,500 $99,750
73,800 73,800
$159,300 $173,550

$114,000
73,800
$187,800

Numberofpools:8
Production(25MHsperpool):
Variable(825$4.05)
Fixed(monthlyamount)
Totalproductionoverhead
Installation(60DLHsperpool):
Variable(860$14.25)
Fixed(monthlyamount)
Totalinstallation
Total

$810
7,950
$6,840
6,150

$8,760

12,990
$21,750

Numberofpools:120
Production(25MHsperpool):
Variable(12025$4.05)
Fixed
Installation(60DLHsperpool):
Variable(12060$14.25)
Fixed
Totaloverhead
Budgetedcapacity
Overheadcostperpool

$12,150
95,400
$102,600
73,800

$107,550

176,400
$283,950
120
$2,366.25

46. YouwouldlikelytellSniderthatheshouldprovidetohissuperiortheequationfor
each cost that provides the most accurate prediction of the cost. To make this
determination,youcouldadviseSnidertouseeachofthetwoequationstopredict
costsinpastperiods.Theequationthatproducestheleasterrorintheprediction
wouldbethebestequationtouseinthebudgetingprocess.SinceSniderusedthe
highlowmethodtodevelophisequations,heusedonlytwomonthsofdatainthe
estimationprocess.Othermonthlydatacouldbeusedtoassesstheaccuracyofeach
equation.Yourinitialbiaswouldfavorthemodelbasedonmachinehoursbecause
thatmodelproducesamuchlowerfixedcost(costunexplainedbythexvariablein
themodel).

47.a. GeorgiaShacks
IncomeStatement(Absorption)
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68

Chapter 3

FortheYearEndedDecember31,2013
Sales
Costofgoodssoldvariable
Fixedoverhead[($1,500,0002,000)1,500]
Grossprofit
Variableselling&administrative
Fixedselling&administrative
Netincome

$1,950,000
1,125,000
$270,000
190,000

$3,750,000
(3,075,000)
$675,000
(460,000)
$215,000

b.
Thedifferenceintheamountsisequaltothe
fixedoverheadof($1,500,0002,000units)or$750perunittimesthe500units
produced but not sold during the year. This $375,000 is contained in ending
inventory under absorption costing, whereas it appears as part of total fixed
overheadexpenseonthevariablecostingincomestatement.
c.
Itisnotonlyethical,butitisalsorequiredfor
thestatementstobeinconformitywithgenerallyacceptedaccountingprinciples.
d.

(1)
GeorgiaShacks
IncomeStatement(Variable)
FortheYearEndedDecember31,2014
$5,500,000
Sales(2,200$2,500)
(2,860,000)
Variablecostofgoodssold(2,200$1,300)
Productcontributionmargin
$2,640,000
(396,000)
Variableselling&administrative($1802,200)
Contributionmargin
$2,244,000
Fixedoverhead
$1,500,000
Fixedselling&administrative
190,000
(1,690,000)
Netincome
$554,000
(2)

GeorgiaShacks
IncomeStatement(Absorption)
FortheYearEndedDecember31,2014
Sales
Costofgoodssoldvariable
Fixedoverhead[($1,500,0002,000)
2,200]
Grossprofit
Variableselling&administrative
Fixedselling&administrative
Netincome

$2,860,000
1,650,000

$396,000
190,000

$5,500,000
(4,510,000)
$990,000
(586,000)
$404,000

(3) Netincomeundervariable
$554,000
costing
Netincomeunderabsorptioncosting (404,000)
Differenceinnetincomes
$150,000
Thedifferenceinthenetincomesisequaltotheincrementaldecreaseinthe
endingbalancesoftheinventoryaccountswhencomparedtothebeginning
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Chapter 3

69

balances.Anotherwaytolookatthismoreeasilyistomultiplythe200units
soldinexcessofthe2,200unitsproducedbythefixedoverheadapplication
rateof$750perunit(200$750=$150,000).
The decrease in income in absorption costing is due to previously
inventoriedcostsnowhittingtheincomestatement.Thishappensbecause
thenumberofunitssoldexceedsthenumberofunitsproduced.
48.

BirdsEyeView
IncomeStatements(Absorption)
FortheYearsEndedDecember31,2013and2014
2013(10,000units)
2014(12,000units)
Sales(units$500)
$5,000,000
$6,000,000
CGS(units$270)
$2,700,000
$3,240,000
UnderappliedFOH
0 (2,700,000)
90,000 (3,330,000)
Grossprofit
$2,300,000
$2,670,000
S&A:
Variable(units$50) $500,000
$600,000
Fixed
180,000 (680,000)
180,000 (780,000)
Incomebeforetaxes
$1,620,000
$1,890,000

BirdsEyeView
IncomeStatements(Variable)
FortheYearsEndedDecember31,2013and2014
2013(10,000units)
2014(12,000units)
$5,000,000
$6,000,000
Sales(units$500)
(2,100,000)
(2,520,000)
CGS(units$210)
ProductCM
$2,900,000
$3,480,000
(500,000)
(600,000)
VariableS&A(units$50)
TotalCM
$2,400,000
$2,880,000
Fixedcosts:
Factory
$750,000
$750,000
S&A
180,000 (930,000) 180,000 (930,000)
Incomebeforetaxes
$1,470,000
$1,950,000
Netincome(absorption)
Netincome(variable)
Differenceinincome

2013
$1,620,000
1,470,000
$150,000

2014
$1,890,000
1,950,000
$(60,000)

Differenceequalsinventorychange
TimesFOHapplicationrate
Differenceinincome

+2,500

$60
$150,000

1,000

$60
$(60,000)

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70

Chapter 3

49.a.

AkronAviation
IncomeStatement(Variable)
FortheYearEndedDecember31,2014

Sales
Variablecostofgoodssold:
Workinprocess1/1/14
Finishedgoods1/1/14
Manufacturingcostsincurred
Totalcostsavailable
Workinprocess12/31/14
Finishedgoods12/31/14
Productcontributionmargin
Variablesellingexpenses
Contributionmargin
Fixedexpenses:
Factoryoverhead
Selling
Administrative
OperatingIncome

$1,015,000
$46,400
16,950
650,600
$713,950
(61,900)
(13,180)

$42,300
44,250
75,000

(638,870)
$376,130
(50,750)
$325,380

(161,550)
$163,830

Supportingcalculations
Variablefinishedgoodsinventoryat1/1/14:
Absorptionfinishedgoodsinventory
Lessfixedoverhead(1,050hours$1perhour)
Variablefinishedgoodsinventory

$18,000
(1,050)
$16,950

Variableworkinprocessinventoryat1/1/14:
Absorptionworkinprocessinventory
Lessfixedoverhead(1,600hours$1perhour)
Variableworkinprocess

$48,000
(1,600)
$46,400

Variablemanufacturingcostsincurredduring2014:
Directmaterial
Directlabor(23,000hours$6perhour)
Variableoverhead(23,000hours$6.20perhour)
Variablemanufacturingcosts

$370,000
138,000
142,600
$650,600

Thedirectlaborrateis($150,00025,000hours)or$6.00perhour.Thevariable
overheadrateis($155,00025,000hours)or$6.20perhour.
Variableworkinprocessinventoryat12/31/14:
Absorptionworkinprocessinventory
Lessfixedoverhead(2,100hours$1)
Variableworkinprocessinventory

$64,000
(2,100)
$61,900

Variablefinishedgoodsinventoryat12/31/14:
Absorptionfinishedgoodsinventory
Lessfixedoverhead(820hours$1)
Variablefinishedgoodsinventory

$14,000
(820)
$13,180

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Chapter 3

71

Variablesellingexpenses=Sales5%=$1,015,0005%=$50,750
Fixedsellingexpenses:
Totalsellingexpenses
Lessvariablesellingexpenses
Fixedsellingexpenses

$95,000
(50,750)
$44,250

b.
Themainadvantageofvariablecostingis
thatitrevealsthemarginalcostofproduction.Thatis,variablecostingfacilitates
makingdecisionsaboutpricing,changesinvolume,andchangesincoststructure.
Variablecostingalsofacilitatesidentificationofthebreakevenpoint.Further,
variablecostingdoesnotlenditselftomanagerialmanipulationofincome.The
majordisadvantageisthatvariablecostingtreatsfixedoverheadasaperiodcost
and, therefore, may violate the matching principle if one believes fixed
manufacturingoverheadisaproductcost.
50.a. Increasingproduction,relativetosalesorrelativetopriorplans,hastheeffectof
movingfixedmanufacturingoverheadfromtheincomestatementtothebalance
sheet. By producing substantially more units than are required to meet sales
demand,asignificantportionofthefixedmanufacturingoverheadcostincurred
canbeputintoinventoryandtheresultisalowerCostofGoodsSoldthanwould
otherwisebereported.
b.
Because the increase in production is not
matched by an increase in sales, finished goods, and perhaps in process,
inventories would increase. Also, the costs of manufacturing would rise as
productionincreases.Therisingcostscouldberealizedintheformofhigher
accounts payable balances, lower cash balances, or higher loan balances.
Assumingthefirmoperateswithinitsrelevantrange,onlythetotalvariablecosts
ofproductionwouldincreasewithincreasesinproduction.Thetotalamountof
fixedmanufacturingoverheadincurredwouldnotbeaffectedbythedecisionto
increaseproduction.
c.
TheCFOsplanisnotethical.Theintentofthe
increaseinproductionistodistortthereportedprofitearnedbythefirm.By
reportingahigherprofit,theCFOwouldlikelypersonallybenefitthroughbonus
compensationand,perhaps,stockoptions.
d.
The effects of the CFOs plan should be
detectible by analyzing the financial statements. The effects to identify are
describedintheanswerto(b).Ofalltheeffectsoftheplan,theriseininventory
levelsislikelythemostprominentflag.
51. a.

TommsTs
IncomeStatement(Variable)
FortheYearEndedDecember31,2013
Sales(40,000$22)

$880,000

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72

Chapter 3

Variablecostofgoodssold(40,000$8.25)
Contributionmargin
Fixedcosts:
Production
Selling&administrative
Incomebeforetaxes

(330,000)
$550,000
$120,000
130,000

(250,000)
$300,000

b.

TommsTs
IncomeStatement(Absorption)
FortheYearEndedDecember31,2013
$880,000
Sales(40,000$22)
$410,000
Costofgoodssold(40,000$10.25)
Underappliedfixedoverhead*
24,000
(434,000)
Grossmargin
$446,000
Lesssellingandadministrativecosts
(130,000)
Incomebeforetaxes
$316,000
NumberofunitsinendingFGinventory=4,000+48,00040,000=12,000
FOH:$120,00060,000=$2.00perunit
UnderappliedFOH=$2.00(60,00048,000)=$2.0012,000=$24,000
c.
Inventory increased from
4,000 to 12,000 units or by 8,000 units. Each added unit absorbs $2.00 in
allocatedfixedoverheadoratotalof$16,000.Thepresumptionintheproblemis
thatthebooksaremaintainedonavariablecostingbasis.Assumingonlythe
currentyearneedstobeadjusted(thebeginninginventoryof2013wascharged
withtheappropriatefixedoverhead),thentheentrywouldbe:
Inventory(8,000$2.00)
CostofGoodsSold(40,000$2.00)
UnderappliedOverhead
FixedFactoryOverhead

16,000
80,000
24,000
120,000

d.
Advantages:
Thefixedcostsarereportedatincurredvalues(andnotapplied),thus
increasingthelikelihoodofbettercontrolofthosecosts.
Profitsaredirectlyinfluencedbychangesinsalesvolume(andnot
influencedbybuildinginventory).
Theimpactoffixedcostsonprofitsisemphasized.
Productline,territory,etc.,marginalcontributionisemphasizedandmore
readilyascertainable.

Disadvantages:
Totalcostsmaybeoverlookedwhenconsideringproblems.
Distinctionbetweenfixedandvariablecostisarbitraryformanycosts.
Emphasisonvariablecostmaycausemanagerstoignorefixedcosts.

e.
Advantages:
Statementswouldreadilyreflectthedirectimpactofsalesvolumeonprofits.

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Chapter 3

73

Theconsequencesoffixedcostswouldbemoreobvious.
Inventoryswingswouldnotinfluenceprofits.

Disadvantages:
Costsarenotmatchedwithrevenues.
Thedifficultyinseparatingfixedandvariablecostsmightcausestatements
tobemisleading.

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accessible website, in whole or in part.

74

Chapter 3

52. a.

Statementswouldconfuseinvestorsusedtoabsorptioncostingstatements.
Confidentialinformation(onthenatureofcosts)couldbedisclosedto
competitors.
(CMAadapted)
x

y
$8,000
9,200
12,000
14,200
18,500
28,000
34,000
30,000
24,000
$177,900

10
14
22
28
40
62
100
90
80
446

xy
$80,000
128,800
264,000
397,600
740,000
1,736,000
3,400,000
2,700,000
1,920,000
$11,366,400

x2
100
196
484
784
1,600
3,844
10,000
8,100
6,400
31,508

x=446 9=49.56
y=$ 177,900 9=$ 19,766.67
xy n(x )( y) = $ 11,366,4009(49.56)( $ 19,766.67) = $ 2,549,675 =$ 271.18
b=
31,5089( 49.56)( 49.56)
9,402.26
x 2n(x)2
a= yb x=$ 19,766.67$ 271.18(49.56)=$ 6,327
y $6,327 + $271.18 (# of charters)
x

xy

x2

$12,000
18,000
26,000
36,000
60,000
82,000
120,000
100,000
96,000
$550,000

$8,000
9,200
12,000
14,200
18,500
28,000
34,000
30,000
24,000
$177,900

$96,000,000
165,600,000
312,000,000
511,200,000
1,110,000,000
2,296,000,000
4,080,000,000
3,000,000,000
2,304,000,000
$13,874,800,000

144,000,000
324,000,000
676,000,000
1,296,000,000
3,600,000,000
6,724,000,000
14,400,000,000
10,000,000,000
9,216,000,000
46,380,000,000

x=$ 550,000 9=$ 61,111.11

y=$ 177,900 9=$ 19,766.67
xy n ( x )( y ) = $ 13,874,800,0009 ( 61,111.11 )( $ 19,766.67 )
b=
46,380,000,0009 ( 61,111.11 ) ( 61,111.11 )
x 2n ( x )2
$ 3,003,131,697.67

=$ 0.235
12,768,890,111.11
a= yb x=$ 19,766.67$ 0.235(61,111.11)=$ 5,405.56
y $5,405.56+$0.235(grossreceipts)

2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
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