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# CHAPTER 8

## VARIABLE COSTING: A DECISION-MAKING PERSPECTIVE

SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOMS TAXONOMY
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True-False Statements
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Multiple Choice Questions
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Brief Exercises
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Exercises
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Completion Statements
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Essay
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**98.
Multi Part Question

## Related to Appendix A: Normal Costing.

Related to Appendix A: Throughput Costing

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8-2

## SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

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TF
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37.

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14.
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Note:

TF = True-False
MC = Multiple Choice
BE = Brief Exercise
MP = Multi Part

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Type

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Study Objective 1
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28. MC
65.
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58. MC
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Study Objective 2
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70. BE
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75. Ex
82.
Study Objective 3
MC
57. MC
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81. Ex
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Study Objective 4
MC
61. MC
Study Objective 5
MC
60. MC
98.
Ex = Exercise
C = Completion
Es = Essay

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ES

1.

## Explain the difference between absorption costing and variable costing.

Under absorption costing, fixed manufacturing costs are product costs. Under
variable costing, fixed manufacturing costs are period costs.

2.

Discuss the effect that changes in production level and sales level have on
net income measured under absorption costing versus under variable
costing. If the production volume is greater than the sales volume, net income
under absorption costing will be greater than net income under variable costing
by the amount of fixed manufacturing costs included in the ending inventory that
results from the units produced but not sold during the period. If the production
volume is less than the sales volume, net income under absorption costing will be
less than it is under variable costing by the amount of fixed manufacturing costs
included in the units sold during the period that were not produced during the
period.

3.

## Discuss the advantages of variable costing versus absorption costing for

management decision-making. The use of variable costing is consistent with
cost-volume-profit analysis and incremental analysis. Net income under variable
costing is not affected by changes in production levels. Instead, it is closely tied
to changes in sales. The presentation of fixed costs in the variable costing
approach makes it easier to identify fixed costs and to evaluate their impact on
the companys profitability.

4.

## Discuss the effect of a normal costing method on income reported under

absorption costing and variable costing. (Appendix8A.) Under absorption
costing, fixed manufacturing overhead is allocated to the product costs based on
production volume variance is expensed to the cost of goods sold in the
accounting period in which it occurs. Under variable costing, in contrast, the fixed
manufacturing cost is still a period cost and is therefore expensed in the
accounting period in which it occurs.

5.

## Discuss the throughput costing method on income reported under variable

costing (Appendix 8A.) Under throughput costing, the product cost is only direct
material costs, and inventory is valued using only direct material costs. All other
manufacturing costs are treated as expenses in the accounting period in which
they occur.

8-3

8-4

## Test Bank for Managerial Accounting, Third Canadian Edition

TRUE-FALSE STATEMENTS
1.

## Full costing is equivalent to absorption costing.

2.

In full or absorption costing, all manufacturing costs are charged to the product.

3.

Variable costing is the approach used for external reporting under generally
accepted accounting principles.

4.

Fixed manufacturing costs are not charged to the product under variable costing.

5.

The difference between absorption costing and variable costing is the treatment

6.

## Fixed manufacturing overhead is a period cost under absorption costing.

7.

Selling and administrative costs are period costs under both absorption and
variable costing.

8.

Manufacturing cost per unit will be higher under variable costing than under
absorption costing.

9.

Some fixed manufacturing costs of the current period are deferred to future
periods through ending inventory under variable costing.

10.

When units produced exceed units sold, income under absorption costing is
higher than income under variable costing.

11.

When units sold exceed units produced, income under absorption costing is
higher than income under variable costing.

12.

GAAP requires that absorption costing be used for the costing of inventory for
external reporting purposes.

13.

Net income under GAAP highlights differences between variable and fixed costs.

14.

When absorption costing is used for external reporting, variable costing can still

15.

## When absorption costing is used, management may be tempted to overproduce

in a given period in order to increase net income.

16.

17.

## The use of absorption costing facilitates cost-volume-profit analysis.

18.

Net income under variable costing is closely tied to changes in sales levels.

19.

## Companies that use just-in-time processing techniques will have significant

differences between absorption and variable costing net income.

8-5

8-6

Item

1.
2.
3.
4.

Ans.

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T
F
T

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5.
6.
7.
8.

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F
T
F

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10.
11.
12.

Ans.

F
T
F
T

Item

13.
14.
15.
16.

Ans.

F
T
T
T

Item

17.
18.
19.

Ans.

F
T
F

20.

## A customer wants to purchase a large quantity of your product at a price below

your normal selling price. Which of the following would be most helpful in
assessing the offer?
a. Cost-volume-profit
b. Either variable or absorption costing
c. Absorption costing
d. Variable costing

21.

## How are fixed manufacturing costs handled under variable costing?

a. They are subtracted from the variable cost of goods sold to determine
the ending inventory value that will be recorded on the Balance Sheet.
b. They are not recorded, which is why variable costing is not used for
external reporting.
c. They are recorded directly on the Balance Sheet.
d. They are treated as period costs.

22.

## Which of the following statements about variable costing is true?

a. As manufacturing output increases, the per unit manufacturing cost
remains constant.
b. As manufacturing output increases, the per unit manufacturing cost
decreases.
c. As manufacturing output increases, the per unit manufacturing cost
increases.
d. As manufacturing output increases, the change in the per unit
manufacturing cost is negated by the change in the per unit selling cost.

23.

## Which of the following statements about absorption costing is true?

a. As manufacturing output increases, the per unit manufacturing cost
remains constant.
b. As manufacturing output increases, the per unit manufacturing cost
decreases.
c. As manufacturing output increases, the per unit manufacturing cost
increases.
d. As manufacturing output increases, the change in the per unit
manufacturing cost is negated by the change in the per unit selling cost.

## Use the following information for items 24 28

Obama Company sells its product for \$25 per unit. During 2012, it produced 20,000 units
and sold 15,000 units (there was no beginning inventory). Costs per unit are: direct
materials \$5, direct labour \$4, and variable overhead \$3. Fixed costs are: \$300,000

8-7

8-8

24.

a. \$12.
b. \$27.
c. \$29.50.
d. \$32.

25.

a. \$12.
b. \$27.
c. \$29.50.
d. \$32.

26.

a. 180,000.
b. \$405,000.
c. \$442,500.
d. \$540,000.

27.

a. \$ 60,000.
b. \$ 240,000.
c. \$ 360,000.
d. \$ 410,000.

28.

period?
a. \$ 70,000.
b. \$ 75,000.
c. \$ 225,000.
d. \$ 300,000.

29.

## Which of the following terms would be found on an Income Statement using

absorption costing?
a. Contribution margin
d. Gross profit

30.

## Which of the following terms would be found on an Income Statement using

variable costing?
a. Contribution margin
c. Fixed manufacturing overhead not included in cost of goods sold
d. Gross profit

31.

## When production is greater than sales

a. Net income under absorption costing will be greater than or less than net
income under variable costing depending on the selling and
b. Net income under absorption costing will be equal to net income under
variable costing.
c. Net income under absorption costing will be less than net income under
variable costing.
d. Net income under absorption costing will be greater than net income
under variable costing.

32.

EKPs unit production cost under variable costing is \$5, and \$7 under absorption
costing. Net income under variable costing was \$10,000 and \$12,000 under
absorption costing last year. EKP sold 15,000 units. How many units did it
produce?
a. 16,000
b. 14,000
c. 17,000
d. 13,000

## Use the following information for items 33 36.

Green Company sells its product for \$11,000 per unit. Variable costs per unit are:
manufacturing, \$6,000; and selling and administrative, \$125. Fixed costs are: \$30,000
beginning inventory at 1/1/10. Production was 20 units per year in 2010 2012. Sales
were 20 units in 2010, 16 units in 2011, and 24 units in 2012.
33.

a. \$ 8,000.
b. \$14,000.
c. \$16,000.
d. \$22,000.

34.

a. \$33,000.
b. \$39,000.
c. \$41,000.
d. \$47,000.

35.

a. \$ 8,000.
b. \$14,000.
c. \$16,000.

8-9

8-10

d.

\$22,000.

36.

a. \$33,000.
b. \$39,000.
c. \$41,000.
d. \$47,000.

*37.

## Normal costing uses:

a. actual costs for direct materials, direct labour and variable and fixed
b. actual costs for direct materials, and direct labour, and a predetermined
production units.
c. actual costs for direct materials, direct labour and variable overhead,
d. variable costing for direct materials, direct labour and variable overhead

*38.

## The use of normal costing with absorption costing

a. is used because it is easier than actual costing with absorption costing.
b. is used because it is more practical than actual costing.
c. is essentially the same as using actual costing; accountants have
created the term for the sake of semantics.
d. means that only normal costs are used in assigning costs to production;
any unexpected costs that occur are immediately expenses as period
costs.

39.

M&Hs unit production cost under variable costing is \$25, and \$32 under
absorption costing. Net income under variable costing was \$250,000 and
\$187,000 under absorption costing last year. Production equalled 63,000 units.
How many units did M&H sell?
a. 72,000.
b. 54,000.
c. 70,000.
d. 56,000.

40.

## When production exceeds sales

a. Ending inventory under variable costing will exceed ending inventory
under absorption costing
b. Ending inventory under absorption costing will exceed ending inventory
under variable costing.
c. Ending inventory under absorption costing will be equal to ending
inventory under variable costing.
d. Ending inventory under absorption costing may either exceed, be equal
to, or be less than ending inventory under variable costing.

## Variable Costing: A Decision-Making Perspective

8-11

41. In income statements prepared under absorption costing and variable costing,
where would you find the terms contribution margin and gross profit?
a.
b.
c.
d.

Contribution margin
In absorption costing income
statement
In absorption costing income
statement
In variable costing income statement
In both income statements

Gross profit
In variable costing income
statement
In both income statements
In absorption costing income statement
In variable costing income statement

*42.

## Using normal costing to cost units of productions, Steven Harper Co has

gathered the following information:
Fixed manufacturing overhead was estimated to be \$120,000 for the year.
Actual production was 40,000 units.
Actual fixed manufacturing overhead costs incurred were \$125,000.
What is the result of this difference between the estimated fixed overhead and
a. The difference is expensed as a period cost the way variable costing
immediately expenses fixed overhead as a period cost.
b. The difference is over or under-applied overhead that if immaterial, will
be closed out to cost of goods sold at year end.
c. The difference will be held in inventory and taken to cost of goods sold
when the units are sold next year.
d. There is no difference.

43.

## The computation of absorption costing gross profit always involves subtracting

a. all current-year fixed manufacturing overhead.
b. some, but not all, current-year fixed manufacturing overhead.
c. all fixed manufacturing overhead applied to units sold in the current year.

44.

## When units produced exceeds units sold

a. net income under absorption costing is higher than net income under
variable costing.
b. net income under absorption costing is lower than net income under
variable costing.
c. net income under absorption costing equals net income under variable
costing.
d. the relationship between net income under absorption costing and net
income under variable costing cannot be predicted.

45.

## When units sold exceeds units produced

a. net income under absorption costing is higher than net income under
variable costing.

8-12

## Test Bank for Managerial Accounting, Third Canadian Edition

b.
c.
d.

net income under absorption costing is lower than net income under
variable costing.
net income under absorption costing equals net income under variable
costing.
the relationship between net income under absorption costing and net
income under variable costing cannot be predicted.

46.

Absorption costing
a. is preferred to variable costing for external reporting purposes, but either
method is acceptable.
b. normally results in higher net income than variable costing, and is
therefore required for income tax purposes.
c. is not allowed for external reporting purposes.
d. is required under GAAP.

**47.

## Choose the answer that is false regarding throughput costing:

a. Throughput costing treats all costs as period costs except direct labour.
b. Throughput costing treats all costs as period costs except direct
materials.
c. Throughput costing is also known as super-variable costing for its close
relationship to variable costing.
d. Assembly line and continuously automated companies are most likely to
choose this method of costing than other companies.

**48.

## Advantages of throughput costing include all of the following except:

a. Throughput costing reduces managements tendency to build inventory
levels over which to spread fixed manufacturing costs of production.
b. Throughput costing motivates managers to reduce operating costs such
as direct labour and variable overhead, which are treated as period
costs rather than product costs.
c. Throughput costing is simpler than normal costing or absorption costing
since all manufacturing overhead is expensed as a period cost
immediately.
d. Throughput costing motivates managers to reduce operating costs such
as direct materials and variable overhead, which are treated as period
costs rather than product costs.

**49.

## A major conceptual difference between throughput costing and variable costing is

a. under variable costing, direct labour and variable manufacturing
overhead are charged to income as period expenses.
b. under throughput costing, direct labour and variable manufacturing
overhead are deferred in inventory rather than charged to income as
period expenses.
c. under throughput costing, direct labour and variable manufacturing
overhead are charged to income as period expenses.
d. there are no conceptual differences between the two methods.

50.

## Management may be tempted to overproduce

a. when using variable costing, in order to increase net income.
b. when using variable costing, in order to decrease net income.
c. when using absorption costing, in order to increase net income.
d. when using absorption costing, in order to decrease net income.

51.

## If a division managers compensation is based upon the divisions net income,

the manager may decide to meet the net income targets by increasing production
a. when using variable costing, in order to increase net income.
b. when using variable costing, in order to decrease net income.
c. when using absorption costing, in order to increase net income.
d. when using absorption costing, in order to decrease net income.

## Use the following information for items 52 55:

The Colin Division of Mochrie Company sells its product for \$30 per unit. Variable costs
per unit are: manufacturing, \$12; and selling and administrative, \$2. Fixed costs are:
no beginning inventory. Expected sales for next year are 40,000 units. Ryan Stiles, the
manager of the Colin Division, is under pressure to improve the performance of the
Division. As he plans for next year, he has to decide whether to produce 40,000 units or
50,000 units.
52.

What would the manufacturing cost per unit be under absorption costing for each
alternative?
40,000 units
50,000 units
a. \$12.00
\$12.00
b. \$14.00
\$14.00
c. \$16.00
\$17.00
d. \$17.00
\$16.00

53.

What would the manufacturing cost per unit be under variable costing for each
alternative?
40,000 units
50,000 units
a. \$12.00
\$12.00
b. \$14.00
\$14.00
c. \$16.00
\$17.00
d. \$17.00
\$16.00

54

What would the net income be under absorption costing for each alternative?
40,000 units
50,000 units
a. \$390,000
\$390,000
b. \$390,000
\$430,000
c. \$390,000
\$440,000
d. \$430,000
\$390,000

8-13

8-14

## Test Bank for Managerial Accounting, Third Canadian Edition

55.

What would the net income be under variable costing for each alternative?
40,000 units
50,000 units
a. \$390,000
\$390,000
b. \$390,000
\$430,000
c. \$390,000
\$440,000
d. \$430,000
\$390,000

56.

Expected sales for next year for the Brady Division are 120,000 units. Drew
Carey, the manager of the Brady Division, is under pressure to improve the
performance of the Division. As he plans for next year, he has to decide whether
to produce 120,000 units or 140,000 units. The Brady Division will have higher
net income, if Drew Carey decides to
a. produce 140,000 units if income is measured under absorption costing.
b. produce 140,000 units if income is measured under variable costing.
c. produce 120,000 units if income is measured under absorption costing.
d. produce 120,000 units if income is measured under variable costing.

57.

## Which of the following is not a potential advantage of variable costing relative to

absorption costing?
a. Net income calculated under variable costing is unaffected by changes
in production levels.
b. It is easier to understand the impact of fixed and variable costs on the
computation of net income when variable costing is used.
c. The use of variable costing is consistent with cost-volume-profit analysis.
d. Net income calculated under variable costing is not closely tied to
changes in sales levels.

58.

## Under variable costing:

a. Only direct variable manufacturing costs are inventoriable.
b. Only direct fixed manufacturing costs are inventoriable.
c. All manufacturing costs are inventoriable.
d. No manufacturing costs are inventoriable.

59.

## Under absorption costing:

a. Only direct variable manufacturing costs are inventoriable.
b. Only direct fixed manufacturing costs are inventoriable.
c. All manufacturing costs are inventoriable.
d. No manufacturing costs are inventoriable.

60.

## Under throughput costing:

a. Only direct variable manufacturing costs are inventoriable.
b. Only direct fixed manufacturing costs are inventoriable.
c. Only direct material costs are inventoriable.
d. Only direct labour costs are inventoriable.

61.

## Under normal costing:

a. Only direct variable manufacturing costs are inventoriable.
b. Only direct fixed manufacturing costs are inventoriable.
d. Overhead costs are charged directly as incurred.

62.

## Under variable costing:

a. Only the quantity of products sold determines cost of goods sold.
b. Only the quantity of products produced determines cost of goods sold.
c. Both the quantity of products produced and sold determines cost of
goods sold.
d. Neither the quantity of products produced or sold determines cost of
goods sold.

63.

## Under absorption costing:

a. Only the quantity of products sold determines cost of goods sold.
b. Only the quantity of products produced determines cost of goods sold.
c. Both the quantity of products produced and sold determines cost of
goods sold.
d. Neither the quantity of products produced or sold determines cost of
goods sold.

64.

## Under absorption costing when production exceeds sales in a year:

a. Inventory values and cost of goods sold are higher than under variable
costing.
b. Inventory values and cost of goods sold are lower than under variable
costing.
c. Inventory values are lower and cost of goods sold are higher than under
variable costing.
d. Inventory values are higher and cost of goods sold are lower than under
variable costing.

65.

## Under absorption costing when production equals sales in a year

a. Inventory values and cost of goods sold are higher than under variable
costing.
b. Inventory values and cost of goods sold are lower than under variable
costing.
c. Inventory values and cost of goods sold are the same as under variable
costing.
d. Inventory values are higher and cost of goods sold is lower than under
variable costing.

66.

## Under absorption costing when inventory increases in a year:

a. There are more fixed costs charged to income.

8-15

8-16

b.
c.
d.
67.

## There are less fixed costs charged to income.

Fixed costs in inventory remain the same regardless of inventory
changes.
Fixed costs in inventory are reduced.

## Under absorption costing:

c. Only variable selling and administration costs are expensed while fixed
selling and administration costs are inventoried.
d. Only fixed selling and administration costs are expensed while variable
selling and administration costs are inventoried.

Item

20.
21.
22.
23.
24.
25.
26.
27.
28.
29.

Ans.

d
d
a
b
b
a
b
a
b
d

Item

30.
31.
32.
33.
34.
35.
36.
37.
38.
39.

Ans.

a
d
a
b
c
a
d
b
b
a

Item

40.
41.
42.
43.
44.
45.
46.
47.
48.
49.

Ans.

b
c
b
c
a
b
d
a
d
c

Item

50.
51.
52.
53.
54.
55.
56.
57.
58.
59.

Ans.

c
c
d
a
b
a
a
d
a
c

Item

60.
61.
62.
63.
64.
65.
66.
67.

Ans.

c
c
a
c
d
c
b
b

8-17

8-18

## Test Bank for Managerial Accounting, Third Canadian Edition

BRIEF EXERCISES
Brief Exercise 68
Huskie Company produces footballs. It incurred the following costs this year:
Direct materials
\$75,000
Direct labour
80,000
125,000
60,000
90,000
Variable selling and administrative expenses 33,000
What are the total product costs for the company under variable costing?
Solution Brief Exercise 68 (35 min.)
Direct materials
\$75,000
Direct labour
80,000
60,000
Total product costs under variable costing \$215,000
Brief Exercise 69
Huskie Company produces footballs. It incurred the following costs this year:
Direct materials
\$75,000
Direct labour
80,000
125,000
60,000
90,000
Variable selling and administrative expenses 33,000
What are the total product costs for the company under absorption costing?
Solution Brief Exercise 69 (35 min.)
Direct materials
\$75,000
Direct labour
80,000
125,000
60,000
Total product costs under variable costing \$340,000
Brief Exercise 70
During 2012 EKP Ltd. produced 40,000 units and sold 30,000 for \$15 per unit. Variable
manufacturing costs were \$7 per unit. Annual fixed manufacturing overhead was
\$40,000 (\$1 per unit). Variable selling and administrative costs were \$2 per unit sold,
and fixed selling and administrative costs were \$70,000. Prepare a variable costing

## Variable Costing: A Decision-Making Perspective

income statement.
Solution Brief Exercise 70 (57 min.)
Sales (30,000 X \$15)
Variable cost of goods sold (30,000 X \$7)
\$210,000
Variable selling and administrative expense (30,000 X \$2)
60,000
Contribution margin
40,000
70,000
Net income

\$450,000
270,000
180,000
110,000
\$70,000

Brief Exercise 71
During 2012 EKP Ltd. produced 40,000 units and sold 30,000 for \$15 per unit. Variable
manufacturing costs were \$7 per unit. Annual fixed manufacturing overhead was
\$40,000 (\$1 per unit). Variable selling and administrative costs were \$2 per unit sold,
and fixed selling and administrative costs were \$70,000. Prepare an absorption costing
income statement.
Solution Brief Exercise 71 (57 min.)
Sales (30,000 X \$15)
Cost of goods sold (30,000 X \$8)
Gross margin
Variable selling and administrative expense (30,000 X \$2)
Net income

\$450,000
240,000
210,000
60,000
70,000

130,000
\$80,000

Brief Exercise 72
In 2011, the ABC Company produced 90,000 units but only sold 70,000 units. Costs
incurred were:
Direct materials
\$ 20,000
Direct labour
30,000
15,000
18,000
25,000
15,000
Total
\$123,000
Instructions:
a. Calculate the value of inventory at the end of the year assuming ABC uses
absorption costing
b. Calculate the value of inventory at the end of the year assuming ABC uses variable
costing
Solution Brief Exercise 72
Direct materials
Direct labour

a. Absorption
\$ 20,000
30,000

b. Variable
\$20,000
30,000

8-19

8-20

## Test Bank for Managerial Accounting, Third Canadian Edition

Amount produced
Unit cost
Amount in inventory
Inventory value

15,000
0
25,000
0
\$90,000
90,000
\$1.00
20,000
\$20,000

0
0
0
0
\$50,000
90,000
\$0.556
20,000
\$11,111

Brief Exercise 73
Simplex Computer Systems has crews of computer repair people that it sends out to job
sites. It has the following information on its activities in the previous year:
\$1,250,000
Total corporate overhead estimated for next year
\$1,500,000
Hours worked by computer technicians
120,000
Budgeted technician hours for the next year
150,000
Instructions:
Calculate the companys predetermined overhead rate for the next year
Solution Brief Exercise 73
\$1,500,000 150,000 = \$10.00 per hour worked

## Variable Costing: A Decision-Making Perspective

EXERCISES
Exercise 74
Determine whether each of the following would be a product cost or a period cost under
an absorption or a variable system for K&N Company

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.

Direct Materials
Variable Indirect Materials
Direct Labour
Factory Utilities (variable)
Factory Rent
Indirect Labour
Factory Supervisory Salaries
Factory Maintenance (variable)
Factory Depreciation
Delivery Truck Insurance
Sales salaries
Sales commissions

Solution Exercise 74

Absorption
Product
Period
___________ _________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________
___________ __________

Variable
Product Period
______ _______
______ _______
______ _______
______ _______
______ _______
______ _______
_______ _______
______ _______
______ _______
______ _______
______ _______
_______ _______

(1015 min.)

a. Direct Materials

Absorption
Variable
Product
Period
Product
Period
_____X_____ __________ _____X____ _________

c. Direct Labour

e. Factory Rent

## _____X_____ __________ __________ _____X___

f. Indirect Labour

## g. Factory Supervisory Salaries _____X_____ __________ __________ _____X___

h. Factory Maintenance (variable)_____X_____ __________ _____X_____________
i. Factory Depreciation
j. Delivery Truck Insurance
k. Sales salaries
l. Sales commissions

## _____X_____ __________ __________ _____X___

__________ __________X__________ ______X____
___________ _____X____ __________ _____X___
__________ _____X____ __________ _____X___

8-21

8-22

## Test Bank for Managerial Accounting, Third Canadian Edition

Exercise 75
Fresh Air Products manufactures and sells a variety of camping products. Recently the
company opened a new plant to manufacture a deluxe portable cooking unit. Cost and
sales data for the first month of operations are shown below:
Manufacturing Costs
Direct labour
Direct material

\$ 150,000
\$ 7 per unit
\$ 15 per unit
\$ 33 per unit

Beginning inventory
Units produced
Units sold

0 units
15,000
11,000

Fixed
Variable

\$ 121,000
\$ 3 per unit sold

The portable cooking unit sells for \$90. Management is interested in the opening
months results and has asked for an income statement.
Instructions
Assume the company uses absorption costing. Calculate the production cost per unit,
and prepare an income statement for the month of June 2012.
Solution Exercise 75

(812 min.)
Per Unit

Direct materials
Direct labour
Total cost

\$33
15
7
10
\$65

## Fresh Air Products

Income Statement (Absorption Costing)
For the Month Ending June 30, 2012
Sales (11,000 x \$90)
\$990,000
Less: Cost of goods sold (11,000 x \$65)
715,000
Gross profit
275,000
Variable (11,000 x \$3)
\$ 33,000
Fixed
121,000
154,000
Net income
\$ 121,000
Exercise 76

## Variable Costing: A Decision-Making Perspective

Fresh Air Products manufactures and sells a variety of camping products. Recently the
company opened a new plant to manufacture a deluxe portable cooking unit. Cost and
sales data for the first month of operations are shown below:
Manufacturing Costs
Direct labour
Direct material

\$
\$
\$
\$

150,000
7 per unit
15 per unit
33 per unit

Beginning inventory
Units produced
Units sold

0 units
15,000
11,000

Fixed
Variable

\$ 121,000
\$ 3 per unit sold

The portable cooking unit sells for \$90. Management is interested in the opening
months results and has asked for an income statement.
Instructions
Assume the company uses variable costing.
a. Calculate the production cost per unit, and prepare an income statement for the
month of June 2012.
b. Explain the amount by which absorption costing income would differ from variable
costing income. (Calculate difference without computing absorption costing income)
Solution Exercise 76
a.
Direct materials
Direct labour
Total cost

(913 min.)
Per Unit
\$33
15
7
\$55
Fresh Air Products
Income Statement (Variable Costing)
For the Month Ending June 30, 2012

## Sales (11,000 x \$90)

Less: Variable costs
Variable cost of goods sold (11,000 x \$55) \$605,000
(11,000 x \$3)
33,000
Contribution margin
Less: Fixed costs

\$990,000

638,000
352,000

8-23

8-24

## Test Bank for Managerial Accounting, Third Canadian Edition

Net income

150,000
121,000

271,000
\$ 81,000

b. When production exceeds sales, absorption costing net income will exceed variable
costing net income by an amount equal to the fixed overhead rate times the number of
units in ending inventory. The ending inventory for June was 4,000 units and the fixed
overhead rate was \$10 per unit (\$150,000 15,000). Therefore, absorption costing
income would exceed variable costing income by \$40,000 (4,000 X \$10).
Exercise 77
Momentum Bikes manufactures a basic road bicycle. Production and sales data for the
most recent year are as follows (no beginning inventory):
Variable production costs
Fixed production costs
Selling price
Production
Sales

## \$85 per bike

\$530,000
\$17 per bike
\$480,000
\$195 per bike
21,200 bikes
19,000 bikes

Instructions
a. Prepare a brief income statement using absorption costing.
b. Calculate the amount to be reported for inventory in the year end absorption costing
balance sheet.
Solution Exercise 77 (8 - 12 min.)
a.
Sales (19,000 x \$195)
Less: Cost of goods sold (19,000 x \$110*)
Gross profit
[(19,000 x \$17) + \$480,000]
Net income

\$3,705,000
2,090,000
1,615,000
803,000
\$ 812,000

## *Variable production costs

Fixed production costs (\$530,000 21,200)
Total cost of goods sold per unit

\$ 85 per bike
25 per bike
\$110 per bike

## b. (21,200 19,000) X \$110 =

\$242,000

Exercise 78
Momentum Bikes manufactures a basic road bicycle. Production and sales data for the
most recent year are as follows (no beginning inventory):
Variable production costs
Fixed production costs

\$530,000

Selling price
Production
Sales

## \$17 per bike

\$480,000
\$195 per bike
21,200 bikes
19,000 bikes

Instructions
a. Prepare a brief income statement using variable costing.
b. Calculate the amount to be reported for inventory in the year end variable costing
balance sheet.
Solution Exercise 78 (8 - 12 min.)
a.
Sales (19,000 x \$195)
Less: Variable costs
Variable cost of goods sold (19,000 x \$85)
Variable selling & admin. costs (19,000 x \$17)
Contribution margin
Less: Fixed costs
Fixed production costs
Net income
b. (21,200 19,000) X \$85 =

\$3,705,000
\$1,615,000
323,000
530,000
480,000

1,938,000
1,767,000
1,010,000
\$ 757,000

\$187,000

Exercise 79
Conan Company produces sporting equipment. In 2011, the first year of operations,
Conan produced 25,000 units and sold 18,000 units. In 2012, the production and sales
results were exactly reversed. In each year, selling price was \$100, variable
manufacturing costs were \$40 per unit, variable selling expenses were \$8 per unit, fixed
manufacturing costs were \$540,000, and fixed administrative expenses were \$200,000.
Instructions
a. Calculate net income under variable costing for each year.
b. Calculate net income under absorption costing for each year.
c. Reconcile the differences each year in income from operations under the two costing
approaches.
Solution Exercise 79 (2025 min.)
a. 2011: [18,000 X (\$100 \$40 \$8)] (\$540,000 + \$200,000) = \$196,000
2012: [25,000 X (\$100 \$40 \$8)] (\$540,000 + \$200,000) = \$560,000
b. 2011: [18,000 X (\$100 \$40 \$21.60)] [\$200,000 + (18,000 X \$8) = \$347,200
2012: {(25,000 X \$100) [7,000 X (\$40 + \$21.60)] [18,000 X (\$40 + \$30)]}
[\$200,000 + (25,000 X \$8)] = \$408,800
c. The variable costing and the absorption costing income can be reconciled as follows:
2011 variable costing income

\$196,000

8-25

8-26

## Fixed manufacturing costs deferred at 12/31/11

under absorption costing
(7,000 X \$21.60)
2011 absorption costing income

151,200
\$347,200

## 2012 variable costing income

2011 fixed manufacturing costs expensed in 2012
under absorption costing
(7,000 X \$21.60)
2011 absorption costing income

\$560,000
(151,200)
\$ 408,800

Exercise 80
Conan Company produces sporting equipment. In 2011, the first year of operations,
Conan produced 25,000 units and sold 18,000 units. In 2012, the production and sales
results were exactly reversed. In each year, selling price was \$100, variable
manufacturing costs were \$40 per unit, variable selling expenses were \$8 per unit, fixed
manufacturing costs were \$540,000, and fixed administrative expenses were \$200,000.
Instructions
a. Prepare an income statement for 2011 using variable costing
b. Prepare an income statement for 2011 using absorption costing.
c. Reconcile the differences each year in income from operations under the two costing
approaches.
Solution Exercise 80
a.

(1520 min.)
Conan Company
Income Statement (Variable Costing)
2011

## Sales (18,000 x \$100)

Less: Variable costs
Variable cost of goods sold (18,000 x \$40) \$720,000
(18,000 x \$8)
144,000
Contribution margin
Less: Fixed costs
Fixed manufacturing costs
540,000
200,000
Net income

\$1,800,000

864,000
936,000
740,000
\$ 196,000

b.
Conan Company
Income Statement (Absorption Costing)
2011
Sales (18,000 x \$100)
Less: Cost of goods sold (18,000 x \$61.60)
Gross profit
Variable (18,000 x \$8)

\$1,800,000
1,108,800
691,200
\$ 144,000

## Variable Costing: A Decision-Making Perspective

Fixed
Net income

200,000

344,000
\$ 347,200

c. The variable costing and the absorption costing income can be reconciled as follows:
2011 variable costing income
Fixed manufacturing costs deferred at 12/31/11
under absorption costing (7,000 X \$21.60)
2011 absorption costing income

\$196,000
151,200
\$347,200

Exercise 81
McCartney Pumps is a division of UK Controls Corporation. The division manufactures
and sells a pump used in a wide variety of applications. During the coming year it
expects to sell 25,000 units for \$17 per unit. George Harrison manages the division. He
is considering producing either 25,000 or 35,000 units during the period. Other
information is presented in the schedule.
Division information - 2012
Beginning inventory
0
Expected sales in units
25,000
Selling price per unit
\$ 17.00
Variable manufacturing cost per unit
\$
6.00
\$ 140,000
Fixed manufacturing overhead costs per unit
Based on 25,000 units
\$ 5.60 per unit (\$140,000 25,000)
Based on 35,000 units
\$ 4.00 per unit (\$140,000 35,000)
Manufacturing cost per unit
Based on 25,000 units
\$ 11.60 per unit (\$6.00 variable + \$5.60 fixed)
Based on 35,000 units
\$ 10.00 per unit (\$6.00 variable + \$4.00 fixed)
Selling and administrative expense (all fixed)
\$37,000
Instructions
a. Prepare an absorption costing income statement with one column showing the results
if 25,000 units are produced, and one column showing the results if 35,000 units are
produced.
b. Why is income different for the two production levels, when sales is 25,000 units
either way?
Solution Exercise 81
a.

(15 - 20 min.)
McCartney Pumps Division
Income Statement
For the Year Ended 2012
Absorption Costing

25,000
Produced
\$ 425,000

35,000
Produced
\$ 425,000

8-27

8-28

## Cost of goods sold

Gross profit
Fixed selling and
Net income

135,000
\$

37,000
98,000

## 250,000 (25,000 X \$10)

175,000
37,000
\$ 138,000

b. Net income is \$40,000 higher when 35,000 units are produced, because under
absorption costing \$40,000 of fixed manufacturing costs (10,000 X \$4) are deferred to
the next year.
Exercise 82
McCartney Pumps is a division of UK Controls Corporation. The division manufactures
and sells a pump used in a wide variety of applications. During the coming year it
expects to sell 25,000 units for \$17 per unit. George Harrison manages the division. He
is considering producing either 25,000 or 35,000 units during the period. Other
information is presented in the schedule.
Division information - 2012
Beginning inventory
0
Expected sales in units
25,000
Selling price per unit
\$ 17.00
Variable manufacturing cost per unit
\$
6.00
\$140,000
Fixed manufacturing overhead costs per unit
Based on 25,000units
\$ 5.60 per unit (\$140,000 25,000)
Based on 35,000 units
\$ 4.00 per unit (\$140,000 35,000)
Manufacturing cost per unit
Based on 25,000 units
\$ 11.60 per unit (\$6.00 variable + \$5.60 fixed)
Based on 35,000 units
\$ 10.00 per unit (\$6.00 variable + \$4.00 fixed)
Selling and administrative expense (all fixed)
\$37,000
Instructions
Prepare an variable costing income statement with one column showing the results if
25,000 units are produced, and one column showing the results if 35,000 units are
produced.
Solution Exercise 82

(1520 min.)

## McCartney Pumps Division

Income Statement
For the Year Ended 2012
Variable Costing
25,000
Produced
Sales (25,000 units X \$17)
\$ 425,000
Variable cost of goods sold (25,000 X \$6)
150,000
Contribution margin
275,000
140,000

35,000
Produced
\$ 425,000
150,000
275,000
140,000

## Fixed selling and

Net income

37,000
\$ 98,000

37,000
\$ 98,000

Exercise 83
E&P Ltd. produced 20,000 units last year. Under absorption costing, operating income
was \$3,000 more than it was under variable costing. Variable manufacturing costs per
unit were \$17, variable selling and administration costs per unit were \$5, total fixed
were \$78,000. Determine how many units were sold last year.
Solution Exercise 83 (46 min.)
The difference between operating income under absorption costing and operating
income under variable costing is caused by the difference between the number of units
produced and the number sold multiplied by the fixed manufacturing cost per unit.
In this case, fixed manufacturing cost per unit equals \$150,000 20,000 units, or \$7.50.
Therefore, \$3,000 \$7.50/unit = 400 units.
If operating income under absorption costing is greater than under variable costing, it
means that production exceeded sales. Therefore, if production equalled 20,000 units,
sales equalled 19,600 units.
Exercise 84
ABC Company uses the FIFO method for
the following information:
Opening inventory
Units produced
Units sold

## costing its inventory. During the year it has

300 units
600
600
\$50 per unit
\$44 per unit

Instructions:
Calculate the difference between operating income in the current year if the company
uses variable or absorption costing
Solution Exercise 84 (46 min.)
Difference: 300 units x (\$50 - \$44) = \$1,800
Absorption costing will result in \$1,800 less income in the current year since the current
overhead rate is lower than last years and more fixed overhead is released into income.
Exercise 85
Bobs Burgers makes burger patties for large supermarket chains. The burgers are
frozen and can last in storage for months. Cost information on the burgers is as follows:
Meat used for burgers
\$200,000
Wages used to make burgers
100,000

8-29

8-30

## Overhead of the factory variable

fixed
Office staff
Sales staff
Bobs salary

50,000
70,000
60,000
120,000
50,000

Bob made 500,000 burgers this past year but only sold 450,000 to his customers. He
sells them for \$1.50 per burger patty. Bob tells you that the office and sales staff are
variable costs while his salary is fixed.
Instructions:
a. Calculate Bobs income assuming he uses variable costing
b. Calculate Bobs income assuming he uses absorption costing
Solution Exercise 85

(10-12 min.)

## Direct materials (meat)

Direct labour (wages)
fixed
Office staff
Sales staff
Fixed selling and admin expenses (Bob
Amount produced
Unit cost

Absorption
\$ 200,000
100,000
50,000
70,000
0
0
0
\$420,000
500,000
\$0.84

Variable
\$200,000
100,000
50,000
0
0
0
0
\$350,000
500,000
\$0.70

Bobs Burgers
Absorption Costing Income Statement
Sales (450,000 x \$1.50)
Cost of sales: 450,000 x \$0.84
Gross profit
Variable costs office staff \$60,000
sales staff \$120,000
Net income

\$675,000
378,000
\$297,000
230,000
\$67,000

Bobs Burgers
Variable Costing Income Statement
Sales (450,000 x \$1.50)
Variable cost of goods sold 450,000 x \$0.70 \$315,000
180,000
Contribution margin
Fixed costs factory
Bobs salary
Net income

\$675,000
495,000
\$180,000
70,000
50,000
\$60,000

## Variable Costing: A Decision-Making Perspective

COMPLETION STATEMENTS
86.

## Under ______________________ all manufacturing costs are charged to, or

absorbed by, the product.

87.

Only direct materials, direct labour, and variable manufacturing costs are
considered product costs when using _________________ .

88.

Fixed manufacturing
__________________.

89.

## The use of absorption costing is required by __________________ for

__________________ financial reports.

90.

## When production exceeds sales, a portion of the _______________ is deferred

to a future period as part of the cost of ending inventory under absorption
costing, but not under variable costing.

91.

The one primary difference between variable costing and absorption costing is
that under variable costing, fixed manufacturing overhead is recorded as a(an)
_______________ in the current period.

92.

When units produced exceed units sold, income under absorption costing is
_________________ than income under variable costing.

93.

The amount remaining after deducting total variable costs from revenue is called
the _________________________.

94.

## Management may be tempted to overproduce in a given period in order to

increase net income if _______________ is used for internal decision-making.

costs

are

treated

as

period

costs

under

8-31

8-32

## Test Bank for Managerial Accounting, Third Canadian Edition

86. absorption costing
87. variable costing
88. variable costing
89. GAAP, external
91. expense
92. higher
93. contribution margin
94. absorption costing

## Variable Costing: A Decision-Making Perspective

Define variable costing and absorption costing. What are some of the benefits to a
manager from using variable costing instead of absorption costing for internal decisionmaking?
Variable costing is a system for determining product costs that is used primarily for
making managerial decisions. This system determines product costs by considering
only direct materials, direct labour, and variable manufacturing overhead. In contrast,
absorption costing is used by some managers and also for external reporting. Under
absorption costing, product costs include direct material, direct labour, and both fixed
Some of the benefits to a manager from using variable costing instead of absorption
costing for internal decision-making include: variable costing already has to be used
when constructing a contribution margin income statement, variable costing puts greater
focus on cost behaviours, fixed expenses do not get tied up in inventory under variable
costing, variable costing is better suited for cost-volume-profit analysis, variable costing
produces income statements that are closer to net cash flows than absorption costing,
and the method ties in with standard costing and flexible budgeting more effectively.
How do differences in production and sales levels affect income under absorption and
variable costing?
If production equals sales in any given period, the net incomes under both absorption
and variable costing will be equal. Under this scenario, fixed manufacturing overhead
will not differ, because the direct cost expense under variable costing will be equal to the
product cost component of fixed overhead under absorption costing.
If production exceeds sales, absorption costing net income will be greater than variable
costing net income. Absorption costing net income is higher because some fixed
manufacturing overhead costs will be deferred in the inventory account until the products
are sold, whereas under variable costing, all fixed manufacturing overhead costs will be
expensed.
If sales exceed production, absorption costing net income will be less than variable
costing net income. Absorption costing net income is less because some fixed
manufacturing overhead costs from the previous period will now be expensed when the
older product is sold, whereas under variable costing, only fixed manufacturing overhead
costs of the current period will be expensed.
Explain why either absorption or variable costing is best for a company to use as their

8-33

8-34

## Test Bank for Managerial Accounting, Third Canadian Edition

costing system for internal decision-making. Why do many firms maintain accounting
records under both systems?
Variable costing is generally preferred over absorption costing for internal decisionmaking. Net income calculated using GAAP (absorption costing) does not highlight
differences between variable and fixed costs, as does variable costing, and can lead to
poor business decisions. Managers may be tempted to over produce in a given period in
order to increase net income when absorption costing is used. Net income under
variable costing is unaffected by changes in production levels. In addition, the use of
variable costing is consistent with cost-volume-profit analysis and other decision-making
tools.
Many firms maintain accounting records under both systems because while they want to
use variable costing for internal decision-making, GAAP does require the use of
absorption costing for external financial reports. Also, absorption costing must be used
on tax returns.
What practical points should a company consider before adopting throughput costing?
Users of throughput costing should be highly automated, process-oriented companies in
which direct labour and manufacturing overhead are fixed costs that do not vary with the
number of units produced. Car companies, with unionized employees provide a good
example of this. Whether cars are produced or not; on a given day of the month, the car
company still incurs direct labour and manufacturing overhead costs. The logic of this is
that since the direct labour and manufacturing overhead costs are fixed, they can be
treated as period costs, rather than product costs, for internal reporting purposes.
The other consideration is that users of throughput costing must acknowledge that they
are doing so for short-term incremental analysis. Users of throughput costing should
therefore be cautioned that use of this method in the long term (without any other costing
method employed for longer term planning) could have negative consequences.

## MULTI PART QUESTIONS

Multi Part Question 99
Fireplug Industries produces spark plugs for use in cars and trucks. Information about
the companys activities is as follows:
Budgeted volume for the year
100,000 plugs
Factory capacity
120,000 plugs
Opening inventory
0
Budgeted sales
Budgeted costs:
Raw materials
Direct labour
Total budgeted costs
Budgeted operating income

\$7,200,000
900,000
1,200,000
1,500,000
1,800,000
600,000
600,000
\$6,600,000
\$600,000

Instructions:
a. Calculate the predetermined overhead rate to be used by the company.
b. If the company produces 100,000 spark plugs but only sells 70,000, calculate its
operating income if the company uses normal absorption costing.
c. Using the same information as part b) calculate the operating income if the company
uses throughput costing
Solution Multi Part Question 99
a. (\$1,500,000 + \$1,800,000) 100,000 = \$33.00
b. Contribution margin per plug: \$3,000,000 100,000 = \$30
Operating income = 70,000 x \$30 (1,800,000 x 70%) 600,000
= \$2,100,000 - \$1,260,000 - \$ 600,000
= \$240,000
c. Contribution margin per plug: \$6,570,000 100,000 =
Contribution margin:
70,000 x \$65.70 =
Less:
Direct labour
\$1,200,000
1,500,000
1,800,000
600,000
600,000
Operating income (loss)
CM:

Opening Inventory
DM costs

\$65.70
\$4,599,000

5,700,000
(\$1,101,000)
0
\$900,000

8-35

8-36

## Closing inventory (900,000 100,000) x 30,000 = 270,000

Variable cost of goods sold
\$630,000

## Variable Costing: A Decision-Making Perspective

LEGAL NOTICE
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reserved.

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