CHAPTER 5 VARIABLE COSTING LEARNING OBJECTIVES After having completed this chapter, the student should be able to: 1. Explain the essential difference between the absorption and variable ‘costing methods. Identify the advantages provided by variable costing as tool for profit Planning, .. Explain how variable costing Is useful in evaluating the performance of the managers. }. Describe how fixed costs are charged to a current period or carried Into the future as part of the cost of inventory. + Explain how profits can be manipulated under absorption costing by decision with respect to the balance of inventory to be carried.INTRODUCTION we made mention in the income statemer the needs of ords of the firm, would like to have an 6 as shown belo1 Cost of Goods Sold (28,000) Gross Profit 32,000 Selling and Administrative Expenses (20.000) Profit 12.000 To assist management on the area of profit planning and performance evaluation of key Personnel the income statement is usually re-arranged according to behavior, as shown below: Sale 60,000 Variable Cost (34,000) Contribution Margin P26,000 Fixed Cost 14,000) Profit 12.900 The income statement arranged according to functions falls under the Full Costing or Absorption Costing Method while the one prepared according to behavior falls under the Disect Costing or Variable Costing Method, Jn this Chapter, we will ty to understand the difference between the Absorption Costing and Variable Costing, Review of Absorption Costing According to genemlly accepted cost sccounting theory underlying income determination, all manufacaring cots ar allocated to the production dzetly or indict Accordingly, the cost of ary manufactured anicle includes the costs of direct matzials the ag oe 450,000. Number of units produced Unit fixed costObserve the considerable difference of the unit fixed cost for each different production levels The differences in unit fixed cost will become more significant as total fixed cost tend to be a large proportion of the total production cost. With increased automation of many manufacturing facilities the trend is toward increased fixed cost. ‘THE NORMAL PRODUCTION CONCEPT As a general rule, it is safe to express fixed cost on a total cost basis. However, expressing fixed cost.on.a.per unit basis is acceptable when computed at a level of production pacity considered normal. Assume in the illustration just given that 150,000 units of product are to be manufactured when the company is operating at normal capacity. Hence, the fixed cost Per unit is P3.00; each unit produced will be assigned/allocated a fixed manufacturing overhead of P3.00, Suppose however that company opts to operate below normal capacity, and manufactures only 100,000 units of product. By using P3.00 rate per unit produced, only P300,000 (100,000 x 3.00) of the total budgeted fixed overhead of P450,000 will be assigned /allocated the finished product. Total budgeted fixed manufacturing overhead 450,000 Fixed overhead absorbed by the products (100,000 x P3,00) 300,000 Unabsorbed fixed overhead or unfavorable capacity variance P150,000 ‘The absorption costing method will enables us to determine whether or not the company is operating at normal capacity. If the company is operating below the normal capacity, the capacity variance will be unfavorable, that is some of the fixed factory overhead will not have been costed to the products. On the other hand, if the company is operating above the normal capacity, the capacity variance will be favorable. Management may try to restore a normal level of production by increasing sales volume or may find that the production level considered normal will have to be redefined. VARIABLE COSTING The proponents of absorption or full costing view fixed production costs as a part of inventory cost. "Thus, fixed production cost should be attached to the finished products and carried forward to the next year when production exceeds sales. Accordingly to this point of view, since fixed production costs are considered to be a part of inventory cost, they are assets; fixed manufacturing costs from one year can provide benefits in a future year. These costa becomes expenses once the products are sold: Hence, both variable and fixed manufacturing costs, regardless of the year in which the costs were incurred, should be matched against the revenue as the inventory of product is sold Advocates of variable costing, however, held a different view with regards to fixed manufacturing overhead. They do not consider fixed factory overhead a part of product cost because they are incurred even without production. According to the proponents of variable costing, fixed manufacturing expenses should not be a part of inventory cost, since they are incurred regularly, year after year. Iti a sort of annual dues that a company is obliged to pay each year to remain a member of the manufacturing club. In variable costing, fixed manufacturing costs are treated as period costs in much the same way as selling and administrative costs 96 eeeABSORPTION AND VARIABLE COSTING COMPARED RATION OF COSTS All costs and expenses are classified and | segregated into fixed and vari |B. INVENTORY VALUES Inventory values include only the variable manufacturing costs, namely direct materials, direct labor and y werhead. C. CONTRIBUTI GIN VS. GROSS PROFIT ‘The income statement shows the marginal income or contribution * margin thereby [iacititating the decision making process. OPERATING INCOME Because of the foregoing differences, under both costing methods will differ. This di This is seldom observed. Fixed factory overhead forms part of the | inventory value aside from direct material, direct labor and variable factory overhead Gross profit is shown instead of contribution margin and its adequacy is determined to bring about the desired rate of return. ‘operating income (and ultimately, net income) fference, however, is only matter of timing. This is because fixed factory overhead, although allocated between costs of goods sold and inventory under absorption costing, is ultimately charged against revenue once the inventory is sold. ‘The differences between the two costing concepts can be emphasized by showing how an income statement prepared under the absorption or full costing method compares with an income statement prepared under the variable or direct costing method. Illustrative Problem Jennings Manufacturing Company supplies you with following data: Per Unit of Product Selling price P80 Variable manufacturing cost 10 Variable selling and administrative expense 5 Total Cost Fixed manufacturing cost for the year 2,000,000 Fixed selling and administrative expenses for the year P_ $00,000 Normal capacity 50,000 units ‘Number of units produced and sold 50,000 units Required: Prepare income statement under Absorption Costing and Variable Costing, 7Solution Jennings Manufacturing Company Comparative income Statement For the year ended December 31, 201 SORP| cosTING nits manufactured and sol p00 ale (50,000 x P80) ost of goods manufactured and sold Variable manufacturing costs (50,000 x P10) 500,004 Fixed manufacturing costs (50,000 x P40) 2,000,004 Cost of goods manufactured and sd £2,500,000 ET Gross Marga Manufacturing Margin 4,000,004 3,500,000 ling and administrative expenses: Variable selling and administrative expenses (50,000 x P5) and administrative expenses Total Selling and administrative expenses Contribution Margin Fixed Costs: Manufacturi 2,000,000 Selling and administrative 500,000 Total Fixed Costs Income before income tax 750,000 Income tax (30%) 225,000 225,000 Net income “525,000 525,000 The net income, in this case, is the same under both costing methods. All of the fixed cost for the year has been matched against the revenue in both methods. Due to the absence of inventories, no fixed manufacturing costs has been carried over from an earlier year as a part of the beginning inventory cost, nor has any fixed manufacturing cost been included in inventory at the end of the year In the absorption costing column, the fixed manufacturing cost is deducted as part of the cost of goods sold. In the variable costing column, the fixed manufacturing cost is deducted as a period cost. The excess of the sales revenue over the variable manufacturing cost of goods sold is designated as the manufacturing margin. This is the amount that will be used to recover fixed cost of manufacturing and operation and generation of profit. The difference between sales revenue and all the variable cost is known as conteibution margin PRODUCTION, SALES, AND INCOME RELATIONSHIPS The illustration given in the preceding paragraphs clearly demonstrate that when sales and production are in balance ( equal ) at any level of operation, the resulting amount of income will be the same under both costing methods. The difference in net income reported under the two costing methods appears when the 98es for the year are more or less than the production. If more is sold than was produced, able costing income is greater than absorption costing income, Selling than Produced means that inventory is being used, Under absorption costing, Fy have attached to them fixed overhead from and sold have all of the current periods fixed overhead attache overhead expensed by absorption costing is greater than the current period's fixed overhead by the amount of fixed overhead flowing out of inventory. Accordingly, variable-costing income i greater than absorption costing income by the amount of fixed overhead flowing out beginning inventory If less is sold than was produced, variable costing income is lesser than absorption income statement. Selling less than what is produced means that the inventory end by increased. The fixed cost portion of the inventory end will be treated as product cost and therefore will not be charged against the revenue of the period under the absorption full costing method, i IE THEN 1, Production = Sales Absorption Net Income = Variable net ineome 2. Production < Sales Absorption Net Income < Variable net income 3. Prozuction > Sales Absorption Net Income > Variable net income ILLUSTRATIVE PROBLEM To illustrative the relationship of production, sales, and income let us consider the ‘operating data of Catnip, Inc. in the years 2009, 2010, and 2011 2009. 2010 201 Beginning Inventory 50,000 Production 150,000 150,000 150,600 Sales 150,000 100,000 200,000 Ending inventory 4 50,000 : Variable cost per unit Direct materials 4.00 Direct labor 1.50 Variable overhead (estimated and actual) 0.50 Variable selling and administrative 0.25 The estimated and actual fixed overhead was P150,000 each year. Normal production Volume is established at 150,000 units per year, The selling price per unit is P10 for each year, Fixed selling and administrative expenses were P50,000 per year, Required: Income Statement for each year under the Absorption Costing and the Variable Costing methods.TNIP, INC. mparative Income Statement (Variable Costing) For the three year period covering 2009, 20 usand pesos) Sales 1,500 Pi,000 P2,000 Less: Variable expenses: Variable cost of goods sold* (900) (600) (1,200) Variable selling and administrative** Gus 23) O Contribution Margin P5625 P375 P750 Less: Fixed expenses: Manufacturing overhead (150) (150) Selling and Administrative (50) Net income bis ‘Beginning Inventory Po Po. P300 ‘Variable Cost of Good Manufactured _900 900 900 Goods available for sale 900 7900 P1200 Less: Ending Inventory is G00) 2 seas Variable Cost of Goods Sold Pom. «ooo B20 PO.25 x Units Sold CATNIP INC. Comparative Income Statement (Absorption Costing) For the year period covering 2009, 2010, & 2011 (In thousand Pesos) 2009 2010 zou Sales 1,500 1,000 P2,000 Less: Cost of Goods Sold * (4,050) 790) 14.400) Gemstar P'450 P300 P 600 Less: Selling and Administrative Expenses 1) (75) (190) ‘Net Income BRS Ea ae * Beginning Inventory - - P 350 Cost of goods manufactured Pigs. = L050. PLOS0. Goods available for sale P1050 1,050 P1,400 Less: Ending Inventory anes 350) : ost of Goods Sold E050 =En0 za Explanation: In 2009, the net income under each method is identical. We can conclude that both costing methods expensed the same amount of fixed factory overhead. Under variable costing, the total fixed factory overhead of P150,000 was expensed. Under the absorption costing, the fixed factory overhead is unitized and becomes part of the product cost. The estimated fixed 100factory overhead annually is P1S0,000, Expressed on a per unit basis the fixed ovethead is P1 (7150,000/150,000units) for all the three years. The fixed overhead applied to production is 150,000 (150,000units x P1) for the three years. Since the fixed factory overhead actually incurred is P150,000, there is no fixed overhead variance in any year. Since the amount of {ietory overhead charged to production under both costing method are the same, the resulting cffect is that they report the same amount of net income. 4 2010, it is quite a different story. The absorption costing method showed an income of 725,000 compared to variable costing income of P175,000. The absorption costing method ‘RPorted a net income higher by PS0,000 compared to variable costing method. The difference is dlue to the inventory end of $0,000 units. Under the variable costing method, the amount of SO OROY end is P300,000 (50,000 x P6) while that of the absorption costing it is P350,000 (50.000 x P7), The P50,000 represent the amount of fixed factory overhead of P1 per unit included in the inventory end which will not be recognized as an expense until the unit inventory is sold, Jn 2011, the relationship between two incomes reverses. The difference is still P50,000 but this time it is in favor of variable costing method. The difference is due to the total amount Of fixed factory overhead recognized as expense during the period. In case of variable costing, the factory overhead recognize as expense is P150,000 (150,000unit x P1). Whereas in the case soln Absorption costing method, the amount of fixed factory overhead recognized as expense in 7411 is £200,000 consists of P150,000 for unit sold (150,000 x P1) plus the P50,000 (30,000 x PI) of the inventory beginning that was sold in 2011 SALES AND PRODUCTION OUT OF BALANCE Difference in net income reported under the two costing methods appears when the sales for the year are more or less. than production, When absorption of fll costing is employed, the {fied manufacturing overhead is shifted from one year to another as part of the inventory cost. If the ‘company produces more than it sells in a given year, not all of the curreat fixed manufacturing cost is deducted against revenue; part of it is held fixed cost will be released as part of the cost of goods sold in a late sales are in excess of production. Management may find it difficult » understand how profit can decrease with increase sales volume and no change in selling price and cost. Seemingly, profit should increase wheg taigs revenue increase. But the shift of Sxed manufacturing cost from one year to ametien because of inventory must be recognized when an absorption costing system is used ILLUSTRATION: ‘The peculiarity of profit behavior of the two costing method can be understood by Fotomate Samparative income statement for Tri-Star Corporation for the two year period 2010and 2011 based on the following data: Selling price per unit P60 Variable manufacturing cost per unit 8 Variable selling and administrative ‘expense per unit 4 Total fixed manufacturing cost 1,600,000 Total fixed selling and administrative expenses 400,000 101Normal capacity is 50,000 unit. Sales and Production data: 2008 ~ Produced 50,000 units Sold 2009 - Produced Sold 50,000 units 000 units Required: — Comparative Income Statement under the Absorption Costing and the Costing methods. TRI-STAR CORPORATION Comparative Income Statement ( Absorption Costing ) For the year ended December 31, 2010 & 2011 2011 2010 Number of units produced 5,000 50.000 Number of units sold 45,000 Sales PB 0 2,700,000 Cost of goods sold: Inventory, beginning of the year Current production costs: Variable cost 400,000 Fixed cost 1,600,000 Cost of goods available for sale 2,000,000 Less: Inventory, end of year o. (200,000) Cost of goods sold ( standard cost ) P2,000,000 P1,800,000 Capacity variance 160,000. lee Si’ Total P2.160,000 P1,800,000 Gross Margin 840.000" — 200.000 Selling and administrative expense Variable cost P200,000 P180,000 Fixed cost 400,000 400,000 Total selling and administrative expenses 600,000 580,000 Net Income Before Tax 240,000 320,000 Income TAX 40% (96,000) (128,000) Net income after taxes —Pra4,000 192,000 ‘The reduction in income before income tax of P80,000 can be explained as follows: Increased in revenue in 2011 over 2010 ‘ (6,000 more units x P60) 300,000 Less: Increase in variable selling and administrative expenses 20,000 Unfavorable capacity variance 160,000 Shift of inventory from 2010 to 2011 200,000 380,000) Decrease in net income before tax (80,000) 102TRI-STAR CORPORATION Comparative Income Statement (Variable Costing ) For the year ended December 31, 2010 & 201 2010 Number of units 45,000 50,000 Number of units sold 50,000 45,000 Sales 73,000,000 72,700,000 Cost of goods sold Inventory, beginning of ye P40,000 P0- Current production cast (variabie) 360,000 400,000 Cost of goods available for sale 400,000 Less: Inventory end of year Cost of goods sold Manufacturing margin Less: Variable selling and administrative expenses 200,000 180,000 Contribution margin 2,400,000 P2,160,000 Less: Fixed Costs: Manufacturing 1,600,000 1,600,000 Selling and administrative __'400,000 400,000 Total Fixed Costs 2,000,000 72,000,000 Income before Income tax 400,000 P160,000 Income tax 40% 160,000 64,000 Net Income after tax —P240,000 226.000 Explanation of the difference of income statement reported under absorption costing. and variable costing: 2008 Absorption costing income before income taxes Less: Fixed manufacturing cost carried to 2011 under absorption costing (5,000 x P32) Variable costing income before income taxes Absorption costing income before income taxes P240,000 ‘Add: Fixed manufacturing cost from 2010 charged to 2011, under absorption costing (5,000 x P32) 160,000 Variable costing income before income taxes 400,000 PROFITS AND INVENTORY ‘With a standard absorption costing system, profit can be shifted from one year to another ‘with increase or decrease in inventory. Profit ean be increased by merely increasing up the inventory. Management should be aware of this effect in evaluating operation For example, assume the Dora Supply Company in preparing a budget for next year, estimates sales of 40,000 units with a price and cost data remaining the same, There is no inventory at the beginning of the year. Under option 1, the company plans to produce and sale 40,000 units. Under option 2, the company plans to proxluce $0,000 units to sell 40,000 units,ried i ae Sales ( 40,000 units @ P80 3,200, 3,200,000 Cost of Goods a 500,0 2,000,000 2,500,000 Less: Inventory end oft (10,000 unit 0 500,000 2,000,000 2,000,000 * Capacity Variance (10,000 @ P40) 00,000 Cost of goods sold 2,400,000 +F2,000,000 Income from Manufacturing P0000 1,200,000 Normal Capacity is 5,000 units. Budgeted fixed manufacturing cost is P2,000,000. Pane suanufacturing overhead per unit under normal capacity is P40 (P2,000,000/50, 060 units) Production of 40,000 units under option will result £0% utilization of the meen capacity. Hence, 20% ofthe fixed manufacturing cost of P2,000,000 was not absorbed by the proce Jcome under Option 2 showed a P400,000 increase over Option 1. ‘The increase of Unlarerar je P08 2 is due to the building up of inventory which resulted in the elimination cr ntavorable capacity variance. The P400,000 increase in income in Option 2 represent the ‘mount of fixed manufacturing cost included in the inventory atthe end ofthe year. ADVANTAGES OF VARIABLE COSTING ‘AiPiough variable costing isnot used ia external reporting, i is recommended for intemal reporting for the following reasons: 1, Easier to understand and use This because direct costi of management. Facilitate profit planning ith the segregation of costs and expenses into variable and fixed and calculation of ter bution margin igure, direct (variable) costing facilities short-range profit planning thrment may volume ges in sales volume directly a arnous ting income with fixed ovethead treated as a period cost, the unit cost of inventory, l to the variable product cost. Absorption (full) costing on the other hand, causes confusion when net income decreases in spite of increased sales, The ce! sion is the fixed manufacturing cost included as part of the cost of invento Facilities intemal reporting Internal reporting is facilitated when variable (direct) costing is being used. Cost data needed for intemal use become readily available. In absorption (free) costing, there is a need for preparing supplementary analysis and reference of auxiliary records before a marginal income statement can be prepared. DISADVANTAGES OF VARIABLE COSTING 1. It is not acceptable for extemal reporting purpose because it is prepared not in accordance with the Internal Financial Reporting Standard (IFRS) of matching costs against Factory overhead, being one of the elements of manufacturing cost is a prod is therefore an inventoriable cost. To attain proper matching of cost against revenue, the Portion of factory overhead allocated to sell units must from part of the cost of goods sold. tis not acceptable for income tax purposes. In as much as it is used in short-range planning, it encourages a short-sighted approach to profit planning It gives the false impression that variable cost is recovered first, that fixed cost is Fecovered later, before any profitis realized. The reality is that the revenue from the sale of each unit of product contains « portion of variable cost, fixed cost, and profit. No one ‘cost has priority over another and each unit of product sold ears a share of profit. With the trend towards automation and computerization, variable cost may become an insignificant portion of the total operating/manufacturing cost. Variable costing therefore, will only be helpful in situations where variable costs are a significant part of total cost. SEGMENT REPORTING Should segmented reporting be on a variable-costing basis or an absorption-costing basis? To answer this question, let us consider Elcom, Inc., a firm that manufactures stereos and video recorders in a single plant and use absorption-costing for both extemal and internal reporting standards. Shown below is the income statement under absorption costing by product line and in total for 2010:Segmented income Statement For the year ended December 31, 2010 Stereos Video Recorders. Total 400,000 290,000 690,000 f Goods Sold 350,000 300.00 _650,000 Gross Margin ? 50,000 (10,000) 40,000 Seling and Administrative Expen (30,000) {20,000} _{50,000) Net income (Loss) 2.20.09 2{39.000) 40.000) Pon seeing the product-line performance, the president of Elcom, Mr. Eletero Susapinday, decided to Hop Producing video recorders, reasoning that profit would increase by P30,000. A year later pomever, the result was quite different. The income statement for 2011 shown below, reported further decrease of net income by P55,000. Elcom. tne Segmented Income Statement For the year ended December 31, 2011 (Absorption Costing) sales 400,000 Cost of Goods Sold (430,000) Gross Margin (30,000) Selling and Administrative Expenses (35,000) Net Income (Loss) (65,000) To his dismay, Mr. usapinday realized thet many fixed costs which has been allocated to the video recorders were not eliminated when the product line was dropped. Since both stereo and vides recorders were produced in the same plant , much of the fied factory overhead was common to bors prodvets. Among them are plant depreciation, taxes insurance, plant manager's salary, ete, Whee the video recorders were dropped, all the common fixed overhead cost where charged to the stereo Product line, The chief accountant recommended the use of variable costing income statement, Under this type of costing method, fixed costs are broken down into two Categories: direct fixed expenses and common financial expenses. These categories highlight controllable costs from non-contetletre costs thereby enhancing management's abilty to evaluate each segment on product lme’s coctrnaie: to overall firm performance. Direct fixed costs/expenses are those fixed expenses that are directly traceable to a segment or product line, They are sometimes referred to as avoldable fixed expenses or traceable fnen expenses because they disappear once the segment or produc line is eliminated. n the Elcom case, depreciation tr, caulment used in producing video recorders and the salary of production superviser assigned to the production of video recorders are example of direct fixed expenses 106Common fixed costs are those that are jointly caused mi re segment oF + line, These fenses will not disappear even if one of the seg product plant depreciation, and the sa illustration, ti ne is eliminated. For example, the common fixed cost as indicated in the ¢ elimination of video record did ed in the elimination sociated depreci nas his job oversee stereo produet line Shown below is the example of the segmented incom: nt of Elcom. Inc. from the year ended December 31, 2011 under variable costing system, ELCOM. INC Segmented income Statement For the year ended December 31, 2011 (Variable Costing System) Stereos Video Recorders Tot Sales 40,000 290,000 690,000 Less: Variable Expenses: Cost of Goods Sold 0 200,000) 500,000) Selling and Administrative Expenses (5,000) {10,000} 115,000) Contribution Margin 95,000 80,000 175,000 Less: Direct fixed expenses: Direct fixed overhead (30,000) (20,000) (50,000) Direct selling and administrative 5,000) (15,000) Segment margin 55,000 110,000 Less: Common fixed expenses: Common fixed overhead (200,000) Common selling and administrative {20,000} Net income (Loss) 120,000) Observe that both product lines have a large position contribution margins (P9S,000 for stereos and P80,000 for video recorders). Both products are providing revenue above variable costs that can be used to help cover the firm’s fixed costs. However, some of firm's fixed costs are caused by segments themselves. Thus, the real measure of the profit contribution of each segmer over after these direct fixed costs are covered The profit contribution each segment makes toward covering a firm's common fixed costs is called the segment margin. A segment should at least be able to cover both its own variable costs and fixed costs. A negative segment margin drags down the firm's total profit, making it time to consider dropping the product. ignoring any effect a segment may have on the sales of other segments, the segment margin measures the change in a firm's profit eliminated. ‘As shown in exhibit above, we see that the video recorder line contributes P55,000 toward covering the firm's fixed costs. if the product line is dropped, total profit decrease by PSS,000. Dropping the video recorder therefore, was a disastrous decision, and now we know why. The correct decision is to retain both products, since they are making equal contribution to the firm’s profitability. Dropping either product simply aggravate the problem, unless it is immediately replaced by a product with a higher segment margin. int is what is left that would occur if the segment were 107MARY Variable and absorption costing costing ¥ overhead. Variable ting treat ‘ed factory overhead ting Consists of direct materials, di overhead. ; A variable costing income statement div €s expenses according to cost behavior. First, variable expenses of manuf Thee, arketing, and administrative are subjected from eae to yield the Contribution margin, Ther nll fixed expenses are subtracted from the contributig, margin to yield fanable-costing net income. An absorption cos ting income statement divides expense according to funetion. First, the dag eos sold is subtracted from a sales to yield gross prot fo, gross margin) then marketing and administrative expenses nee subtracted from gross profit to yield absorption: costing net income. AY Separating costs according to behasior, variable costin enhances traceability of cost. Variable mranin® reserves the correspondence between effort avg outcome necessary for good evaluation of ‘management performance. Jn seement reporting, variable costing emphasizes the cost of behavior of each segment so that ‘management can property evaluate each segments contribution g over-all firm performance. KEY TERMS FoR REVIEW Contribution Margin is the amount thatis left oft r deducting variable cost from revenue. Fixed Cost is a type of cost that does not change in total amount with changes in volume of output or activity Manufacturing margin is the amount thot is left ofter deducting variable manufacturing cost form Normal capacity is the balance between prectical plont ca Point of actual average plant utilization. This Predetermined Overhead Rate (P.0.R). pacity and sales demand in the long run; the 's the copacity that used as denominator when computing Normal costing is @ product casting system wherein the direct material and direct labor are expressed im octual cost, whereas, the factory overhead ore expressed in estimated cost Perlod costs a type of cost that is charged aginst the revenue onthe period it is incurred. Relevant range isthe range of activity within withthe cast behavior potterns is valid Semi Variable Cost is a mixture of variable cast and fixed cost. Variable Cost is 0 type of cost that varies in ttal amount in dlrect proportion to changes in level of activityQUESTIONS FoR REVIEW Why do fixed costs create difficu {mn traditional cost accounting, i, . fixed factory overhead Cost applied to th How is a fixed manufacturing cost s When the varial r ‘ost applied Products? What is the essential difference betwee: What do you understand by capacity variance? Why is there no capacity variance under variable costing? Differentiate manufacturing margin rom contribution margin Why is the concept of contribution in, 0. Expt bsorption costing? absorption and variable costing? ortant to management? in why variable costing might be looked upon as a short-sighted approach to planning EXERCISES E-1_ Factory overhead has been estimated as follows At 30,000 direct labor hours 80,000 ‘At 40,000 direct labor hours £100,006 Compute the following: (mac) 1. Variable factory overhead rate per direct lator hour. 2. Fixed factory overhead. 3. Factory overhead rate based on the normal capacity of 32,000 direct labor hour. E-2 You are given the following information Net income under direct costing 15,000 Inventory, Beginning-Second year 2,000 units Inventory, Ending-Second year 3, 500 units Fixed factory overhead per annum 30,000 Units produced First year 10,000 units Second year 12,000 units Compute the follow! 1. Fixed cost per unit inthe first year 2. Fixed cost per unit in the second year 3. Fixed cost per unit based on normal capacity of 12,500 units E3_ Gordon Company began its operations on January 2011 and produces a single product that sells for P10 per unit. Gordon uses an actual (historical) cost system. In 2011, 100,000 units were produced and 80,000 units were sold. There was no work-in-process inventory at December 31 2011. Manufacturing costs and selling and administrative expenses for 2011 were os followsRaw Material Direct labor tory overhead Selling and adm Compute the following: (mac) 1, Operating income for 2011 under variable costing method. 2. Finished goods inventory at December 31, 2011 under the absorption method Galang Corporation produced 10,000 units of Product A during the month of November. Cost incurred during the month was as follows: Direct materials used 20,000 Direct labor 16,000 Variable manufacturing overhead 8,000 Fixed manufacturing overhead 10,000 Variable selling and administrative expenses 2,400 Fixed selling and administrative expenses 9,000 Total 265.400 Compute the followin; 1. Product cost per unit under Variable and Absorption Costing method 2. Total variable cost, The company sold 9,000 units in 2011. The inventories at the beginning and end of the same year were as follows: No. of units Unit costs: Direct materials Direct labor Factory overhead: Variable Fixed ‘Compute the following: 1. Production volume in 2011 2. Net income for 2011 under variable costing and absorption costing. At the production level of 30,000 units, there is an unfavorable volume variance of 16,000, while at 40,000 units, the volume variance is, P4,000, favorable ‘Compute the following: 1, The normal capacity must te: a. 35,000 units b. 38,000 units ¢. 36,000 units 4. not given 2. Fixed factory overhead cost.E7 _Atthe production capacity of 40, While at 25,000 units, itis P3.75, Compute the following: 1. Total fixed factory overhead 2. Variable cost per unit Garfield Company produced 40,000 units d P48 per unit. The company chose pr Predetermined overhead rate Manufacturing costs are follows Expected and actual fixed overhead Expected and actual variable overhead Direct labor Direct materials Compute the following: 1. Unit cost and the PROBLEMS Pa basis are as follows: Manufacturing cost (per unit) Direct materials (2 Ib@ P2) Direct labor (1.5 hr @ P9) Variable overhead (1.5 hr @ P2) Fixed overhead (1.5 hr @ P3) Total Selling and administrative costs: Variable per unit Fixed (Total) tical a Bellingham, Inc. has just completed its first year of oper y overhead per u uring its first year of operations and sold 36,000 at ivity ~ at 40,000 units ~to compute its 140,000 48,000 320,000 120,000 Cost of finished goods inventory under absorption costing, 2. Unit cost and the cost of finished goods invent ‘ory under variable costing, ations. The unit costs on a normal-costing P 4.00 13.50 190,000 During the year, the company had the following activity Units produced Units sold Unit selling price Direct labor hours worked ‘Actual fixed overhead was P12,000 less than the budgeted fixed overhe: overhead was P5,000 less than the actual vari activity level of 36,000 direct labor hours to © overhead variances are closed to Cost of Goods Sold. 24,000 21,500 a2 36,000 ad. Budgeted variable lable overhead, The company used an expected “ompute the predetermined overhead rates. Any iRequired: (hansen) 1. Compute the unit cost using ab: and variable cost 2. Prepare income statement f riable costing and absorption costing metho 3. Reconcile the difference bet come statem Tresler Film Company reduced its finished FY in 2011 from 80,000 units to 40,000 units. Fixed manufacturing overhead of P1,360,000 was applied to the 170,000 units produced during the year. The manufacturing overhead capacity for the year was P240,000, and was unfavorable. Variable manufacturing cost per unit was P4. Each unit of product was sold for PIS. Required: (moore) 1. Income Statement under for 2011 under both the variable and absorption costing system 2. Reconciliation of the difference in profit between the two (2) costing system Kerkland Co. a manufacturer operating at 95% of capacity. Kerklen has been offered a new order of P7.25 per unit requiring 15% of capacity. No other use of the 5% current idle capacity can be found. However, if the order were accepted, the subcontracting for the required 10% additional Capacity would cost P7.50 per unit. The variable cost of production for Kerklen on a per-unit basis follows: Materials, Labor Variable overhead Required: (wiley) 1. In applying the contribution margin approach to evaluating whether to accept the new order, assuming subcontracting, compute the average variable cost per unit 2. Based on your answer in #1, determine the contribution margin per unit of the new order. Below is the annual flexible budget prepared for use in making decisions relating to Product x 10,000 150,000 200,000 Units Units Units Sales volume 800,000 1,200,000 1,600,000 Manufacturing costs: Variable 300,000 450,000 Fixed -200,000 _200,000 500,000 650,000 Selling & Other Expenses: Variable 200,000 —_P300,000 Fixed 160,000 _160,000 360,000 P460,000 Income (Loss) 160,000) B_90,000 112he 200,000 unit bud willbe used for allocating fixed manufactur osts to units of Product ailable All fixed costs are budgeted and incurred uniformly throughout the year and all costs incurred coincide with the budget. Over and under applied fixed manufacturing costs are deferred until the year-end. Annual sales have the following seasonal pattern First quarter Second quarter Third quarter Fourth quarte Required: (wiley) 1, The amount of fixed factory costs applied to product during the first six months under absorption costing 2. Net income (loss) for the first six months operations under absorption costin Net income (loss) for the first six months operations under variable costing Assuming that 90,000 unit of Product X were sold during the first six months and this isto be used as a basis to compute the revised budget estimate for total number of units to be sold, Nicholson Instruments, Inc. produces various measuring devices that are sold to the health care industry. An instrument for testing blood is manufactured exclusively in one division, A budget for the next year shows that 450,000 instrument can be sold in the regular market ext year at a price of P95 per unit. Estimates indicate that the division will increase inventory next year by 30,000 units in anticipation of increased sales in the subsequent ye The variable cost to manufacture 480,000 units next year has been budgeted at P33,600,000. Fixed manufacturing overhead for the year is expected to amount to P9,000,000. The fixed ‘manufacturing overhead is applied to production at the rate of P15 per unit The vice-president for sales announces that 50,000 additional units can be sold to an overseas government a a total contract price of P4,000,000 and the government wil absorb the shipping charges. The president is reluctant to accept the contract, pointing out that it cost P4, 250,000 to ‘make 50,000 units and that the division will lose P250,000 on the contract. The inventory isto be increased by 30,000 units whether the contract is accepted or not Required: 1. Prepare income statement for manufacturing for the next year’s operation under variable costing and absorption costing. 2. Show proof why the income statement from manufacturing is more on the absorption costing than on the variable costing,Variable Cost Olango Island P400 P250 Hinatungan 350 175 Nalusu-an Island 540 360 fixed costs, such’as the salaries of the managers and tour guide been estimated at P800,000 for the year. The fixed costs have been allocated to each tour on the basis of the estim ‘customers to be served ‘it is clear that the Olango Island tour is our most profitable tour”, the sa er observes. “If we spend any more on promotion, we should promote the Olango Island tour.” Required 1. Do you agree with the sales manager's observation? If yes, explain why. If not, explain why not. Prepare an income statement showing the total contribution margin fre tour. Show the fixed costs subtracted only from the total contribution ms all three tours, Which of the three tours yields the best contribution margin per cust yield the best contribution margin percentage. You have been working on the budget for 2011 for KBD Company. The president of the company plans to go for a tour of overseas plants within two hours, and you have been asked to have a sales budget in units of product prepared for the main plant at Atlante to give to overseas producers. ‘You have certain data on your desk but nothing about units to be sold. Available information reveals that four (4) units of direct materials are required for each unit of product manufactured. An inventory of 160,000 units of materials is to be on hand at the beginning of the year. This inventory level is to be maintained until the end of the thin quarter, when it will be increased to 200,000 units Materials can be used in production during the quarter acquired Purchases for the year have been planned as follows: Quarter Units of Materials 1 1,200,000 Z 1,500,000 3 2,000,000 4 2,500,000 Each unit of materials purchased cost is P2.50. 14at the en 000 uw al Purchases ‘Materials used in production Budgeted Cost of The Estevan Mfg. Co. prod luses standard-cost system and allocates the fixed factory overhead based on a denominator activity of 50,000 units. During 2011, production amounted to 46,000 units while sales for this period were 56,000 units; the “net” variance for variable manufacturing costs in 2011 was P4,000, favorable, and fixed factory costs amounted to 60,000 (there was no budget variance for fixed factory costs). Variable manufacturing costs (materials, labor, and variable manufacturing overhead) at standard are P2 per unit. Fixed selling and administrative expenses in 2011 were P10,000 and variable selling and administrative expenses were P1 per unit. There were no inventories of work in process at either the beginning or end of 2011; the finished goods inventory at the beginning of 2011 was 18,000 units, and was valued at standard cost. All manufacturing cost variances are to be written off as additions (or deductions from) Cost of Goods Sold Required: 1. The “actual” contritution margin for 2011 2. Finished goods inventory at December 31, 2011 under absorption and variable costing methods, The total amount of fixed manufacturing costs deducted on the 2011 absorption income statement The amount of difference between the operating income computed under variable costing and absorption costing.