Learn key differences between variable and absorption costing

CHAPTER 10—COST ANALYSIS FOR MANAGEMENT DECISION MAKING
MULTIPLE CHOICE
1. Which of the following is a more descriptive term of the type of cost accounting often
called "direct costing"?
a. Prime costing
b. Out-of-pocket costing
c. Variable costing
d. Relevant costing
Variable costing may be considered a more descriptive term than direct costing because
only the variable costs are used to determine a product's cost.
PTS: 1 DIF: Easy REF: P. OBJ: 1

NAT: IMA 2B - Cost Management TOP: AACSB - Analytic
2. What costs are treated as product costs under direct costing?

a. Only direct costs
b. Only variable manufacturing costs
c. All variable costs
d. All variable and fixed manufacturing costs
Only variable production costs are treated as product costs in direct or variable costing.
Although all variable costs are subtracted from sales in order to determine the
contribution margin, only those variable costs related to the manufacturing process are
allocated to the products.
PTS: 1 DIF: Moderate REF: P. OBJ: 1

NAT: IMA 2B - Cost Management TOP: AACSB - Reflective
3. The basic assumption made in a variable costing system with respect to fixed costs is
that all fixed costs are:
a. Sunk costs.
b. Product costs.
c. Fixed as to the total cost.
d. Period costs.
The variable costing method assigns all fixed costs to the period in which they
originated; therefore, they are all classified as period costs.
4. Donellan Company produces a special gear used in automatic transmissions. Each

gear sells for $30, and the company sells approximately 500,000 gears each year. Unit
cost data for the year follows:
Direct material $9.00

Direct labor 8.00
Other costs: Variable Fixed

Manufacturing $3.00 $7.00
Distribution 5.00 3.00
The unit cost of gears for variable costing inventory purposes is:
a. $14.
b. $17.
c. $20.
d. $24.
Under variable costing, only variable manufacturing costs are assigned to the product.
These costs include:
Direct materials $ 9.00

Direct labor 8.00
Variable manufacturing cost 3.00
Total variable costs $20.00

5. Mobile, Inc., manufactured 700 units of Product A, a new product, during the year.
Product A's variable and fixed manufacturing costs per unit were $5.00 and $2.00,
respectively. The inventory of Product A on December 31 of the year consisted of 100
units. There was no inventory of Product A on January 1 of the year. What would be
the change in the dollar amount of inventory on December 31 if the variable costing
method was used instead of the absorption costing method?
a. $800 decrease
b. $200 decrease
c. $500 decrease
d. $200 increase
Ending inventory under absorption costing (100 units x $7) $700
Ending inventory under variable costing (100 units x $5) 500
$200

6. Which of the following is true about absorption costing?

a. No fixed factory overhead is charged to production.
b. It is also known as direct costing.
c. The term used to designate the difference between sales and cost of goods sold is the
“manufacturing margin.”
d. Over-applied factory overhead is reflected in the income statement as a reduction cost
of goods sold.
Overapplied factory overhead occurs only with absorption costing. Choices a, b and c
are characteristics of variable costing.

7. Which of the following does not appear on an income statement prepared using
variable costing?
a. factory rent/profit.
b. Manufacturing margin
c. Fixed production costs.
d. Variable production costs.
dr
The term commonly used in variable costing to designate the difference between sales
and variable cost of goods sold is manufacturing margin. It is a absorption costing
statement that would be expected to show gross margin/profit.

8. What factor related to manufacturing costs causes the difference in net earnings
computed using absorption costing and net earnings computed using variable costing?
a. Absorption costing considers all costs in the determination of net earnings, whereas
variable costing considers only direct costs.
b. Absorption costing "inventories" all direct costs, but variable costing considers direct
costs to be period costs.
c. Absorption costing "inventories" all fixed manufacturing costs for the period in ending
finished goods inventory, but variable costing expenses all fixed costs.
d. Absorption costing allocates fixed manufacturing costs between cost of goods sold
and inventories, and variable costing considers all fixed costs to be period costs.
Absorption costing considers fixed manufacturing costs to be an essential element of

cost in producing a product; therefore, fixed manufacturing costs are allocated to the
inventories and cost of goods sold. However, when variable costing is used, all fixed
costs for a given period are charged only to that period.

9. Net income reported under absorption costing will exceed net income reported under
variable costing for a given period if:
a. Production equals sales for that period.
b. Production exceeds sales for that period.
c. Sales exceed production for that period.
d. The variable overhead exceeds the fixed overhead.
When production exceeds sales under the absorption cost method, the unsold (ending)
inventory contains part of the fixed cost of the period which, along with other inventory
costs, are deferred to the next period. Under the variable costing method, all fixed costs
are charged to the current period. Therefore, when production exceeds sales and
results in unsold inventory, net income reported under absorption costing will exceed the
net income reported under variable costing for the period.

10. A manager can increase income under absorption costing by

a. increasing variable costs.
b. increasing production.
c. increasing fixed costs.
d. increasing leased assets.
By increasing production, the fixed costs are absorbed by more units. This lowers the
cost per unit and thus increasing income.
11. The use of either absorption or variable costing will make little difference in
companies
a. with large inventories.
b. using JIT.
c. with high fixed costs.
d. with high variable costs.
If JIT or just-in-time is used then inventories levels are minimized. Absorption and
variable cost would have nearly identical results as no costs are deferred in inventories.
PTS: 1 DIF: Hard REF: P. OBJ: 1

12. A basic tenet of variable costing is that fixed overhead costs should be currently
expensed. What is the basic rationale behind this procedure?
a. Fixed overhead costs will occur whether or not production occurs and so it presents a
clearer picture of how changes in production volume affect costs and income.
b. Fixed overhead costs are generally immaterial in amount and the cost of assigning the
amounts to specific products would outweigh the benefits.
c. Allocation of fixed overhead costs is arbitrary at best and could lead to erroneous
decisions by management.
d. Fixed overhead costs are uncontrollable and should not be charged to a specific
product.
Variable costing assumes that the category of costs defined as fixed costs will occur with
or without production and should be charged as expenses in the period in which they are
incurred as a current cost. It highlights the relationship between sales and variable
production costs thus providing a clearer picture of how changes in production volume
affect costs and income.

13. Absorption cost is required for:

a. income tax purposes.
b. external financial reporting but not income tax purposes.
c. both external financial reporting and income tax purposes.
d. neither external financial reporting nor income tax purposes.
Although variable costing may provide useful information for internal decision making, it
is not a generally accepted accounting method of reporting inventory for external
financial statements nor is it permitted by the Internal Revenue Service to compute
taxable income.

NAT: IMA 2E - External Financial Reporting TOP: AACSB - Analytic
14. Segment profitability analysis may be used to evaluate the profitability of:
a. Divisions.
b. Sales territories.
c. Product lines.
d. All of these are correct.
Segment profitability analysis may be used to evaluate the profitability of divisions, sales
territories, product lines, or other identifiable organizational unit.

NAT: IMA 3D - Decision Analysis TOP: AACSB - Reflective
15. When evaluating profitability of a segment, costs that are directly identifiable with a
specific segment are called:
a. Direct costs.
b. Common costs.
c. Indirect costs.
d. Fixed costs.
Direct costs are costs, variable or fixed, that are directly identifiable with a specific
segment, so they would disappear if that segment was eliminated.

NAT: IMA 3D - Decision Analysis TOP: AACSB - Analytic
16. When evaluating profitability of a segment, costs that would disappear if the
company eliminated the segment are called:
a. Direct costs.
b. Common costs.
c. Indirect costs.
d. Fixed costs.
Direct costs are costs, variable or fixed, that are directly identifiable with a specific
segment, so they would disappear if that segment was eliminated.

17. The excess of revenue over variable costs, including manufacturing, selling and
administrative, is called:
a. Gross margin.
b. Manufacturing margin.
c. Contribution margin.
d. Segment margin.
Contribution margin is defined as sales less variable costs.

18. Johns Company operates in three different industries each of which is appropriately
regarded as a reportable segment. Segment No. 1 contributed 60 percent of Johns
Company's total sales. Sales for Segment No. 1 were $600,000 and total variable costs
were $400,000. Total common costs for all segments were $320,000. Johns allocates
common costs based on the ratio of each segment's sales to the total sales. What
should be the contribution margin presented for Segment No. 1?
a. $(100,000)
b. $8,000
c. $20,000
d. $200,000
Segment No. 1
Sales $600,000
Less variable costs 400,000
Contribution margin $200,000

19. Nolan Company has two segments: Audio and Video. Sales for the Audio Segment
were $500,000, and variable costs were 40% of sales. The Video Segment also had
sales of $500,000, but variable costs were 60% of sales. Fixed costs directly traceable
to the Audio and Video segments were $150,000 and $120,000, respectively. Common
fixed costs of $200,000 were arbitrarily allocated equally to each segment.
What was the contribution margin of the Audio Segment.

a. $50,000
b. $300,000
c. $200,000
d. $150,000
Sales $500,000
Variable costs (500,000 x 40%) 200,000

20. Nolan Company has two segments: Audio and Video. Sales for the Audio Segment
were $500,000, and variable costs were 40% of sales. The Video Segment also had
sales of $500,000, but variable costs were 60% of sales. Fixed costs directly traceable
to the Audio and Video segments were $150,000 and $120,000, respectively. Common
fixed costs of $200,000 were arbitrarily allocated equally to each segment.
What was the segment margin of the Video Segment.

a. $200,000
b. $80,000
c. $(20,000)
d. $150,000
Sales $500,000
Variable costs (500,000 x 60%) 300,000
Contribution margin 200,000
Direct fixed costs 120,000
Segment margin $ 80,000

21. Consider the Marshall Company’s segment analysis:

Division A Division B Total Company
Sales $300,000 $200,000 $500,000
Variable costs 150,000 150,000 300,000
Contribution margin 150,000 50,000 200,000
Direct fixed costs 50,000 30,000 80,000
Segment margin 100,000 20,000 120,000
Allocated common fixed costs 90,000 60,000 150,000
Operating income (loss) $ 10,000 $(40,000) $(30,000)
Common costs are allocated arbitrarily based on sales dollars. If Marshall eliminates
Segment B, what is the impact on the operating loss of the company?
a. The loss decreases by $40,000.
b. The loss increases by $20,000.
c. The loss decreases by $60,000.
d. The loss increases by $40,000.
Since the common costs are arbitrarily allocated, a more appropriate segment analysis
follows:
Division A Division B Total Company
Sales $300,000 $200,000 $500,000
Variable costs 150,000 150,000 300,000
Contribution margin 150,000 50,000 200,000
Direct fixed costs 50,000 30,000 80,000
Segment margin 100,000 20,000 120,000
Common fixed costs - - 150,000
Operating income (loss) $100,000 $ 20,000 $(30,000)
It is apparent from this analysis, that the company would lose $20,000 of profits.

22. A technique that uses the degrees of cost variability to measure the effect of
changes in volume on resulting profits is:
a. Standard costing.
b. Variance analysis.
c. Cost-volume-profit analysis.
d. Segment profitability analysis.
Cost-volume-profit analysis uses the degrees of cost variability to measure the effect of
changes in volume on profitability.

23. Break-even sales volume in units is determined by:

a. Dividing the fixed cost by the difference between the unit selling price and unit
variable costs.
b. Subtracting the fixed cost from the contribution margin.
c. Dividing the fixed cost by the unit selling price.
d. Subtracting the variable cost per unit from the unit selling price.
Break-even sales volume = fixed costs / (unit selling price - unit variable cost)

24. If the selling price and the variable cost per unit both increase 10 percent and fixed
costs do not change, what is the effect on the contribution margin per unit and the
contribution margin ratio?
a. Contribution margin per unit and the contribution margin ratio both remain unchanged.
b. Contribution margin per unit and the contribution margin ratio both increase.
c. Contribution margin per unit increases and the contribution margin ratio decreases.
d. Contribution margin per unit increases and the contribution ratio remains unchanged.
If the selling price is originally greater than the variable cost and they both increase by
the same percentage, the absolute increase in selling price will be greater than the
variable cost increase. Therefore, the contribution margin will be increased. If the
relative increase in both items is the same, the ratio measuring them will not be affected.
To prove this numerically, assume sales are $10 and variable costs are $5. A 10%
increase will make sales $11 and variable costs $5.50.
Original Example With 10% Increase
Contribution margin $10 - $5 = $5 $11 - $5.50 = $5.50
Contribution margin ratio $5 / $10 = 50% $5.50 / $11 = 50%

25. The Company is planning to sell Product Z for $10 a unit. Variable costs are $6 a
unit and fixed costs are $100,000. What must total sales be to break even?
a. $266,667
b. $250,000
c. $200,000
d. $166,667
Selling price $10.00 100%
Variable costs 6.00 60%
Contribution margin $ 4.00 40%
Break-even
sales volume = Fixed cost
Contribution margin ratio
= $100,000
.40
= $250,000

26. The Blue Saints Band is holding a concert in Toronto. Fixed costs relating to
staging a concert are $350,000. Variable costs per patron are $5.00. The selling price
for a tickets $25.00. The Blue Saints Band has sold 23,000 tickets so far.
How many tickets does the Blue Saints Band need to sell to break even?
a. 23,000
b. 20,000
c. 14,000
d. 17,500
Break-even sales volume (units) = Fixed cost / Unit contribution margin

Break-even sales volume = $350,000 / ($25 - $5) = 17,500 tickets.

27. Consider the income statement for Pickbury Farm:

Sales $500,000
Variable costs 350,000
Fixed costs 80,000
Net income $ 70,000
What is the break-even point in sales dollars (rounded to the nearest dollar)?
a. $714,286
b. $500,000
c. $266,667
d. $120,000
Break-even point in dollars = Fixed cost / contribution margin ratio

Break-even point = $80,000 / ($150,000/$500,000)
Break-even point = $80,000 / 30% = $266,667

28. Each of the following would affect the break-even point except a change in the:
a. Variable cost per unit.
b. Total fixed costs.
c. Sales price per unit.
d. Number of units sold.
A change in the number of units sold will not have any effect on the determination of the
break-even point.

29. Tennenholtz Company’s break-even graph is depicted below. The line labeled “D”
is:
a. The sales line.

b. The contribution margin line.
c. The total cost line.
d. The variable cost line.
The line starting on the J axis where the F line (fixed cost line) intersects J that has the
upward slope is the total cost line. The upward slope from the fixed cost line represents
the variable costs.

30. Tennenholtz Company’s break-even graph is depicted below. Which area indicates
the profitability of the company’s product?
a. E.
b. G.
c. B.
d. H.
The area labeled “B” indicates the profitability of the product. It is beyond the break-
even point, and the revenue line, labeled “C” exceeds the total cost line, which is labeled
“D.”

31. Franklin Company is a medium-sized manufacturer of bicycles. During the year a

new line called "Radical" was made available to Franklin's customers. The break-even
point for sales of Radical is $250,000 with a contribution margin ratio of 40 percent.
Assuming that the profit for the Radical line during the year amounted to $80,000, total
sales during the year would have amounted to:
a. $450,000.
b. $420,000.
c. $400,000.
d. $475,000.
Break-even sales $250,000

Contribution margin ratio x 40%
Calculated fixed cost (must equal contribution margin to break-even 100,000
Net income $ -0-
Sales to make $80,000 profit:
Sales = .60S + $100,000 (fixed) + $80,000 (profit)
.40S = $100,000 + $80,000
S = $180,000
.40
S = $450,000

32. Kehler Corporation wished to market a new product for $2.00 a unit. Fixed costs to
manufacture this product are $100,000. The contribution margin is 40 percent. How
many units must be sold to realize net income of $100,000 from this product?
a. 200,000
b. 250,000
c. 300,000
d. 350,000
Selling price $ 2.00

Contribution margin x 40%
Contribution margin $ .80
Fixed cost $100,000

Net income 100,000
Total $200,000
Total $200,000 / $.80 = 250,000 units

How many tickets does the Blue Saints Band need to sell to achieve net income of
$75,000.
a. 21,250
b. 14,000
c. 17,500
d. 17,000
Target volume (units) = (Fixed cost + target net income) / Unit contribution margin.
Target volume = $350,000 + $75,000 / ($25 - $5)
Target volume = $425,000 / $20 = 21,250 tickets

Sales $500,000
Fixed costs 80,000
Net income $ 70,000
At what sales level does Pickbury achieve net income of $100,000?

a. $700,000
b. $600,000
c. $300,000
d. $530,000
Target sales volume = (Fixed cost + Target profit) / contribution margin ratio
Target sales volume = ($80,000 + $100,000) / ($150,000/$500,000)
Target sales volume = $180,000 / 30% = $600,000

35. If the fixed costs related to a product increase while variable costs and sales price
remain constant, what will happen to (1) contribution margin and (2) break-even point?
Contribution
Margin Break-even
Point
a. Unchanged Unchanged
b. Unchanged Increase
c. Increase Decrease
d. Decrease Increase
The contribution margin is determined using only variable costs and is unaffected by
fixed costs. The fixed cost increase, however, will require more sales to break even.
To prove numerically, assume that the sales price is $10 per unit and variable costs are
$5 per unit. The contribution margin of $10 - $5 = $5 does not change. However, if
fixed costs increase from $10,000 to $20,000, the break even point increases from 2,000
units ($10,000/$5) to 4,000 units ($20,000/$5).

36. Which of the following would cause the break-even point to change?
a. Sales volume increased.
b. Fixed costs increased due to addition to physical plant.
c. Total variable costs increased as a function of higher production.
d. Total production decreased.
An increase in fixed cost will also increase the break-even point. Changes in production
levels will not impact the break-even point.

37. A company increased the selling price for its product from $1.00 to $1.20 a unit
when total fixed costs increased from $400,000 to $450,000 and variable cost per unit
remained unchanged. How would these changes affect the break-even point?
a. The break-even point in units would be increased.
b. The break-even point in units would be decreased.
c. The break-even point in units would remain unchanged.
d. The effect cannot be determined from the information given.
The change in fixed cost from $400,000 to $450,000 represents an increase of 12.5
percent; therefore, if the contribution margin increases:
1. by more than 12.5 percent, the break-even point would decrease.

2. at 12.5 percent, the break-even point would be unchanged.
3. by less than 12.5 percent, the break-even point would increase.
The relative change in contribution margin is 20%; therefore, the effect of the change is
a decrease in the break-even point.
To prove numerically, assume variable costs are $.20 per unit:

Contribution Margin Break-even point in units
Selling price $1.00;
fixed costs $400,000
$1.00 - $.20 = $.80
$400,000/ $.80 = 500,000 units
Selling price $1.20;
fixed costs $450,000
$1.20 - $.20 = $1.00
$450,000/ $1.00 = 450,000 units

38. The relative percentage of unit sales among the various products made by a firm is
the:
a. sales volume.
b. sales margin.
c. sales mix.
d. sales ratio.
The sales mix is the relative percentage of unit sales among the various products made
by a firm.

39. Consider the following information about the Gumm Company:
Budgeted Sales Unit Contribution Margin

Mint gum 6,000 cases $2.00
Bubble gum 4,000 cases $2.50
Budgeted fixed costs are $550,000. The weighted-average unit contribution margin is:
a. $2.25
b. $4.50
c. $2.20
d. $2.30
Number of units Unit CM Total

Mint gum 6,000 $2.00 $12,000
Bubble gum 4,000 $2.50 10,000
Total 10,000 $22,000
$22,000 / 10,000 units = $2.20 per case


Budgeted fixed costs are $550,000. The break-even point in total cases is:
a. 250,000
b. 275,000
c. 220,000
d. 200,000
Weighted-average contribution margin:

Mint gum 6,000 $2.00 $12,000
Bubble gum 4,000 $2.50 10,000
Total 10,000 $22,000
$22,000 / 10,000 units = $2.20 per case
Break-even in units = fixed cost / weighted-average contribution margin

Break-even = $550,000 / $2.20 = 250,000 case


Budgeted fixed costs are $550,000. The break-even number of cases for the mint gum
is:
a. 250,000
b. 100,000
c. 132,000
d. 150,000
Weighted-average contribution margin:
Mint gum 6,000 $2.00 $12,000
Bubble gum 4,000 $2.50 10,000
Total 10,000 $22,000
$22,000 / 10,000 units = $2.20 per case
Break-even in units = fixed cost / weighted-average contribution margin

Break-even = $550,000 / $2.20 = 250,000 case
250,000 units x (6,000/10,000) = 150,000 cases of mint gum.

42. The margin of safety is the amount:

a. by which the sales price per unit exceeds the variable cost per unit.
b. that the contribution margin exceeds fixed cost.
c. by which the profit calculated under absorption costing exceeds the profit calculated
under variable costing.
d. that sales can decrease before the company will suffer a loss.
The margin of safety is the amount that sales can decrease before the company will
suffer a loss. It can be expressed in dollars or units and is calculated by subtracting
break-even sales revenue from sales revenue under review.

43. The Company is planning to sell Product Z for $10 a unit. Variable costs are $6 a
unit and fixed costs are $100,000. If the company is currently selling 30,000 units, what
is the margin of safety in units?
a. 5,000
b. 10,000
c. 25,000
d. 20,000
Selling price $10.00 100%

Variable costs 6.00 60%
Contribution margin $ 4.00 40%
Break-even in
units = Fixed cost
Contribution margin per unit
= $100,000
$4.00
= 25,000
With sales volume of 30,000 units, the margin of safety would be 30,000 - 25,000 or
5,000 units.

At the current level of sales, what is the margin of safety in dollars?

a. $137,500
b. $87,500
c. $180,000
d. $115,000
Break-even volume (dollars) = Fixed cost / Contribution margin ratio.

Break-even volume = $350,000 / ($25 - $5 / $20)
Break-even volume = $350,000 / 80% = $437,500
Sales dollars at current level = $25 x 23,000 = $575,000
Margin of safety = Sales revenue - break-even sales revenue

Margin of safety = $575,000 - $437,500 = $137,500


Sales $500,000
Fixed costs 80,000
Net income $ 70,000
What is the margin of safety ratio (to the nearest percentage point)?
a. 47%
b. 70%
c. 30%
d. 88%
Break-even point in dollars = Fixed cost / contribution margin ratio

Break-even point = $80,000 / ($150,000/$500,000)
Break-even point = $80,000 / 30% = $266,667
Margin of safety ratio = (sales - break-even sales) / sales

Margin of safety ratio = ($500,000 - $266,667) / $500,000
Margin of safety ratio = $233,333 / $500,000 = 46.67%

At the current level of sales, what is the margin of safety ratio?

a. 20.0%
b. 23.9%
c. 15.2%
d. 31.3%
Break-even volume (dollars) = Fixed cost / Contribution margin ratio.

Break-even volume = $350,000 / ($25 - $5 / $20)
Break-even volume = $350,000 / 80% = $437,500
Sales dollars at current level = $25 x 23,000 = $575,000
Margin of safety = Sales revenue - break-even sales revenue

Margin of safety = $575,000 - $437,500 = $137,500
Margin of safety ratio = Margin of safety / sales

Margin of safety ratio = $137,500 / $575,000 = 23.9%
How many tickets does the Blue Saints Band need to sell to achieve net income of
$50,000 after income tax, assuming the income tax rate is 50%?
a. 2,500
b. 18,000
c. 22,500
d. 17,500
Target volume (units) = (Fixed cost + (target net income/(1 - tax rate)) / Unit contribution
margin.
Target volume = ($350,000 + ($50,000 / (1 - .5) / ($25 - $5)
Target volume = $350,000 + $100,000 / $20 = 22,500 tickets

48. The difference in cost between two alternatives, such as to make a component part
of a final product versus buying the part from an outside supplier is called:
a. Variable cost.
b. Differential cost.
c. Product cost.
d. Indirect cost.
The difference in cost between two alternatives is the differential cost.

49. Donellan Company produces a special gear used in automatic transmissions. Each
gear sells for $30, and the company sells approximately 500,000 gears each year. Unit
cost data for the year follows:
Direct material $9.00

Direct labor 8.00
Other costs: Variable Fixed

Manufacturing $3.00 $7.00
Distribution 5.00 3.00
Donellan has received an offer from a foreign manufacturer to purchase 25,000 gears.
Domestic sales would be unaffected by this transaction. If the offer is accepted, variable
distribution costs will increase $1.00 per gear for insurance, shipping, and import duties.
The relevant unit cost to a pricing decision on this offer is:
a. $18.00.
b. $20.00.
c. $24.00.
d. $26.00.

Direct labor 8.00
Variable manufacturing cost 3.00
Variable distribution cost 5.00
Increase in variable distribution costs 1.00
Total $26.00
The fixed manufacturing and distribution costs are irrelevant to the decision because
they are not changed by the 25,000 gear order.

50. Bradley Inc. has the capacity to make 100,000 windows. Bradley is currently
operating at 80% capacity. The windows usually sell for $20.00 each. Costs for each
window follow:

Direct labor 3.00
Variable factory overhead 2.00
Fixed factory overhead 4.00
Total $14.00
The Army has offered to buy 10,000 windows for $12.00 each for barracks. Bradley
should:
a. Reject the offer because it currently does not have enough capacity to accept the
order.
b. Reject the order because the company will lose $20,000 on the order.
c. Accept the offer because the company will realize $20,000 in additional contribution
margin.
d. Accept the offer because the company will realize $40,000 in additional contribution
margin.
Bradley has enough excess capacity to manufacture 20,000 additional units (100,000 x
(1 - .80). The relevant costs are:
Direct labor 3.00
Total $10.00
The $12.00 special selling price exceeds the variable costs of $10.00 for a contribution
margin of $2.00 each, or a total contribution margin of $20,000 (10,000 x $2.00).

51. Bradley Inc. has the capacity to make 100,000 windows. Bradley is currently
operating at 100% capacity. The windows usually sell for $20.00 each. Costs for each
window follow:

Direct labor 3.00
Total $14.00
The Army has offered to buy 10,000 windows for $12.00 each for barracks. Bradley
should:
a. Reject the offer because it currently does not have enough capacity to accept the
order.
b. Reject the order because the company will lose $20,000 on the order.
c. Accept the offer because the company will realize $20,000 in additional contribution
margin.
d. Accept the offer because the company will realize $40,000 in additional contribution
margin.
Bradley should reject the offer if it would have to displace orders for the windows that are
priced higher than $12.00.

52. The practice of accepting a selling price when there is excess capacity, as long as it
exceeds variable cost is called:
a. Contribution pricing.
b. Differential pricing.
c. Capacity pricing.
d. Special pricing.
The practice of accepting a selling price when there is excess capacity as long as it
exceeds variable cost is called contribution pricing, thus contributing some positive
contribution margin in times of excess capacity.

53. Chapman Corporation manufactures lamps. Management is currently studying

whether the company should continue to make the cord assembly or purchase them
from Graham Company for $5.25. Chapman needs 20,000 cord assemblies a year. If
the part is purchased, the company can not use the released facilities for another
manufacturing activity.
Chapman’s unit cost to manufacture the cord assembly is:

Direct materials $2.25
Direct labor 1.75
Factory overhead (70% fixed) 2.50
Total $6.50
The decision Chapman should make and the related differential income is:
Decision Differential Income
a. Buy from Graham $10,000
b. Make the assembly $10,000
c. Make the assembly $25,000
d. Buy from Graham $25,000
The relevant cost of manufacturing the cord assembly:

Direct labor 1.75
Variable factory overhead
(2.50 x 30%)
.75
Total $4.75
Number of assemblies 20,000
Cost to make assemblies $ 95,000
Cost to purchase assemblies

(5.25 x 20,000)
$105,000
Chapman should made the cord assembly. The differential income in making the
assemblies is $10,000 ($105,000 - $95,000).

54. Cleese Company currently purchases a finished part from Idle Company, but is
considering using it excess capacity to make the part. Normal capacity is 20,000 hours,
but Cleese is currently running at 17,000 hours. Details about budgeted factory
overhead follow:
Total Per Hour
Fixed factory overhead $40,000 $2.00
Variable factory overhead 50,000 2.50
$90,000 $4.50
Direct costs to manufacture 1,000 parts in-house would be:

Materials $ 6,000
Direct labor (2,000 @ $8 per hour) 16,000
$22,000
The relevant unit cost Cleese should use to decide whether to make or buy the part is:
a. $31.00
b. $24.50
c. $27.00
d. $26.00
Direct material ($6,000 / 1,000) $ 6.00

Direct labor (2* hours @ 8.00) 16.00
Variable factory overhead (2 hours @ 2.50) 5.00
Total $27.00
* 2,000 hours / 1,000 units = 2 hours per unit.

55. Another term for cost incurred to sell and deliver products is:
a. Differential costs.
b. Administrative costs.
c. General costs.
d. Distribution costs.
Another term for selling and delivery costs is distribution costs.

56. An example of a distribution cost that can be directly assigned to selling activity
would be:
a. Advertising costs.
b. Commissions.
c. Sales manager’s salary.
d. Telephone expenses.
Commissions would be directly linked to specific sales. The other costs are indirect
costs of selling.

57. In performing an activity-based costing study for distribution costs, appropriate cost
drivers for preparing orders for shipment would include all of the following except the:
a. Number of orders shipped.
b. Time spent packing orders.
c. Time devoted to selling each product.
d. Number of items per order.
The time devoted to selling each product would not impact the cost for preparing the
orders for shipping.

PROBLEM
1. Praeger Company began operations on January 1 and produces a single product that
sells for $10.00 per unit. Standard capacity is 100,000 units per year. During the year,
100,000 units were produced and 80,000 units were sold. There was no inventory at the
beginning of the year. Manufacturing costs and selling and administrative expenses
follow:
Fixed Costs Variable Costs
Raw materials -- $2.50 per unit produced
Direct labor -- 1.50 per unit produced
Factory overhead $250,000 .50 per unit produced
Selling and administrative 100,000 .50 per unit sold
There were no variances from the standard variable costs. Any under- or overapplied
overhead is written off directly at year end as an adjustment to cost of goods sold.
a. In presenting inventory on the balance sheet at December 31, what is the unit cost
under absorption costing?
b. In presenting inventory on the balance sheet at December 31, what is the unit cost
under variable costing?
c. What is the net income for the year under absorption costing?
d. What is the net income for the year under direct costing?
e. What is the cost of the ending inventory under absorption costing?
f. What is the cost of the ending inventory under variable costing?
2. The Tijama Manufacturing Company has determined the cost of manufacturing a unit
of product to be as follows, based on normal production of 50,000 units per year:

Direct labor 15.00
Variable factory overhead 10.00 $45.00
$57.00
Operating statistics for the month of August and September include:
August September
Units produced 4,200 4,000
Units sold 3,500 4,200
Selling and administrative expenses $25,000 $35,000
The selling price is $70 per unit. There were no inventories on August 1, and there is no
work in process at September 30.
Prepare comparative income statements for each month under the following methods:
a. Absorption costing method
b. Direct costing method
3. Jasper Company makes two versions of one product, Standard and Deluxe. In
November, sales of standard and Deluxe amount to $680,000 and $520,000,
respectively. The contribution margin ratio for Standard is 30% and Standard had direct
fixed production and administrative costs of $125,000. The contribution margin ratio for
Deluxe was 40% and direct fixed costs were $160,000. Common costs that couldn’t be
allocated in a meaningful way were $100,000.
Prepare a segmented income statement for the month of November.
4. The following data relate to a year's budgeted activity for Jorgensen Corporation, a
single product company:
Per Unit
Selling price $8.00
Variable manufacturing costs 3.00
Variable selling costs 2.00
Fixed manufacturing costs (based on 120,000 units) .25
Fixed selling costs (based on 120,000 units) .75
Total fixed costs remain unchanged within the relevant range in which the company is
currently operating.
a. What is the projected annual break-even sales in units?

b. What dollar amount of sales would Jorgenson need to achieve operating income of
$30,000?
c. If fixed costs increased $7,500, how many more units must be sold to break even?
5. A traditional break-even chart is illustrated below:
Identify each letter on the above chart, using the proper terminology.
6. Tress Enterprises manufactures shampoo and conditioner. Last year, Tress sold
120,000 bottles of product. Unit sales of conditioner amounted to 60% of the number of
units of shampoo. This trend is expected to continue. The selling price for both
products is $12.00, however, the variable cost of a unit of shampoo is $6.00, while the
variable cost of a unit of conditioner is $8.00. Fixed costs are expected to be $420,000.
(a) Compute the number of each product sold.

(b) Compute the weighted-average contribution margin per unit.
(c) Compute the overall break-even point in units.
(d) Compute the unit sales of shampoo and conditioner at the break-even point.
(e) Compute the dollar sales of shampoo and conditioner at the break-even point.
7. The Gaylord Company has sales of $800,000, variable costs of $400,000, and fixed
costs of $250,000.
Compute the following:

a. Contribution margin ratio
b. Break-even sales volume
c. Margin of safety ratio
d. Net income as a percentage of sales
8. Sherpa Manufacturing has the following income statement for 6,000 units:
Sales $600,000
Fixed costs 80,000
Net income $160,000
(a) At what sales volume (in sales dollars) does Sherpa break even?
(b) At what sales volume (in units) does Sherpa break even?
(c) Given the income statement above, compute the margin of safety.
(d) What level of sales volume must be attained to reach net income of $200,000?
(e) What level of sales volume must be attained to reach net income of $180,000,
assuming Sherpa had to pay income taxes at a rate of 40%?
9. Westwood Gear, Inc., recently received a special order to manufacture 10,000 units
for a Canadian company. This order specified that the selling price per unit should not
exceed $50. Since the order was received without the effort of the sales department, no
commission would be paid. However, an export handling charge of $5 per unit would be
incurred. Management anticipates that acceptance of the order will have no effect on
other sales.
The company is now operating at 80 percent of capacity, or 80,000 units, and expects to
continue at this level for the coming year without the Canadian order. Unit costs based
on estimated actual capacity for the coming year include:
Selling price $65.00

Expenses:
Direct labor 16.00
Sales commissions 5.00
Other marketing expenses (two-thirds variable) 3.00
General expenses (60% fixed) 5.00
Total $60.00
Prepare an analysis showing the effect on profits if the special order is accepted by the
company. Based on your analysis, should the order be filled, and why?
10. Busby Company needs 10,000 units of a certain part to use in its production cycle.
The following information is available:
Costs incurred by Busby to make the part:

Direct materials $15
Direct labor 12
Variable factory overhead 13
Fixed factory overhead 10
Total $50
Costs to buy the part from Thurco: $45
If Busby buys the part from Thurco instead of making it, Busby could not use the
released facilities in another manufacturing activity. However, twenty percent of the
fixed overhead would be avoided because one of the supervisors could be let go.
(a) In deciding whether to make or buy the part, what are the relevant costs that Busby
must consider.
(b) What decision should Busby make?
11. Hoctor Industries wishes to determine the profitability of its products and asks the
cost accountant to make a comparative analysis of sales, cost of sales and distribution
costs of each product for the year. The accountant gathers the following information
which will be useful in preparing the analysis:
Standard Deluxe
Number of units sold 500,000 350,000
Number of orders received 15,000 4,000
Selling price per unit $10 $20
Cost per unit $ 4 $12
Advertising expenses total $100,000, with 60% being expended to advertise the Deluxe
model. The representatives commissions are 5% and 7% for the standard and deluxe
models, respectively. The sales manager’s salary of $50,000 is allocated evenly
between products. Other miscellaneous selling costs are estimated to be $6 per order
received.
(a) Compute the selling cost per unit.

(b) Prepare an analysis for Hoctor Industries that will show in comparative form the
income derived from the sale of each unit for the year.

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CHAPTER 10—COST ANALYSIS FOR MANAGEMENT DECISION MAKING

PTS: 1 DIF: Easy REF: P. OBJ: 1

2. What costs are treated as product costs under direct costing?

PTS: 1 DIF: Moderate REF: P. OBJ: 1

4. Donellan Company produces a special gear used in automatic transmissions. Each

Direct material $9.00

Other costs: Variable Fixed

Direct materials $ 9.00

PTS: 1 DIF: Moderate REF: P. OBJ: 1

PTS: 1 DIF: Moderate REF: P. OBJ: 1

6. Which of the following is true about absorption costing?

PTS: 1 DIF: Moderate REF: P. OBJ: 1

PTS: 1 DIF: Moderate REF: P. OBJ: 1

Absorption costing considers fixed manufacturing costs to be an essential element of

PTS: 1 DIF: Moderate REF: P. OBJ: 1

PTS: 1 DIF: Moderate REF: P. OBJ: 1

10. A manager can increase income under absorption costing by

PTS: 1 DIF: Hard REF: P. OBJ: 1

PTS: 1 DIF: Hard REF: P. OBJ: 2

13. Absorption cost is required for:

PTS: 1 DIF: Easy REF: P. OBJ: 2

PTS: 1 DIF: Easy REF: P. OBJ: 3

PTS: 1 DIF: Easy REF: P. OBJ: 3

PTS: 1 DIF: Moderate REF: P. OBJ: 3

Contribution margin is defined as sales less variable costs.

PTS: 1 DIF: Easy REF: P. OBJ: 3

PTS: 1 DIF: Moderate REF: P. OBJ: 3

What was the contribution margin of the Audio Segment.

PTS: 1 DIF: Easy REF: P. OBJ: 3

What was the segment margin of the Video Segment.

PTS: 1 DIF: Moderate REF: P. OBJ: 3

21. Consider the Marshall Company’s segment analysis:

PTS: 1 DIF: Hard REF: P. OBJ: 3

PTS: 1 DIF: Easy REF: P. OBJ: 4

23. Break-even sales volume in units is determined by:

PTS: 1 DIF: Easy REF: P. OBJ: 4

PTS: 1 DIF: Hard REF: P. OBJ: 4

PTS: 1 DIF: Moderate REF: P. OBJ: 4

Break-even sales volume (units) = Fixed cost / Unit contribution margin

PTS: 1 DIF: Moderate REF: P. OBJ: 4

27. Consider the income statement for Pickbury Farm:

Break-even point in dollars = Fixed cost / contribution margin ratio

PTS: 1 DIF: Moderate REF: P. OBJ: 4

PTS: 1 DIF: Moderate REF: P. OBJ: 4

a. The sales line.

PTS: 1 DIF: Moderate REF: P. OBJ: 4

PTS: 1 DIF: Moderate REF: P. OBJ: 4

31. Franklin Company is a medium-sized manufacturer of bicycles. During the year a

Break-even sales $250,000

Sales to make $80,000 profit:

Sales = .60S + $100,000 (fixed) + $80,000 (profit)

.40S = $100,000 + $80,000

PTS: 1 DIF: Hard REF: P. OBJ: 4

Selling price $ 2.00

Fixed cost $100,000

PTS: 1 DIF: Moderate REF: P. OBJ: 4

34. Consider the income statement for Pickbury Farm:

At what sales level does Pickbury achieve net income of $100,000?

PTS: 1 DIF: Moderate REF: P. OBJ: 4

PTS: 1 DIF: Moderate REF: P. OBJ: 4

PTS: 1 DIF: Hard REF: P. OBJ: 4

1. by more than 12.5 percent, the break-even point would decrease.

To prove numerically, assume variable costs are $.20 per unit: