Professional Documents
Culture Documents
Advantages
1. Simplifies the record keeping and provides a better basis for accounting and
control of the total fixed costs incurred.
2. Appraisal of performance of product line or other segments of the business
can be facilitated without the need for arbitrary allocation of fixed overhead.
3. The income statement format is extremely useful for management purposes
like determining CVP relationships and profit planning.
4. Enhances relevant cost and pricing decisions.
Disadvantages
1. Variable costing may encourage a myopic approach to profit planning at the
expense of the long-term situations.
2. Variable costing is not acceptable for external and tax purposes.
3. Variable costing tends to give the impression that variable costs are
recovered first, that fixed costs are recovered later.
4. Costs are required to be separated into fixed and variable overhead. This can
be very difficult and often subject to individual judgment.
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 of fixed
manufacturing overhead.
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 be used
for internal reporting purposes.
16. Net income under variable costing is unaffected by changes in production levels.
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.
20. Sales mix is a measure of the percentage increase in sales from period to period.
21. Sales mix is not important to managers when different products have substantially
different contribution margins.
22. The weighted–average contribution margin of all the products is computed when
determining the breakeven sales for a multi-product firm.
23. If Conan Corporation sells two products with a sales mix of 75%-25%, and the
respective contribution margins are $100 and $300, then weighted-average unit
contribution margin is $150.
24. If fixed costs are $100,000 and weighted-average unit contribution margin is $50, then
the breakeven point in units is 2,000 units.
25. Net income can be increased or decreased by changing the sales mix.
26. The breakeven point in dollars is variable costs divided by the weighted-average
contribution margin ratio.
27. Cost structure refers to the relative proportion of fixed versus variable costs that a
company incurs.
28. Operating leverage refers to the extent to which a company’s net income reacts to a
given change in fixed costs.
29. The degree of operating leverage provides a measure of a company’s earnings volatility.
30. If O’Brien Company has a margin of safety ratio of .60, it could sustain a 60 percent
decline in sales before it would be operating at a loss.
Problems
Problem 1
Determine whether each of the following would be a product cost or a period cost under an
absorption or a variable system for Carson Company
Absorption Variable
Product Period Product Period
Problem 2
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
Fixed overhead $ 108,000
Variable overhead $ 3 per unit
Direct labor $ 12 per unit
Direct material $ 30 per unit
The portable cooking unit sells for $110. Management is interested in the opening month’s
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 2005.
b. Explain the amount by which absorption costing income would differ from variable costing
income. (Compute difference without computing absorption costing income)
Problem 3
Shell Corporation manufactures bottled vinegar. Data pertaining to the company’s 2009
operations follow:
Production for the year 90,000 units
Sales for the year (selling price per unit, P45) 97,500 units
Beginning 2009 inventory 17,500 units
Problem 4
Carlos has gone over the financial statement s of Primero, Inc. The income statement has
been prepared on an absorption costing basis and Carlos would like to have the statement
revised on a variable costing basis.
The company has a normal capacity of 1,200,000 units each year. Only one line of
product is manufactured, and the inventory is accounted for on a FIFO basis. In 2009,
the fixed factory overhead was P6,000,000. During the year, Primero, Inc. manufactured
1,100,000 units of product.
Primero, Inc
Income Statement
For the Year Ended December 31, 2009
Sales P20,700,000
Cost of goods sold:
Inventory, beginning P1,980,000
Current production 13,200,000
Goods available for sale 15,180,000
Inventory, ending 1,380,000 13,800,000
Gross margin P 6,900,000
Factory overhead capacity variance 500,000
Income from manufacturing P 6,400,000
=========
For the current year, 2010, plans have been made to manufacture 1,400,000 units of
product and sell 1,450,000 units. The unit variable cost and the selling price are
expected to be the same as they were last year. The normal capacity level will remain
unchanged but fixed factory overhead can be reduced to P5,400,000 for the year.
Required:
a. Recast the income statement for 2009 to place it on a variable costing basis.
b. Prepare an income statement for 2010 under the absorption costing basis.
c. Prepare another income statement for 2010 under the variable costing basis.
Problem 5
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
30,000 units for $10 per unit. George Harrison manages the division. He is considering
producing either 30,000 or 50,000 units during the period. Other information is presented in the
schedule.
Instructions
(a) Prepare an absorption costing income statement with one column showing the results if
30,000 units are produced, and one column showing the results if 50,000 units are produced.
(b) Why is income different for the two production levels, when sales is 30,000 units either way?
Problem 6
Norwood Corporation is considering changing its method of inventory valuation from absorption
costing to direct costing and engaged you to determine the effect of the proposed change on the
2012 income statements.
The corporation manufactures Gink, which is sold for P20 per unit. Marsh is added before
processing starts and labor and overhead are added evenly during the manufacturing process.
Production capacity is budgeted at 100,000 units of Gink annually. The standard costs per unit
of Gink are:
Marsh, 2 kilos P3.00 Variable Manufacturing overhead P1.00
Labor 6.00 Fixed Manufacturing overhead 1.10
A process cost system is used employing standard costs. Variances from standard costs are
now charged or credited to cost of goods sold. Inventory data for 2012 are as follows:
January 1 December 31
Finished goods in units 20,000 12,000
Transferred to finished goods during 2012, 110,000 units
Actual fixed manufacturing overhead during the year was P121,000. There were no variances
between standard variable costs and actual variable costs during the year. There was no work-
in-process in the beginning and end of the period.
Required:
At the beginning of 2012, the president of Sun Company presented the budget to the parent
company and accepted a commitment to contribute $15,000 to Guardian’s consolidated profit in
2012. The president has been confident that the year’s profit would exceed the budget target,
since the monthly sales reports that he has been receiving have shown that sales for the year
will exceed budget by 10%. The president is both disturbed and confused when the controller
presents an adjusted forecast as of November 30, 2012, indicating the profit will be 11% under
budget.
Sun Cmpany
Forecast of Operating Results
FORECASTS AS OF
1/1/2012 11/30/2012
Sales $268,000 $294,800
Cost of sales at standard 212,000* 233,200
Gross margin at standard 56,000 61,600
Over-(Under) absorbed fixed
Manufacturing overhead (6,000)
Actual gross margin $ 56,000 $ 55,600
Selling expenses 13,400 14,740
Administrative expenses 26,800 26,800
Total operating expenses $ 40,200 $ 41,540
Earnings before tax $ 15,800 $ 14,060
======= =======
There have been no sales price changes or product-mix shifts since the 2012 forecast. The only
cost variance on the income statement is the underabsorbed manufacturing overhead. This
arose because the company produced only 16,000 standard machine-hours (budgeted
machine-hours were 20,000) during 2012 as a result of a shortage of raw materials while its
principal supplier was closed by a strike. Fortunately, Sun Company’s finished goods inventory
was large enough to fill all sales orders received.
Required:
1. Analyze and explain why the profit has declined in spite of increased sales and good
control over costs. Show computations
2. What plan, if any could Sun Company adopt during December to improve its reported
profit at year-end? Explain your answer.
3. Illustrate and explain how Sun Company could adopt an alternative internal cost-
reporting procedure that would avoid the confusing effect of the present procedure.
Show the revised forecasts under your alternative.
4. Would the alternative procedure described in No. 3 be acceptable to Guardian, Inc., for
financial reporting purposes? Explain.
Problem 8
The Lyon Company stresses competition between the heads of its various divisions, and it
rewards stellar performance with year-end bonuses that vary between 5% and 10% of division
net operating income (before considering the bonus or income taxes). The divisional managers
have great discretion in setting production schedules.
The Normandy Division produces and sells a product for which there is a long-standing demand
but which can have marked seasonal and year-to-year fluctuations. On November 30, 2012,
Pierre Lablanc, the Normandy Division manager, is preparing a production schedule for
December. The following data available for January 1 through November 30 (FF means French
Franc):
Beginning inventory, January 1, in units 10,000
Sales price, per unit FF500
Total fixed costs incurred for manufacturing FF11,000,000
Total fixed costs, other (not inventoriable) FF 11,000,000
Total variable costs for manufacturing FF 22,000,000
Total other variable costs FF 5,000,000
Units produced 110,000
Units sold 100,000
Variances None
Production in October and November was 10,000 units each month. Practical capacity is
12,000 units per month. Maximum available storage for inventory is 25,000 units. The sales
outlook, for December through February, is 6,000 units monthly. To retain a core of key
employees, monthly production cannot be scheduled at less than 4,000 units without special
permission from the president. Inventory is never to be less than 10,000 units.
The denominator used for applying fixed factory overhead is regarded as 120,000 units
annually. The company uses a standard absorption-costing system. All variances are disposed
of at year-end as an adjustment to standard cost of goods sold.
Required:
1. Given the restrictions as stated, and assuming that the manager wants to maximize the
company’s net income for 2012:
a. How many units should be scheduled for production in December
b. What net operating income will be reported for 2012 as a whole, assuming that the
implied costs behavior patterns will continue in December as they did throughout the
year to date? Show computations.
c. If December production is scheduled at 4,000 units, what would reported net income
be?
2. Assume that standard direct costing is used rather than standard absorption costing:
a. What would net income for 2012 be, assuming that the December production
schedule is the one in Requirement 1, part a?
b. Assuming that production was 4,000 units?
c. Reconcile the net income in this requirement with those in Requirement 1.
3.
The statements to which Ms. Gale was referring are shown below:
July August September
Sales (@ P25) P 1,750,000 P 1,875,000 P 2,000,000
Less: Cost of goods sold:
Beginning inventory 80,000 320,000 400,000
Cost applied to production:
Variable manufacturing costs 765,000 720,000 540,000
Fixed manufacturing overhead 595,000 560,000 420,000
Cost of goods manufactured 1,360,000 1,280,000 960,000
Goods available for sale 1,440,000 1,600,000 1,360,000
Les: Ending Inventory 320,000 400,000 80,000
Cost of goods sold 1,120,000 1,200,000 1,280,000
Under(over) applied fixed overhead (35,000) - 140,000
Adjusted cost of goods sold 1,085,000 1,200,000 1,420,000
Gross margin 665,000 675,000 580,000
Less: Selling and Administrative Expenses 620,000 650,000 680,000
Net income (loss) P 45,000 P 25,000 (100,000)
Harry Harp, a new graduate form a state university who has just been hired by Warner, has stated to
Ms. Gale that the contribution margin approach, with variable costing, is much better way to report
profit data to management. Sales and production data for the last quarter follow:
July August September
Production in units 85,000 80,000 60,000
Sales in units 70,000 75,000 80,000
Additional information about the company’s operations is given below:
a. Five thousand units were in inventory on July 1.
b. Fixed manufacturing overhead costs total P1,680,000 per quarter and are incurred evenly
throughout the quarter. This fixed manufacturing overhead cost is applied to units of product on
the basis of a budgeted production volume of 80,000 units per month.
c. Variable selling and administrative expenses are P6 per unit sold. The remainder of the selling
and administrative expenses on the income statements above are fixed.
d. The company uses a FIFO inventory flow assumption. Work in process inventories are
insignificant and can be ignored.
“I know production is somewhat out of step with sales”’ said Karla Cortes, the company’s controller.
“But we had to build inventory early in the quarter in anticipation of a strike in September. Since the
union settled without a strike, we then had to cut back production in September in order to work off
the excess inventories. The income statements you have are completely accurate”.
Required:
1. Without preparing the income statements, compute the income for each month using the
variable costing.
2. Compute the monthly break-even point under variable costing.
3. Explain to Ms. Gale why profits have moved erratically over the three-month period shown in
the absorption costing statements above and why profits have not been more closely related to
changes in sales volume.
4. Reconcile the variable costing and absorption costing net income (loss) figures for each month.