To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 Measuring and Assigning Costs for Income Statements LEARNING OBJECTIVES Chapter 14 addresses the following questions: Q1 How are absorption costing income statements constructed? Q2 What factors affect the choice of production volume measures for allocating fixed overhead? Q3 How are variable costing income statements constructed? Q4 How are throughput costing income statements constructed? Q5 What are the uses and limitations of absorption, variable, and throughput costing income statements? These learning questions (Q1 through Q5) are cross-referenced in the textbook to individual exercises and problems COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook This question requires students to extend knowledge beyond the applications e shown in the textbook Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):  Step skills (Identifying)  Step skills (Exploring)  Step skills (Prioritizing)  Step skills (Envisioning) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-2 Cost Management QUESTIONS 14.1 The three methods are similar because they assign some costs to inventory as product costs, and expense other costs as period costs The three methods differ in the categories that are used for product and period costs Details of these categorizations follow Absorption costing allocates all production costs, both fixed and variable, to units as product costs so cost of goods sold and inventory on the balance sheet include fixed manufacturing costs Cost of goods sold is subtracted from revenue to arrive at gross margin, and then other nonmanufacturing expenses are subtracted to arrive at operating income Variable costing assigns direct costs (direct labor and direct materials) and variable overhead costs to inventory and variable cost of goods sold Variable cost of goods sold and all other non-manufacturing variable costs are subtracted from revenue to arrive at contribution margin All fixed costs, both manufacturing and non-manufacturing, are then subtracted from contribution margin to arrive at operating income Throughput costing assigns only direct materials costs to inventory and throughput cost of goods sold Throughput cost of goods sold is subtracted from revenue to arrive at throughput margin All other costs are considered period costs and deducted from throughput margin to arrive at operating income Uses of the three methods are different, also Absorption costing income statements meet GAAP and are used by shareholders and other external stakeholders Variable costing income statements generally not meet GAAP and are only available for internal reporting Information from these reports is used in decision-making Throughput accounting income statements provide information for very short-term decisions and are especially helpful when capacity constraints exist 14.2 The allocated fixed manufacturing overhead that is added (if production is greater than sales) or subtracted (if production is less than sales) from finished goods is the reconciliation amount between variable versus absorption costing 14.3 The volume variance arises because of differences between actual volumes and budgeted volumes used to allocate fixed manufacturing overhead Under variable costing all fixed manufacturing overhead is treated as a period expense; there are no allocations of fixed manufacturing overhead to inventory or variable cost of goods sold Hence, there will be no volume variances 14.4 Under variable costing, all fixed manufacturing overhead is treated as an expense of the period, regardless of how many units were produced or sold; income will vary only with the number of units sold, the level of production has no effect Under absorption costing, fixed manufacturing overhead is first assigned to product; the amount of fixed overhead that appears on the income statement depends on unit sales Income depends upon both the level of production and the level of sales To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-3 14.5 Eventually all of the units are sold under either method, so eventually all of the fixed manufacturing cost will be expensed under either method Under variable costing, it is expensed during the period it is incurred, whereas under absorption costing, a portion of fixed manufacturing cost is inventoried and expensed when the inventory is sold rather than during the period it was incurred 14.6 A variable cost increases proportionately with volume Variable costing is a method of calculating income 14.7 Unless the organization is not-for-profit, none For most on-going, profit-seeking firms, denominator volume should exceed breakeven volume because the firm plans to be operating at volumes greater than breakeven 14.8 The fixed manufacturing overhead of the current period will be shown in its entirety as an expense if variable costing is used If absorption costing is used, some of it will be assigned to the units added to inventory, so that the fixed manufacturing overhead included in cost of goods sold will be less than the total fixed manufacturing overhead that is expensed on the variable costing income statement 14.9 GAAP requires absorption costing to match production-related expenses to revenues 14.10 This can be accomplished through the use of an adjusting journal entry at the end of the period The objective is to distribute or allocate the fixed manufacturing overhead of the period between inventories on hand (WIP and FG) and cost of goods sold 14.11 A joint cost may be either fixed or variable and a separable cost may be either fixed or variable Both variable and absorption costing can be applied to joint product situations Under variable costing, the joint costs are first categorized as fixed or variable and then listed on the income statement under the headings of variable or fixed production costs Under absorption costing, the common and separable costs are considered product costs and assigned to inventory To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-4 Cost Management EXERCISES 14.12 Famous Desk Company A and B First list all pertinent information: Revenue = 220 desks x $300 = $66,000 Variable production costs = 220 desks x $80 = $17,600 Variable selling and administrative costs = 220 desks x $30 = $6,600 Fixed selling and administrative = $6,000 Fixed overhead absorbed into inventory under normal production = $10,000/150 desks = $66.67 per desk Fixed overhead volume variance = $10,000 – (200 desks x $66.67) = $3,334 overapplied, which is closed to COGS Variable Costing Absorption Costing Revenue Variable costs: Production Selling Contribution Margin $66,000 Revenue Cost of goods sold (17,600) 220 desks x ($80 + $66.67) (6,600) Volume variance 41,800 Gross Margin Fixed costs: Production Admin and Sales Operating income Selling and administrative (10,000) ($6,600 + $6,000) (6,000) Operating income $25,800 $66,000 (32,267) 3,334 37,067 (12,600) $24,467 Double-check calculations: Difference in operating income = 20 units x $66.67 = $1,333 (fixed overhead brought onto income statement from units produced in prior periods) Difference in income = $25,800 - $24,467 = $1,333 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-5 14.13 Rock Crusher Corp A sample spreadsheet showing the calculations for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) A Variable costing income statement VARIABLE COSTING Variable cost per unit produced Revenue Variable costs: Production: A100 A300 Selling Contribution margin Fixed costs: Production: Selling and administrive Operating income A100 $5.00 A300 $2.50 $240,000 $15,000 10,000 (25,000) (35,000) 180,000 (100,000) (60,000) $20,000 Computation details for variable production cost per unit: A100: $20,000/4,000 tons = $5 per ton A300: $15,000/6,000 tons = $2.50 per ton B Absorption costing income statement: ABSORPTION COSTING Fixed production cost per ton Total production cost per ton: A100 A300 Revenue Cost of goods sold: A100 A300 Gross margin Selling and administrative: Variable Fixed Operating income $10.00 $15.00 $12.50 $240,000 $45,000 50,000 $35,000 60,000 (95,000) 145,000 (95,000) $50,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-6 Cost Management Calculation details for cost of goods sold: Fixed production cost per ton = $100,000/10,000 tons = $10 per ton Variable production cost per ton was calculated in Part A Cost of goods sold: A100 [($10+$5) x 3,000] $45,000 A300 [($10+$2.50) x 4,000] 50,000 Total $95,000 C The difference in income resides in inventory There was no beginning inventory, but there were 3,000 tons (10,000 tons produced – 7,000 tons sold) with $10 of fixed production cost per ton absorbed into inventory on the balance sheet under absorption costing The difference in income = $50,000 - $20,000 = $30,000, and the fixed production cost in inventory is 3,000 x $10 = $30,000 14.14 Plains Irrigation A The value of inventory is higher when absorption costing is used because some fixed manufacturing overhead is allocated to inventory to match revenue with expense at the time of sale If there is fixed manufacturing overhead, the value of inventory under absorption costing will always be higher than under variable costing B To identify the costing method that would result in higher income, first calculate the change in inventory during October under both methods: October inventory added under absorption costing ($2,598-$1,346) October inventory added under variable costing ($1,647-854) Difference $1,252 793 $ 459 Because $459 more cost was assigned to inventory under absorption costing, income during October would be higher by $459 under absorption than under variable costing 14.15 Asian Iron A Under variable costing: Total variable production cost = (NT$2,300 + 3,300 + 2,800) = NT$8,400 Variable cost per unit = NT$8,400/10,500 = NT$0.80 per unit Units in ending inventory = 10,500 – 9,400 = 1,100 units Ending inventory = NT$0.80 x 1,100 units = NT$880 Under absorption costing: Fixed manufacturing overhead = NT$8,250/10,500 units = NT$0.7857 per unit Total cost per unit = NT$0.80 + NT$0.7857 = NT$1.5857 Ending inventory = NT$1.5857 x 1,100 units = NT$1,744 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-7 Under throughput costing: Total direct materials cost per unit = NT$2,300/10,500 units = NT$0.21905 Ending inventory = NT$0.21905 x 1,100 units = NT$241 B.1, 2, Variable Costing Absorption Costing Throughput Costing Revenue NT$32,900 Variable costs: Production (NT$0.80 x 9,400) (7,520) Selling (940) Contribution margin 24,440 Fixed costs: Production (8,250) Selling and admin (14,560) Operating income NT$ 1,630 Revenue NT$32,900 Cost of goods sold (NT$1.5857 x 9,400) (14,906) Gross margin 17,994 Selling and admin (NT$940 + 14,560) (15,500) Operating income NT$ 2,494 Revenue NT$32,900 Direct materials (NT$0.21905 x 9,400) (2,059) Throughput margin 30,841 Operating expenses (a) (29,850) Operating income NT$ 991 (a) NT$(3,300 + 2,800 + 940 + 8,250 + 14,560) = NT$29,850 Double-check computations for absorption versus variable costing: There were no beginning inventories Therefore, the change in inventory is equal to the ending inventory (calculated in Part A) Inventory under absorption costing NT$1,744 Inventory under variable costing 880 Difference in inventory NT$ 864 Difference in operating income - NT$2,494 - NT$1,630 NT$ 864 Double-check computations for absorption versus throughput costing: Inventory under absorption costing Inventory under throughput costing Difference in inventory NT$1,744 241 NT$1,503 Difference in operating income - NT$2,494 - NT$991 NT$1,503 C It is first necessary to calculate the revenue and variable costs per unit: Revenue per unit = NT$32,900/9,400 = NT$3.50 Variable production cost per unit = NT$0.80 Variable selling cost per unit = NT$940/9,400 = NT$0.10 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-8 Cost Management There are several ways to estimate variable costing operating income at 12,110 units One way is to prepare an estimated income statement: Revenue (12,110 x $3.50) Variable costs: Production (12,110 x NT$0.80) Selling (12,110 x NT$0.10) Contribution margin Fixed costs: Production Selling and administrative Operating income NT$42,385 (9,688) (1,211) 31,486 (8,250) (14,560) NT$ 8,676 Another way is to begin with operating income at 9,400 units (calculated in Part B) and add the incremental contribution margin for the additional 2,710 units (12,110 – 9,400): Operating income at 9,400 units Incremental contribution margin [2,710 x (NT$3.50 – 0.80 – 0.10)] Operating income at 12,110 units NT$1,630 7,046 NT$8,676 14.16 Wild Bird Feeders A sample spreadsheet showing the calculations for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) A and B Absorption and variable costing ending inventory The problem does not provide the company’s cost flow assumption (LIFO or FIFO) However, the problem states that the prior costs are the same as 2004 planned costs The 2004 actual costs for direct materials, direct labor, and variable manufacturing overhead are the same as the planned costs (i.e., $3,120,000/130,000 units = $24.00 for direct materials, $2,340,000/130,000 units = $18.00 for direct materials, and $520,000/130,000=$4.00 for variable manufacturing overhead) The problem also states that all over- or underapplied overhead is assigned directly to cost of goods sold Therefore, the 2004 overhead costs assigned to inventory are the same as the planned costs Thus, the prior year inventory costs are the same as the current year inventory costs, and it does not matter which cost flow assumption the company uses To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-9 COST OF ENDING INVENTORY Production cost per unit: Direct materials (actual) Direct labor (actual) Variable manufacturing overhead (allocated=actual) Fixed manufacturing overhead (allocated) Total Units: Beginning inventory Production Sales Ending inventory 2003 Absorption Variable Costing Costing $24.00 $24.00 18.00 18.00 4.00 4.00 5.00 $51.00 $46.00 2004 Absorption Variable Costing Costing $24.00 $24.00 18.00 18.00 4.00 4.00 5.00 $51.00 $46.00 30,000 130,000 (125,000) 5,000 35,000 Cost of ending inventory Assuming FIFO $1,785,000 $1,610,000 Cost of ending inventory Assuming LIFO Beginning inventory Increase in inventory Total $1,530,000 255,000 $1,785,000 $1,380,000 230,000 $1,610,000 C Manufacturing and total contribution margin VARIABLE COSTING Revenue Variable production costs Manufacturing contribution margin Other variable costs: Variable selling Variable administrative Total contribution margin Fixed costs: Manufacturing overhead Selling Administrative Operating income $12,375,000 (5,750,000) 6,625,000 $1,750,000 125,000 $710,000 980,000 850,000 (1,875,000) 4,750,000 (2,540,000) $2,210,000 D This question asks for the total fixed costs on the income statement and then proceeds to develop that cost in steps as follows Fixed selling and administration = ($980,000 + $850,000) = $1,830,000 Fixed manufacturing overhead allocated to COGS: Fixed overhead at given allocation rate (125,000 x $5) $625,000 As noted in the answer to Parts A and B, the cost per unit during 2003 was the same as the cost per unit assigned to inventory during 2004 Therefore, the cost per unit assigned to cost of goods sold and to inventory is not affected by whether the company’s inventory levels increased or decreased during 2004 In other words, sales of units that were produced last year not need to be considered Calculation of overapplied (underapplied) overhead: Overhead allocated to production Actual overhead (Underapplied) overhead $650,000 710,000 $ (60,000) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-10 Cost Management Total fixed costs on income statement = $1,830,000 + $625,000 + $60,000 (because the underapplied overhead is closed to COGS) = $2,515,000 E Variable costs on variable costing income statement (see the solution to Part C): $5,750,000 + $1,875,000 = $7,625,000 F Absorption income would be higher than variable income because the company produced more units that it sold, and the units remaining in ending inventories include an allocation of fixed manufacturing overhead cost under absorption costing Therefore, total overhead expense on the income statement is less under absorption than under variable costing, where the total fixed cost for the period is expensed G There are two ways to answer this question The first method is to calculate the amount of fixed overhead added to inventory under absorption costing The fixed overhead allocation rate is $5 per unit, and 5,000 units were added to inventory Therefore, absorption costing income should be $25,000 higher than variable costing income The second method is to prepare the two income statements and compare the results The difference in income is (income statements are available on the sample spreadsheet for this problem): Absorption costing operating income $2,235,000 Variable costing operating income 2,210,000 Difference $ 25,000 14.17 Happy Bikers Motorcycle Company A, B, C Variable Costing Revenue (a) Variable costs: Production (b) Selling (c) Contribution margin Fixed costs: Production Selling and admin Operating income $150,000 (45,000) (3,750) 101,250 Absorption Costing Revenue (a) Cost of goods sold (d) Volume variance (e) Gross margin Selling and admin (f) Operating income $150,000 (105,000) 26,667 71,667 (43,750) $ 27,917 Throughput Costing Revenue (a) Raw materials (g) Throughput margin Operating expenses (h) Operating income $150,000 (30,000) 120,000 (101,750) $ 18,250 (40,000) (40,000) $ 21,250 Calculation details: (a) Revenue = 15 motorcycles x $10,000 (b) Variable production costs = 15 motorcycles x ($2,000 + $1,000) = $45,000 (c) Variable selling and administrative costs = 15 motorcycles x $250 = $3,750 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-13 Variable costing income statements: 2004 2005 2006 €10,000,000 €4,000,000 €10,000,000 Revenues (jets sold x €1,000,000) Variable costs: Production (jets sold x €200,000 + €150,000 + €50,000) (4,000,000) (4,000,000) (1,000,000) Selling (jets sold x €100,000) (1,000,000) Contribution margin Fixed costs: Production Administrative and selling (100,000) Operating income 4,300,000 5,000,000 5,000,000 (1,600,000) (400,000) 2,000,000 (600,000) (100,000) (600,000) (600,000) (100,000) € 4,300,000 €1,300,000 € B Throughput costing income statements: 2004 Revenues (jets sold x €1,000,000) Direct materials (jets sold x €200,000) (2,000,000) Throughput margin Operating expenses: Direct labor (jets produced x €150,000) Variable production overhead (jets produced x €50,000) Variable selling (jets sold x €100,000) Fixed production overhead Fixed administrative and selling (100,000) Operating income 4,700,000 2005 2006 €10,000,000 €4,000,000 €10,000,000 (2,000,000) (800,000) 8,000,000 8,000,000 3,200,000 (1,500,000) (900,000) (1,200,000) (500,000) (1,000,000) (1,000,000) (600,000) (100,000) (300,000) (400,000) (400,000) (600,000) (600,000) (100,000) € 4,300,000€ 900,000 € C Cost per jet under absorption costing: Direct materials Direct labor Variable production overhead Fixed production overhead per unit: €600,000/units produced Total cost per jet 2004 €200,000 150,000 50,000 2005 €200,000 150,000 50,000 2006 €200,000 150,000 50,000 60,000 €460,000 100,000 €500,000 75,000 €475,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-14 Cost Management Jets sold Jets produced 10 10 Cost of goods sold: Units produced this year €4,600,000 €3,800,000 €4,600,000 €4,800,000 Units produced last year Total 10 €2,000,000 1,000,000 €2,000,000 Absorption costing income statements: 2004 Revenues (jets sold x €1,000,000) Cost of goods sold (4,800,000) Throughput margin Administrative and selling [€100,000 + (jets sold x €100,000)] (1,100,000) Operating income 4,100,000 2005 2006 €10,000,000 €4,000,000 €10,000,000 (4,600,000) (2,000,000) 5,400,000 5,200,000 (1,100,000) € 4,300,000 2,000,000 (500,000) €1,500,000 € D Normal capacity is an average capacity over time It represents the volume of production that is expected to occur in a typical year E There are likely to be differences of opinion on the normal volume One way to estimate the normal volume is to calculate the average over the three years presented, or jets per year The following income statement is calculated using jets as the normal volume Cost per jet under absorption costing: Direct materials Direct labor Variable production overhead Fixed production overhead per unit: €600,000/8 jets Total cost per jet €200,000 150,000 50,000 75,000 €475,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-15 Volume variance: Jets produced Fixed production overhead allocated Actual fixed production overhead Over (under)applied overhead 2004 2005 2006 10 €750,000 € 450,000 €600,000 600,000 600,000 600,000 €150,000 €(150,000) € The volume variance does not appear to be material relative to total production costs in 2004 or 2005 Therefore, all of it is allocated to cost of goods sold Absorption costing income statements: 2004 Revenues (jets sold x €1,000,000) Cost of goods sold (jets sold x €475,000) Volume variance adjustment Throughput margin Administrative and selling [€100,000 + (jets sold x €100,000)] (1,100,000) Operating income 4,150,000 2005 2006 €10,000,000 €4,000,000 €10,000,000 (4,750,000) (1,900,000) (4,750,000) 150,000 (150,000) 5,400,000 5,250,000 (1,100,000) € 4,300,000 1,950,000 (500,000) €1,450,000 € F The textbook is not clear about which absorption costing income (the one in Part C or the one in Part E) to use in the reconciliation Therefore, reconciliations are shown for both income statements 2004 2005 2006 Jets produced 10 Jets sold 10 10 Increase (decrease) in inventory of jets (2) Throughput costing income (Part B) Direct labor and variable production overhead added to (subtracted from) ending variable costing inventory [Change in inventory x (€150,000+€50,000)] Variable costing income (Part A) Fixed overhead costs allocated to ending absorption costing income Change in inventory x €100,000 (200,000) Absorption costing income (Part C) 4,100,000 €4,300,000€ 900,000€4,700,000 4,300,000 4,300,000 400,000 (400,000) 1,300,000 200,000 € 4,300,000 €1,500,000 € To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-16 Cost Management €4,300,000 €4,300,000 Variable costing income (Part A) Fixed overhead costs allocated to ending absorption costing income Change in inventory x €75,000 (a) (150,000) Absorption costing income (Part E) 4,150,000 €1,300,000 150,000 € 4,300,000 €1,450,000 € (a) Because the volume variance was allocated 100% to cost of goods sold during 2004 and 2005, it can be ignored in this reconciliation 14.20 Fighting Kites A, B, and C Product costs: Direct materials Other variable production costs Fixed production costs (a) Total product costs Variable Throughput Absorption $ 40,000 $40,000 $ 40,000 60,000 60,000 80,000 $100,000 $40,000 $180,000 (a) Absorption costing fixed production rate: $100,000/25,000 kits = $4 per kit Fixed production cost allocated to kits produced: $4 x 20,000 kits = $80,000 Cost per kit (20,000 produced) $5 Cost for 18,000 kits sold (assuming LIFO) Cost for 2,000 kits added to inventory Total product costs Variable Costing Revenue (a) Variable costs: Production (above) Selling Contribution margin Fixed costs: Production Selling and admin Operating income $540,000 (90,000) (18,000) 432,000 $ 90,000 10,000 $100,000 Throughput Costing Revenue (a) Raw materials (above) Throughput margin Operating expenses (b) Operating income (100,000) (100,000) $232,000 Calculation details: (a) Revenue = 18,000 kits x $30 = $540,000 $2 $540,000 (36,000) 504,000 (278,000) $226,000 $36,000 4,000 $40,000 $9 $162,000 18,000 $180,000 Absorption Costing Revenue (a) $540,000 Cost of goods sold (above) (162,000) Volume variance (c) (18,000) Gross margin 360,000 Selling and admin (d) (118,000) Operating income $242,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-17 (b) Throughput costing operating expenses: Other variable production costs Fixed production costs Variable selling costs Fixed selling and administrative costs Total (c) Volume variance: Fixed production cost allocated ($4 x 20,000 kits) Actual fixed production cost (Underallocated) fixed production costs $ 60,000 100,000 18,000 100,000 $278,000 $ 80,000 100,000 $ (20,000) Because the volume variance is material, it is prorated between cost of goods sold and ending inventory: Cost of goods sold ($20,000 x 18,000/20,000 kits) $(18,000) Ending inventory ($20,000 x 2,000/20,000 kits) (2,000) Total volume variance adjustment $(20,000) (d) Selling and administrative: Variable selling costs $ 18,000 Fixed selling and administrative costs 100,000 Total $118,000 Although the problem does not ask for a reconciliation of income across the three methods, it is useful to prepare a reconciliation to double-check the preceding computations: Throughput costing operating income Direct labor and variable overhead costs added to ending variable costing inventory ($60,000 x 2,000/20,000 kits) Variable costing operating income Fixed overhead costs allocated to ending absorption costing income (after the volume variance adjustment, this is equal to actual fixed overhead cost per unit $100,000 x 2,000/20,000 kits Absorption costing operating income $226,000 6,000 232,000 10,000 $242,000 D Student answers to this question should demonstrate that they have considered how the managers might use the absorption costing information, and they should also clarify their assumptions If the managers’ primary goal in using absorption costing is to assign actual costs to inventory as accurately as possible, then next year’s expected production volume should be used as the denominator value If demand and production volumes are expected to remain at 20,000, then a volume of 20,000 would be appropriate If production volumes are not stable, then next year’s volume could be estimated using sales forecasts for next year and/or production volumes over several past years On the other hand, the managers may wish to monitor use of capacity, particularly if production volumes vary In that case, a volume such as practical capacity might be best To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-18 Cost Management E Student responses will vary Following is an example of a good response I recommend that Fighting Kites use variable income or throughput income because both of these methods provide less incentive to build up inventories and more incentive to control fixed and overhead costs In addition, these statements provide information about current period costs to those individuals charged with evaluating managers’ performance The variable income statement displays fixed and variable, production and nonproduction costs in such a manner that they are easily compared across time for meaningful performance evaluation For example, if manufacturing fixed costs are considerably higher or lower in one period than in the prior periods, this information would be easy to identify and managers could be rewarded or encouraged to control costs better In addition, the information from both variable and throughput costing income statements is broken down into categories that are useful for decision-making When Fighting Kites needs to make a short or long term production decision, the variable costing income statement provides ample relevant information When capacity constraints exist, throughput costing information may be better If Fighting Kites guarantees its direct labor employees a 40-hour work week, then throughput costing information provides the best information for decision-making 14.21 Security Vehicles A Variable costing income statement for January: Revenue (3 vehicles x $100,000) Variable costs: Production (3 vehicles x $60,000) Administrative and selling (3 vehicles x $5,000) Contribution margin Fixed costs: Production Administrative and selling Operating income B Absorption costing income statement for January: Revenue (3 vehicles x $100,000) Cost of goods sold (a) Gross margin Operating expenses: Administrative and selling ($20,000 + $5,000 x vehicles) Operating income $300,000 (180,000) (15,000) 105,000 (60,000) (20,000) $ 25,000 $300,000 (225,000) 75,000 (35,000) $ 40,000 (a) Absorption cost per unit (assuming that fixed costs are allocated based on actual costs and actual production volume): Variable production costs $60,000 Fixed production costs ($60,000/4 vehicles) 15,000 Total absorption cost per unit $75,000 Cost of goods sold (3 vehicles x $75,000) $225,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-19 C This question calls for a reconciliation of February incomes under variable and absorption costing First calculate February income under these two methods: Variable Costing Revenue (6 x $100,000) Variable costs: Production (6 x $60,000) Selling (6 x $5,000) Contribution margin Fixed costs: Production Administrative and selling Operating income Absorption Costing $600,000 Revenue (6 x $100,000) $600,000 Cost of goods sold (a) (435,000) (360,000) Gross margin 165,000 (30,000) Administrative and selling 210,000 ($20,000 + $5,000 x vehicles) (50,000) Operating income $115,000 (60,000) (20,000) $130,000 Computation details: (a) Absorption cost per unit (assuming that fixed costs are allocated based on actual costs and actual production volume): Variable production costs $60,000 Fixed production costs ($60,000/5 vehicles) 12,000 Total absorption cost per unit during February $72,000 Cost of goods sold: Vehicles produced during February (5 vehicles x $72,000) Vehicle produced during January (1 vehicle x $75,000) Total $360,000 75,000 $435,000 C In February, under absorption cost income, one Hummer was sold from January’s production In January, overhead allocated to production was $15,000, so February’s income under absorption costing is $15,000 less than variable costing D An organization could produce absorption cost income statements for external users such as shareholders, creditors, and suppliers For internal decision-making information, variable cost income statements could be produced 14.22 Northcoast Manufacturing Company [Note: Parts B and C require students to use and evaluate overhead allocation methods introduced in Chapters and 11.] A Among the budgeted levels of activity presented in the problem, the one closest to the actual production of 500,000 units is for 540,000 units of production Based on this budgeted level of activity, the amount of over/underapplied overhead is calculated as follows: To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-20 Cost Management Estimated overhead allocation rate = Total budgeted overhead/budgeted direct labor cost = $961,200/(36,000 x $15) = 178% of direct labor cost Allocated overhead [(35,000 x $15) x 178%] Actual incurred overhead Overapplied (Underapplied) Overhead $ 934,500 1,130,000 $ (195,500) This amount is material because it is over 11% of COGS ($195,500/$1,720,960) B If machine hours were used, the amount of over/underapplied overhead would have been: Overhead allocation rate $961,200/108,000 machine hours = $8.90 per machine hour Allocated overhead ($8.90 x 130,000 machine hours) Actual incurred overhead Overapplied (Underapplied) Overhead $1,157,000 1,130,000 $ 27,000 C Machine hours would be a more appropriate allocation base for Northcoast Manufacturing’s fixed manufacturing overhead because the company appears to have a capital-intensive manufacturing process where each direct laborer operates two to four machines simultaneously In this type of setting, the use of machines drives a large portion of overhead costs, such as depreciation, maintenance, and utilities Consequently, using machine hours as the allocation base results in more reliable cost information and better decisions D If units are used as the denominator volume, managers can shift costs from the income statement to the balance sheet by producing more inventory than is sold Each unit of inventory carries with it a portion of fixed cost that is booked as an asset (inventory) on the balance sheet and so fixed overhead cost is not completely expensed for the accounting period 14.23 GameZ A Three choices are available for income statement formats, absorption costing, variable costing, and throughput costing Absorption costing meets GAAP standards and is used for income statements required by banks and creditors Variable and throughput costing income statements produce detailed information that can be used in decision-making B Absorption costing matches revenues with expenses under accrual accounting Because this is required for GAAP, these statements are appropriate for external reports to creditors and shareholders Variable costing separates costs into fixed and variable categories and expenses all fixed costs as period costs Income levels are not affected by changes in inventory levels so managers have no incentive to manipulate inventory when To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-21 income is reported using variable costing The same advantages and disadvantages apply to absorption costing C As mentioned above, the bank and other creditors will want the absorption income statement, but the brother will want information produced by either the variable cost or throughput income statements Variable cost statements provide more detail than throughput costing so variable income statements would likely be preferred for developing information for decision-making For compensation purposes, variable or throughput income statements are best because income is less subject to manipulation through inventory level adjustments 14.24 Palm Producers A San Jose plant manager’s bonus = 5% of $12,646 = $632.30 Singapore plant manager’s bonus = 5% of $5,791 = $289.55 Each plant manager would prefer higher income to receiver higher bonus amounts B For the San Jose plant, sales increase but cost of goods sold decreases Either cost reductions were instituted or there was a build-up of inventory over the period, which would reduce the amount of fixed overhead in cost of goods sold C If variable costs are immaterial, the difference in inventory amounts between the last two quarters is assumed to be expense that is on the balance sheet instead of on the income statement San Jose Plant Singapore Plant Fourth quarter income $12,646 $5,791 Change in inventory (18,100) (2,508) Variable costing income $ (5,454) $3,283 D I would conclude that the San Jose plant manager’s performance was poor during the last quarter of the year, and certainly not as good as the performance of the Singapore plant manager E There is no one answer to this part Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-22 Cost Management BUILD YOUR PROFESSIONAL COMPETENCIES 14.25 Focus on Professional Competency: Communication The answers below provide suggestions for improved communication Additional ideas can be found in the following article: Jim Cole, “Speak English Please! How to Communicate Financial Information to Non-Accountants,” SmartPros, October 2004, available at www.smartpros.com/x44566.xml A Here are a few ideas for improving the conciseness and clarity of written and spoken communications; students may think of others Practice eliminating unnecessary words Re-read what you have written and remove words or phrases that not add meaning Think of ways to say the same thing with fewer words Reflect on phrases or sentences you have spoken and identify ways to simplify them Avoid using jargon and overly-technical language Adopt words that will convey your professionalism and also communicate effectively Read any written communication out loud to detect wordy passages or sentences with unclear meaning If you stumble over a phrase, it should be rewritten to reflect simple, yet concise language Learn from your listeners’ reactions Requests to repeat what you have said might suggest that you mumble or speak too softly Watch for nonverbal cues, such as frowns or puzzled faces, which indicate your audience does not understand Avoid speaking too quickly, particularly when leaving telephone messages Speak slowly and distinctly when providing information such as your name and telephone number Also slow down when you are trying to make a point B Audience members vary in terms of their expectations, prior experience with the subject matter, learning styles, and so on It is not possible to fully anticipate the needs of everyone in an audience Group brainstorming is an excellent way to learn about other peoples’ perceptions Try this activity and see what you learn! There will be many different types of answers to this question The purpose is to help students recognize that communication styles should vary from setting to setting There are two major differences in communication among the three methods introduced in this chapter First, each costing method assigns a different proportion of production costs to the cost of goods manufactured All production costs are assigned to products under absorption costing, whereas only variable production costs are assigned to products under variable costing, and only direct materials costs are assigned under throughput costing Under all three methods, costs not assigned to products are treated as period costs when calculating operating income Second, each method presents a subtotal on the operating statement that has a unique meaning To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-23 Under absorption costing, the gross margin is the excess of revenues over the product cost of goods sold Under variable costing, the contribution margin is the excess of revenues over both production and nonproduction variable costs Under throughput costing, the throughput margin in the excess of revenues over direct material costs of goods sold C Indirect messages are any part of communication that is not explicit but that may convey meaning Examples include posture, facial and other body expressions, tone of voice, connotation of words used, eye contact, personal appearance, quality of penmanship, and physical materials used for written communications Indirect messages can help communication by conveying information, emphasizing what is said, and improving interactions Indirect messages can also hinder communication because they may be misinterpreted, particularly between people from different backgrounds who may fail to understand their intended meaning Effective communication over time involves engaging in continuous improvement in both communicating and understanding others’ communications and ensuring that interactions not break down Students’ examples for this question are likely to vary widely The purpose is to help students use what they have learned from past communication experiences to actively promote more effective future communication Again, student responses will vary D Here is one possible answer to this question Students are likely to think of additional media and additional pros and cons Printed report Pros: Easily generated and distributed; allows the user to read at own pace; some people prefer reading printed material Cons: May not contain useful information; may be ignored; no direct interaction between the sending and receiving parties; may be costly to produce and distribute; may take time to distribute; ineffective communication medium for auditory learners; may be distributed to unauthorized parties Best for: Reports with content that the receiving party needs to study; wide distribution of information Electronic report Pros: Easily generated and distributed; allows the user to read at own pace; can be accessible almost instantly Cons: May not contain useful information; may be ignored; no direct interaction between the sending and receiving parties; some people not like reading information electronically; ineffective communication medium for auditory learners; may be distributed to unauthorized parties Best for: Reports with content that the receiving party needs to study; wide distribution of information at little cost To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-24 Cost Management Oral presentation Pros: Allows opportunity for questions and interaction; ensures that audience is exposed to the report content; allows control over distribution of information (i.e., recipients are present) Cons: Requires individuals to be physically or electronically connected; ineffective communication medium for visual learners; audience has little or no opportunity to study the information and prepare questions Best for: Relatively simple or highly aggregated information; situations where interaction is desirable Oral presentation with visual display (such as PowerPoint) Pros: Allows opportunity for questions and interaction; ensures that audience is exposed to the report content; addresses needs of both auditory and visual learners; visual display can improve audience attention Cons: Requires individuals to be physically or electronically connected; audience has little or no opportunity to study the information and prepare questions Best for: Relatively simple or highly aggregated information; situations where interaction is desirable; professional appearance 14.26 Integrating Across the Curriculum: Financial Accounting and Auditing A Channel stuffing is the practice of coercing customers to take delivery of excess merchandise for the purpose of improving the seller’s reported financial results B Sales volumes are uncertain for most companies because they are subject to a variety of economic factors that cannot be fully anticipated, such as shifts in customer tastes, changes in competition, introduction of substitute products, changes in customer perceptions about product quality, consumer spending habits, fluctuations in the economy, variations in the sales effort of product distributors, and so on Uncertainties about sales quantities make it more difficult for companies to plan production volumes, particularly when they cannot be rapidly increased or decreased C In the case of Harley-Davidson and Bristol-Myers, customers were dealers or distributors with whom they had developed long-term relationships Accordingly, these customers were willing to accept excess inventories because they were afraid that sufficient future inventories could be in doubt if they failed to cooperate Sometimes the threat is explicit For example, in the Bausch & Lomb case discussed in chapter 1, the distributors were told that they would lose their distributorships if they refused to take additional shipments at the end of 1993 D Here is a possible paragraph, written from the perspective of a Harley-Davidson manager: The demand for our bikes has not slowed down For several years, we have steadily increased our production to better meet customer demand Our goal is to keep our customers happy, which includes reducing delivery time In the past, we have lost sales To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-25 to competitors because we could not deliver bikes fast enough Now we are in a better position to compete, and we expect even stronger sales during our 100-year anniversary E The first step is to examine the FASB’s accounting standards Then the SEC’s accounting guidelines will be examined There are two major pronouncements by the FASB with implications for revenue recognition in cases of channel stuffing According to FASB Concepts Statement No 5, revenue must meet the following two criteria to be recognized: the revenue must be (a) realized or realizable and (b) earned.1 The first criterion requires the seller to have obtained cash or have a claim to a known amount of cash from the buyer The second criterion for a typical manufacturer such as Harley-Davidson or Bristol-Myers generally refers to the delivery of merchandise According to paragraph 84, “…revenues from manufacturing and selling activities … are commonly recognized at time of sale (usually meaning delivery).” Channel stuffing typically meets both conceptual criteria because the merchandise is delivered to customers, and the terms of payment are known because they are specified in a contract Because channel stuffing involves selling customers more merchandise than they need, a risk exists that the customers might later return the excess merchandise FAS No 48 provides guidance for revenue recognition when buyers have the right to return merchandise to the seller.2 According to FAS 48, companies should not recognize revenue if they are unable to reasonably estimate the amount of future returns (paragraph 6.f) FAS 48 also lists specific conditions that may impair the ability to make a reasonable estimate (paragraph 8), which include: Relatively long periods in which a particular product may be returned: Returns of overstocked sales because of channel stuffing often occur over a longer time period than regular returns Thus, this condition could potentially apply to channel stuffing However, it is also possible for managers to argue that no material amount of sales returns will occur This argument is difficult to refute when sales are made to long-time customers who in the past have made few returns Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprise's marketing policies or relationships with its customers: Channel stuffing often occurs during a period of changing conditions for the seller, in which it alters the normal terms of sale to its customers These shifts make it more difficult to estimate returns Thus, this condition could potentially apply to channel stuffing Once again, managers could argue that the sales are to long-time customers who are not likely to return material amounts of merchandise Financial Accounting Standards Board (FASB), Statement of Financial Accounting Concepts No 5, “Recognition and Measurement in Financial Statements of Business Enterprises,” Paragraph 83, Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards No 48, “Revenue Recognition When Right of Return Exists,” Paragraphs and To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-26 Cost Management Overall, the FASB guidance makes it unclear whether companies that have engaged in channel stuffing should be allowed to recognize the revenues Valid theoretical arguments could be made for and against recognition Because of the uncertainties discussed in Part B, it is difficult for auditors or others to distinguish between cases like Harley-Davidson, in which no significant returns later occurred, and cases like BristolMyers, which experienced large returns In recent years, the SEC has investigated numerous instances of channel stuffing, and its staff has expanded its revenue recognition guidelines to address this problem The SEC’s accounting standards for revenues refer to FASB Concepts Statement No and FAS 48 (discussed above).3 The standards also contain a series of questions and answers about whether revenue should be recognize in various situations Two of these issues may apply to channel stuffing and are discussed below Persuasive evidence that an arrangement exists The SEC states that companies should not recognize revenue unless they have reached a clear understanding with their customer about the nature and terms of the transaction When channel stuffing occurs, the seller often requires the buyer to sign a purchase agreement On the surface revenue recognition appears to be appropriate; however, the substance of the transaction may be different than its legal form If the seller did not voluntarily agree to the terms, then it could be argued that no agreement exists and that revenue should not be recognized Inability to reasonably estimate product returns The SEC staff expanded the list of conditions for FAS 48 to include additional factors that might prevent a company from making a reasonable estimate of its product returns and, therefore, from recognizing revenue These factors include: Significant increases in or excess levels of inventory in a distribution channel (sometimes referred to as “channel stuffing”) The inability to determine or observe the levels of inventory in a distribution channel and the current level of sales to end users The SEC guidelines provide a more stringent test for evaluating whether revenue can be recognized in cases where channel stuffing might have occurred These guidelines require managers and auditors to evaluate the trends in inventory levels not only at the company but also in its distribution channels If customer inventory levels have increased significantly, then the revenue probably cannot be recognized F As stated in the problem, an error is defined as an unintentional mistake, while fraud is intentional Thus, the auditor must evaluate whether Bristol-Myers’ misstatement was intentional or unintentional This is a difficult question, because one cannot read the minds of the managers Were they simply aggressive in meeting sales goals? Or did they SEC Staff Accounting Bulletin, Codification of Staff Accounting Bulletins, Topic 13: Revenue Recognition, Revised as of December 2003, available at www.sec.gov To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14: Measuring and Assigning Costs for Income Statements 14-27 intentionally force customers to take inventories that they knew might later be returned? The auditing standards provide some guidance in this area According to SAS 99, the auditor should presume intent (i.e., fraud) in cases where revenue is improperly recognized, unless evidence demonstrates that the misstatement was unintentional.4 Thus, an auditor is likely to conclude that the Bristol-Myers misstatement constituted fraud G Managers have many incentives to continue reporting sales and earnings growth These incentives include performance-based bonuses, the value of the manager’s stock or stock options, manager reputation, and job security H Behavior such as channel stuffing imposes both direct and indirect costs on the company Direct costs include higher income taxes, foregone opportunities to reduce production costs, and possible increases in customer bad debts Indirect costs include loss of reputation, which in turn increases the company’s cost of capital, weakens its relationships with customers, and encourages higher employee turnover In addition to the company’s own effects, the stockholders often experience a large decline in the value of their investment This type of fraud can also lead to greater financial trouble for the company, which often increases employee layoffs and can cause financial distress for the company’s suppliers and customers Auditing Standards Board, Statement of Auditing Standards No 99, “Consideration of Fraud in a Financial Statement Audit.” ... inventories on hand (WIP and FG) and cost of goods sold 14.11 A joint cost may be either fixed or variable and a separable cost may be either fixed or variable Both variable and absorption costing can... common and separable costs are considered product costs and assigned to inventory To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 14-4 Cost Management. .. allocates all production costs, both fixed and variable, to units as product costs so cost of goods sold and inventory on the balance sheet include fixed manufacturing costs Cost of goods sold is