CHAPTER 11 ABSORPTION/VARIABLE COSTING AND COST-VOLUME-PROFIT ANALYSIS MULTIPLE CHOICE Consider the following three product costing alternatives: process costing, job order costing, and standard costing Which of these can be used in conjunction with absorption costing? a b c d job order costing standard costing process costing all of them ANSWER: absorption costing variable costing direct costing standard costing ANSWER: a EASY Another name for absorption costing is a b c d full costing direct costing job order costing fixed costing ANSWER: EASY In a recent period, Marvel Co incurred $20,000 of fixed manufacturing overhead and deducted $30,000 of fixed manufacturing overhead Marvel Co must be using a b c d d a EASY If a firm produces more units than it sells, absorption costing, relative to variable costing, will result in a b c d higher income and assets higher income but lower assets lower income but higher assets lower income and assets ANSWER: a MEDIUM 11–1 11–2 Chapter 11 Under absorption costing, fixed manufacturing overhead could be found in all of the following except the a b c d work-in-process account finished goods inventory account Cost of Goods Sold period costs ANSWER: EASY only on the balance sheet only on the income statement on both the balance sheet and income statement on neither the balance sheet nor income statement ANSWER: c EASY Under absorption costing, if sales remain constant from period to period 2, the company will report a larger income in period when a b c d period production exceeds period production period production exceeds period production variable production costs are larger in period than period fixed production costs are larger in period than period ANSWER: d If a firm uses absorption costing, fixed manufacturing overhead will be included a b c d Absorption/Variable Costing and Cost-Volume-Profit Analysis a MEDIUM The FASB requires which of the following to be used in preparation of external financial statements? a b c d variable costing standard costing activity-based costing absorption costing ANSWER: d EASY Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis An ending inventory valuation on an absorption costing balance sheet would a b c d sometimes be less than the ending inventory valuation under variable costing always be less than the ending inventory valuation under variable costing always be the same as the ending inventory valuation under variable costing always be greater than or equal to the ending inventory valuation under variable costing ANSWER: 10 EASY treatment of fixed manufacturing overhead treatment of variable production costs acceptability for external reporting arrangement of the income statement ANSWER: b EASY Which of the following is not associated with absorption costing? a b c d functional format gross margin period costs contribution margin ANSWER: 12 d Absorption costing differs from variable costing in all of the following except a b c d 11 11–3 d EASY Unabsorbed fixed overhead costs in an absorption costing system are a b c d fixed manufacturing costs not allocated to units produced variable overhead costs not allocated to units produced excess variable overhead costs costs that cannot be controlled ANSWER: a EASY 11–4 13 Chapter 11 Profit under absorption costing may differ from profit determined under variable costing How is this difference calculated? a b c d Change in the quantity of all units in inventory times the relevant fixed costs per unit Change in the quantity of all units produced times the relevant fixed costs per unit Change in the quantity of all units in inventory times the relevant variable cost per unit Change in the quantity of all units produced times the relevant variable cost per unit ANSWER: 14 a EASY What factor, related to manufacturing costs, causes the difference in net earnings computed using absorption costing and net earnings computed using variable costing? a b c d Absorption costing considers all costs in the determination of net earnings, whereas variable costing considers fixed costs to be period costs Absorption costing allocates fixed overhead costs between cost of goods sold and inventories, and variable costing considers all fixed costs to be period costs Absorption costing “inventories” all direct costs, but variable costing considers direct costs to be period costs Absorption costing “inventories” all fixed costs for the period in ending finished goods inventory, but variable costing expenses all fixed costs ANSWER: 15 Absorption/Variable Costing and Cost-Volume-Profit Analysis b EASY The costing system that classifies costs by functional group only is a b c d standard costing job order costing variable costing absorption costing ANSWER: d EASY Chapter 11 16 Absorption/Variable Costing and Cost-Volume-Profit Analysis A functional classification of costs would classify “depreciation on office equipment” as a a b c d product cost general and administrative expense selling expense variable cost ANSWER: 17 EASY process costing job order costing variable costing absorption costing ANSWER: c EASY Under variable costing, which of the following are costs that can be inventoried? a b c d variable selling and administrative expense variable manufacturing overhead fixed manufacturing overhead fixed selling and administrative expense ANSWER: 19 b The costing system that classifies costs by both functional group and behavior is a b c d 18 11–5 b EASY Consider the following three product costing alternatives: process costing, job order costing, and standard costing Which of these can be used in conjunction with variable costing? a b c d job order costing standard costing process costing all of them ANSWER: d EASY 11–6 20 Chapter 11 Another name for variable costing is a b c d full costing direct costing standard costing adjustable costing ANSWER: 21 EASY only on the balance sheet only on the income statement on both the balance sheet and income statement on neither the balance sheet nor income statement ANSWER: b EASY Under variable costing, a b c d all product costs are variable all period costs are variable all product costs are fixed product costs are both fixed and variable ANSWER: 23 b If a firm uses variable costing, fixed manufacturing overhead will be included a b c d 22 Absorption/Variable Costing and Cost-Volume-Profit Analysis a EASY How will a favorable volume variance affect net income under each of the following methods? a b c d Absorption reduce reduce increase increase ANSWER: c Variable no effect increase no effect reduce EASY Chapter 11 24 Absorption/Variable Costing and Cost-Volume-Profit Analysis Variable costing considers which of the following to be product costs? a b c d Fixed Mfg Costs yes yes no no ANSWER: 25 Variable Mfg Costs yes yes yes yes Variable Selling & Adm no yes yes no EASY costs are classified by their behavior costs are always lower it is required for external reporting it justifies higher product prices ANSWER: a EASY The difference between the reported income under absorption and variable costing is attributable to the difference in the a b c d income statement formats treatment of fixed manufacturing overhead treatment of variable manufacturing overhead treatment of variable selling, general, and administrative expenses ANSWER: 27 d Fixed Selling & Adm no no no no The variable costing format is often more useful to managers than the absorption costing format because a b c d 26 11–7 b EASY Which of the following costs will vary directly with the level of production? a b c d total manufacturing costs total period costs variable period costs variable product costs ANSWER: d EASY 11–8 28 Chapter 11 On the variable costing income statement, the difference between the “contribution margin” and “income before income taxes” is equal to a b c d the total variable costs the Cost of Goods Sold total fixed costs the gross margin ANSWER: 29 EASY deducted in the period that they are incurred inventoried until the related products are sold treated like period costs inventoried until the related products have been completed ANSWER: b EASY In the application of “variable costing” as a cost-allocation process in manufacturing, a b c d variable direct costs are treated as period costs nonvariable indirect manufacturing costs are treated as product costs variable indirect manufacturing costs are treated as product costs nonvariable direct costs are treated as product costs ANSWER: 31 c For financial reporting to the IRS and other external users, manufacturing overhead costs are a b c d 30 Absorption/Variable Costing and Cost-Volume-Profit Analysis c EASY A basic tenet of variable costing is that period costs should be currently expensed What is the rationale behind this procedure? a b c d Period costs are uncontrollable and should not be charged to a specific product Period costs are generally immaterial in amount and the cost of assigning the amounts to specific products would outweigh the benefits Allocation of period costs is arbitrary at best and could lead to erroneous decision by management Because period costs will occur whether production occurs, it is improper to allocate these costs to production and defer a current cost of doing business ANSWER: d MEDIUM Chapter 11 32 Absorption/Variable Costing and Cost-Volume-Profit Analysis Which of the following is a term more descriptive of the type of cost accounting often called “direct costing”? a b c d out-of-pocket costing variable costing relevant costing prime costing ANSWER: 33 EASY only direct costs only variable production costs all variable costs all variable and fixed manufacturing costs ANSWER: b EASY Which of the following must be known about a production process in order to institute a variable costing system? a b c d the variable and fixed components of all costs related to production the controllable and non-controllable components of all costs related to production standard production rates and times for all elements of production contribution margin and break-even point for all goods in production ANSWER: 35 b What costs are treated as product costs under variable (direct) costing? a b c d 34 11–9 a EASY Why is variable costing not in accordance with generally accepted accounting principles? a b c d Fixed manufacturing costs are treated as period costs under variable costing Variable costing procedures are not well known in industry Net earnings are always overstated when using variable costing procedures Variable costing ignores the concept of lower of cost or market when valuing inventory ANSWER: a EASY 11–10 36 Chapter 11 Which of the following is an argument against the use of direct (variable) costing? a b c d Absorption costing overstates the balance sheet value of inventories Variable factory overhead is a period cost Fixed manufacturing overhead is difficult to allocate properly Fixed manufacturing overhead is necessary for the production of a product ANSWER: 37 b c d EASY The cost of a unit of product changes because of changes in the number of units manufactured Profits fluctuate with sales An idle facility variation is calculated None of the above ANSWER: b EASY An income statement is prepared as an internal report Under which of the following methods would the term contribution margin appear? a b c d Absorption costing no no yes yes ANSWER: 39 d Which of the following statements is true for a firm that uses variable costing? a 38 Absorption/Variable Costing and Cost-Volume-Profit Analysis b Variable costing no yes no yes EASY In an income statement prepared as an internal report using the variable costing method, fixed manufacturing overhead would a b c d not be used be used in the computation of operating income but not in the computation of the contribution margin be used in the computation of the contribution margin be treated the same as variable manufacturing overhead ANSWER: b EASY 11–50 24 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis “This makes no sense at all,” said Bill Sharp, president of Essex Company “We sold the same number of units this year as we did last year, yet our profits have more than doubled Who made the goof—the computer or the people who operate it?” The statements to which Mr Sharp was referring are shown here (absorption costing basis): Sales (20,000 units each year) Less cost of good sold Gross margin Less selling and administrative expenses Income before income taxes 2001 $700,000 460,000 $240,000 200,000 $ 40,000 2002 $700,000 400,000 $300,000 200,000 $100,000 The company was organized on January 1, 2001, so the previous statements show the results of its first two years of operation In the first year, the company produced and sold 20,000 units; in the second year, the company again sold 20,000 units, but it increased production in order to have a stock of units on hand, as shown here: Production in units Sales in units Variable production cost per unit Fixed overhead costs (total) 2001 20,000 20,000 $8 $300,000 2002 25,000 20,000 $8 $300,000 Fixed overhead costs are applied to units of product on a basis of each year’s production (The company produces and sells a single product.) Variable selling and administrative expenses are $1 per unit sold Required: Compute the cost of single unit of product for each year under: a absorption costing b variable costing What is the value of ending inventory in 2002 under: a full cost? b variable cost? Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis ANSWER: a Variable man Fixed man 2001 $ 15 $23 b Variable man a 5,000 × $23 = $115,000 b 5,000 × 20 = 100,000 MEDIUM 2001 $8 2002 $ 12 $20 2002 $8 2001 $300,000 = $15 20,000 2002 $300,000 = $12 25,000 11–51 11–52 25 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis The following data have been taken from the records of a company: Production in units during 2001 Units sold during 2001 Selling price per unit Standard variable costs per unit: Material and labor Indirect manufacturing costs Selling & administrative expenses Fixed costs budgeted for year: Indirect manufacturing costs Selling & administrative expenses 200,000 190,000 $15.00 $8.00 2.00 1.00 $11.00 $400,000 300,000 $700,000 Required: Determine the income (loss) before income taxes for the year 2001 under (a) absorption costing and (b) variable costing What is the value of ending inventory under (a) absorption costing and (b) variable costing? Reconcile the difference in the two incomes Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis ANSWER: (a.) Sales – COG S (190,000 × 12) – SLA Income before income taxes $2,850,000 2,280,000 $ 570,000 490,000 $ 80,000 (a.) $12 × 10,000 = $120,000 (b.) $10 × 10,000 = $100,000 11–53 (b.) Sales $2,850,000 – VC (190,000 × 11) 2,090,000 CM $ 760,000 – FC 700,000 Income before income taxes $ 60,000 PRODUCT COST ABSORPTION VARIABLE VAR $10 FIX  NI = (200,000 – 190,000) × $2 = $20,000 MEDIUM $12 $10 (400,000) (200,000) _ $10 11–54 26 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis Actual costs for Sonic, Inc for the past year were as follows: Direct material (2 pounds @ $5) Direct labor (3 hours @ $10) Variable selling and administrative Fixed selling and administrative $10 per unit $30 per unit $2 per unit $80,000 During the year, 10,000 units were produced and 9,000 units were sold There were no beginning inventories Thirty thousand direct labor hours were worked during the year Actual overhead for the year totaled $252,000 of which $140,000 was fixed Selling price = $100/unit Budgeted fixed overhead was $150,000 and the expected activity level was 30,000 direct labor hours Variable overhead was budgeted at direct labor hours per unit and $4 per direct labor hour The company uses a normal costing system and overhead variances are closed to cost of goods sold Required: a Determine the unit cost using variable costing b Determine the unit cost using absorption costing c Using variable costing, determine the contribution margin, and variable costing income d Using absorption costing, determine the gross margin, and absorption costing income Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis ANSWER: a b c DM DL 30 V-FOH (3 × $4) $10 DM DL V-FOH F-FOH (3 × $5) $10 30 12 15 $67 12 $52 $150,000 = $5 30,000 Sell Price $100 – VAR Cost 54 ($52 + $2) CM $ 46 × 9,000 units = – FC = Income before income taxes (STD) + favorable VAR-FOH SPD VAR Income before income taxes (actual) $414,000 (230,000) $184,000 8,000 $192,000 Variable FOH spending variance = $112,000 – (30,000 × $4) = $8,000 F d SP $100 – COGS 67 GM $ 33 × 9,000 units = – S&A EXP (9,000 × $2) + $80,000 Income before income taxes (STD) + Favorable variance Income before income taxes actual MEDIUM $297,000 (98,000) $199,000 8,000 $207,000 11–55 11–56 27 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis Sports Innovators has developed a new design to produce hurdles that are used in track and field competition The company’s hurdle design is innovative in that the hurdle yields when hit by a runner and its height is extraordinarily easy to adjust Management estimates expected annual capacity to be 90,000 units; overhead is applied using expected annual capacity The company’s cost accountant predicts the following 2001 activities and related costs: Standard unit variable manufacturing costs Variable unit selling expense Fixed manufacturing overhead Fixed selling and administrative expenses Selling price per unit Units of sales Units of production Units in beginning inventory $12 $5 $480,000 $136,000 $35 80,000 85,000 10,000 Other than any possible under- or overapplied fixed overhead, management expects no variances from the previous manufacturing costs Under- or overapplied fixed overhead is to be written off to Cost of Goods Sold Required: Determine the amount of under- or overapplied fixed overhead using (a) variable costing and (b) absorption costing Prepare projected income statements using (a) variable costing and (b) absorption costing Reconcile the incomes derived in part Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis ANSWER: a $0 b (90,000 – 85,000) × $5.33 = $26,650 U a Sales (80,000 × $35) = – VC (80,000 × $17) = CM – FC Income before income taxes $2,800,000 (1,360,000 ) $1,440,000 (616,000) $ 824,000 b Sales (80,000 × $35) – COGS ($17.33 × 80,000) GM $1,413,600 – S&A Income before income (STD) – VOL VAR Income before income taxes $2,800,000 (1,386,400) 5,000 × $5.33 = $26,650 MEDIUM (536,000) $ 877,600 (26,650) $ 850,950 11–57 11–58 28 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis On December 30, 2001, a bomb blast destroyed the bulk of the accounting records of the Horne Division, a small one-product manufacturing division that uses standard costs and flexible budgets All variances are written off as additions to (or deductions from) income; none are pro-rated to inventories In addition, the chief accountant mysteriously disappeared You have the task of reconstructing the records for the year 2001 The general manager has said that the accountant has been experimenting with both absorption costing and variable costing The records are a mess, but you have gathered the following data for 2001: a b c d e f g h i j k l m n o Cash on hand, December 31, 2001 Sales Actual fixed indirect manufacturing costs Accounts receivable, December 31, 2001 Standard variable manufacturing costs per unit Variances from standard of all variable manufacturing costs Operating income, absorption-costing basis Accounts payable, December 31, 2001 Gross profit, absorption costing at standard (before deducting variances) Total liabilities Unfavorable budget variance, fixed manufacturing costs Notes receivable from chief accountant Contribution margin, at standard (before deducting variances) Direct-material purchases, at standard prices Actual selling and administrative costs (all fixed) $10 $128,000 21,000 20,000 $5,000 U $14,400 18,000 22,400 100,000 1,000 U 4,000 48,000 50,000 6,000 These not necessarily have to be solved in any particular order Ignore income taxes Required: Operating income on a variable-costing basis Number of units sold Number of units produced Number of units used as the denominator to obtain fixed indirect cost application rate per unit on absorption-costing basis Did inventory (in units) increase or decrease? Explain By now much in dollars did the inventory level change (a) under absorption costing, (b) under variable costing? Variable manufacturing cost of goods sold, at standard prices Manufacturing cost of goods sold at standard prices, absorption costing Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis 11–59 ANSWER: CM – FC Operating Income (STD) – unfavorable variances Operating Income (actual) $48,000 (26,000 ) $22,000 (6,000) $16,000 Actual fix mfg – unfavorable VAR fix cost @STD Sales – CM = VC $128,000 (48,000 ) $ 80,000/$1 UNIT = 80,000 units sold Sales – GM COGS $128,000 (22,400) $105,600/80,000 = $1.32 Difference in OI = (P – S) × fix mfg/unit $(1,600) = (P – 80,000) × $.32 P = 75,000 OI – absorption cost = $22,400 – $6,000 = variances – other VAR VOL VAR $16,400 (14,400) $ 2,000 6,000 $ 4,000 OI STD OI ACT UNF UNF FAV $4,000 F = (75,000 – X) × $.32 X = 62,500 units produced Inventory decreased OI absorption is less than OI variable Absorption cost 5,000 units × $1.32 = $6,600 Variable cost 5,000 units × $1 = $5,000 80,000 units × $1 = $80,000 80,000 × $1.32 = $105,600 DIFFICULT $21,000 (1,000 ) $20,000 11–60 29 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis Smith Company produces and sells two products: A and B in the ratio of 3A to 5B Selling prices for A and B are, respectively, $1,200 and $240; respective variable costs are $480 and $160 The company’s fixed costs are $1,800,000 per year Compute the volume of sales in units of each product needed to: Required: a breakeven b earn $800,000 of income before income taxes c earn $800,000 of income after income taxes, assuming a 30 percent tax rate d earn 12 percent on sales revenue in before-tax income e earn 12 percent on sales revenue in after-tax income, assuming a 30 percent tax rate Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis ANSWER: A SP – VC CM $1,200 (480 ) $ 720 B SP – VC CM $240 (160 ) $ 80 Weighted CM = (3 × $720) + (5 × $80) = $2,560 a $1,800,000 = 703.125 $2,560 A = 704 × = 2,112 units B = 704 × = 3,520 b $1,800,000 + $800,000 = 1015.625 $2,560 A = 1,016 × = 3,048 units B = 1,016 × = 5,080 c $800,000/1 – = $1,142,857 $1,800,000 + $1,142,857 = 1,149.55 $2,560 d SP = (3 × $1,200) + (5 × $240) = $4,800 X = $1,800,000 + $.12X = $4,354,839 $2,560/$4,800 A = ($4,354,839 × 75)/$1200 = 2,722 units B = ($4,354,839 × 25/$240 = 4,537 e X = $1,800,000 + $.12X – = $4,973,684 $2,560/$4,800 A = ($4,973,684 × 75)/$1,200 = 3,109 units B = ($4,973,684 × 25/$240 = 5,181 MEDIUM A = 1,150 × = 3,450 units B = 1,150 × = 5,750 11–61 11–62 30 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis The Jones Company makes three products Data follow: Selling price Variable costs Product A $10 Product B $20 12 Product C $40 16 Total annual fixed costs are $840,000 The firm’s experience has been that about 20 percent of dollar sales come from product A, 60 percent from B, and 20 percent from C Required: a Compute break-even in sales dollars b Determine the number of units to be sold at the break-even point Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis ANSWER: a SP – VC = CM CMR A $10 (7) $ 30% B $20 (12 ) $ 40% C $40 (16 ) $24 60% CMR = (.2 × 30%) + (.6 × 40%) + (.2 × 60%) = 42% BE = $840,000/.42 = $2,000,000 b A ($2,000,000 × 20)/$10 = 40,000 units B ($2,000,000 × 60)/$20 = 60,000 units C ($2,000,000 × 20)/$40 = 10,000 units MEDIUM 11–63 11–64 31 Chapter 11 Absorption/Variable Costing and Cost-Volume-Profit Analysis The Fred Company sells two products, A and B, with contribution margin ratios of 40 and 30 percent and selling prices of $5 and $2.50 a unit Fixed costs amount to $72,000 a month Monthly sales average 30,000 units of product A and 40,000 units of product B Required: a Assuming that three units of product A are sold for every four units of product B, calculate the dollar sales volume necessary to breakeven b As part of its cost accounting routine, Fred Company assigns $36,000 in fixed costs to each product each month Calculate the break-even dollar sales volume for each product c Fred Company is considering spending an additional $9,700 a month on advertising, giving more emphasis to product A and less emphasis to product B If its analysis is correct, sales of product A will increase to 40,000 units a month, but sales of product B will fall to 32,000 units a month Recalculate the break-even sales volume, in dollars, at this new product mix Should the proposal to spend the additional $9,700 a month be accepted? ANSWER: a CM = (3 × $2) + (4 × $.75) = $9 SP = (3 × $5) = (4 × $2.50) = $25 BE = $72,000 = $400,000 $9/$25 b A = $36,000 = $90,000 B = $36,000 = $120,000 c CM = (5 × $2) + (4 × $.75) = $13 SP = (5 × $5) + (4 × $2.50) = $35 BE = $72,000 + $9,700 = $219,962 $13/35 OLD NEW CM A = 30,000 × $2 = $60,000 B = 40,000 × $.75 = 30,000 $90,000 – FC (72,000 ) OI $18,000 CM A = 40,000 × $2 = $ 80,000 B = 32,000 × $.75 = 24,000 $104,000 – FC (81,700) OI $ 22,300 At current sales levels increase advertising MEDIUM ... Costing and Cost- Volume-Profit Analysis b EASY The costing system that classifies costs by functional group only is a b c d standard costing job order costing variable costing absorption costing... goods sold and inventories, and variable costing considers all fixed costs to be period costs Absorption costing “inventories” all direct costs, but variable costing considers direct costs to be... variable costing? a b c d job order costing standard costing process costing all of them ANSWER: d EASY 11–6 20 Chapter 11 Another name for variable costing is a b c d full costing direct costing standard