CHAPTER 13 STANDARD COSTING AND VARIABLE COSTING 13-1 JIT and Costing Methods Throughput costing is most compatible because it penalizes production in excess of sales Variable costing does not penalize excess production, while absorption costing actually rewards overproduction Throughput costing expenses everything except material cost as those costs are incurred It expenses material costs when material goes into production Thus, starting to make something gives rise to expense, which encourages managers to produce only when they can sell the product Absorption costing rewards high production because it capitalizes fixed production costs in inventory, thus postponing their appearance in the income statement until products are sold 13-2 Use of Costing Methods The construction company is least likely to use standard costs because it does not make standard products Such a company could, and probably does, budget costs for major projects, but these are not standards An automaker uses standard costs both for control and because it could not possibly use actual or normal process costing because of product diversity Job order costing would be prohibitively costly A processor of flour could use actual or normal costing, but would benefit from the control uses of standards 13-3 Product Cost Period Cost Classifying a cost as either product or period tells little about the cost itself but rather describes how we treat it for reporting purposes Identifying a cost as a product cost results in its being reported as an expense in the period in which the product is sold Identifying a cost as a period cost results in its being reported as an expense in the period in which it is incurred The distinction between period and product costs has no relevance to decision making except, perhaps, in connection with capital budgeting decisions where the period of expense reporting for tax purposes is relevant to the determination of future cash flows 13-4 Costing Methods and Zero Inventories All three methods will give the same results Total expenses will equal total costs incurred, including purchases of materials and components 13-5 Costing Methods and Cash Flows Throughput costing will probably be the closest because the flow of costs parallels their incurrence Absorption costing will have the least close relationship to cash flow 13-1 13-6 Fundamentals of Absorption and Variable Costing (15 minutes) Sales, 18,000 x $50 Standard cost of sales, 18,000 x $30 Standard gross margin Selling and administrative expenses Income $900,000 540,000 360,000 300,000 $ 60,000 Sales, Standard variable cost of sales, 18,000 x $10 Standard gross margin, contribution margin Fixed costs, $400,000 + $300,000 Income $900,000 180,000 720,000 700,000 $ 20,000 The cost of sales sections of the income statement focus attention on inventories Absorption Variable Beginning inventory Variable production costs Fixed production costs Total available Ending inventory, 2,000 units at $30, $10 Cost of sales $ 200,000 400,000 600,000 60,000 $540,000 $ 200,000 200,000 20,000 $180,000 Because actual production equalled the level used to set the standard, there is no volume variance You might ask how much income the company should earn per month if it continues to sell 18,000 units The answer is $20,000, because the company cannot indefinitely make 2,000 units more than it sells 13-7 Fundamentals of Absorption and Variable Costing (15 minutes) Sales, 22,000 x $50 Standard cost of sales, 22,000 x $30 Standard gross margin Selling and administrative expenses Income $1,100,000 660,000 440,000 300,000 $ 140,000 Sales, 22,000 x $50 Standard variable cost of sales, 22,000 x $10 Standard gross margin, contribution margin Fixed costs, $400,000 + $300,000 Income $1,100,000 220,000 880,000 700,000 $ 180,000 The cost of sales sections of the income statement again focus attention on inventories Absorption Variable Beginning inventory, 13-5 Variable production costs Fixed production costs Total available Ending inventory Cost of sales $ 60,000 200,000 400,000 660,000 $660,000 13-2 $ 20,000 200,000 220,000 $220,000 Because actual production again equalled the level used to set the standard, there is no volume variance 13-8 Basic Standard Costing Absorption and Variable (25 minutes) Income Statements Variable Costing March Sales at $7 per case Cost of sales: Beginning inventory: 30,000 x $3 Production costs: 130,000 x $3 90,000 x $3 Total Ending inventory: 30,000 x $3 20,000 x $3 Variable cost of sales Contribution margin Fixed costs: Production Selling and administrative Total fixed costs Income April $700,000 90,000 390,000 _ 390,000 270,000 360,000 90,000 300,000 400,000 60,000 300,000 400,000 300,000 60,000 360,000 $ 40,000 300,000 60,000 360,000 $ 40,000 Income Statements Absorption Costing March Sales, at $7 per case Cost of sales: Beginning inventory: 30,000 x ($3 + $2)* Production costs applied: Variable 130,000 x $3 90,000 x $3 Fixed costs applied: 130,000 x $2 90,000 x $2 Total Ending inventory: 30,000 x $5 20,000 x $5 Standard cost of sales at $5 Volume variance: $300,000 - $260,000 $300,000 - $180,000 Actual cost of sales Gross margin Selling and administrative Income $700,000 $700,000 April $700,000 150,000 390,000 270,000 260,000 650,000 180,000 600,000 150,000 500,000 100,000 500,000 40,000 U 540,000 160,000 60,000 $100,000 120,000 U 620,000 80,000 60,000 $ 20,000 * Standard fixed overhead per unit is $2 ($300,000 total fixed manufacturing cost divided by 150,000 units at practical capacity) B&Y should earn about $40,000 per month, the variable costing income Absorption costing income depends on production, which over time must 13-3 approximate sales As inventories stabilize, income will approach $40,000, the variable costing equilibrium amount This answer does not rely on the company's using absorption costing or variable costing In the long run, any method will give the same result (You might want to point out that variable costing is not acceptable for tax purposes, so income differences cannot rise from investing tax savings, as can happen with LIFO.) Note to the Instructor: You can this exercise without the details of the cost of sales section, as shown below The cost of sales section can be used to show how the costs flow and why incomes turn out the way they do, but it is not necessary Income Statements Variable Costing Sales, at $7 per case Variable cost of sales at $3 Contribution margin Fixed costs: Production Selling and administrative Total fixed costs Income March $700,000 300,000 400,000 April $700,000 300,000 400,000 300,000 60,000 360,000 $ 40,000 300,000 60,000 360,000 $ 40,000 Income Statements Absorption Costing March Sales, at $7 per case Standard cost of sales at $5 Volume variance: $300,000 - $260,000 $300,000 - $180,000 Actual cost of sales Gross margin Selling and administrative Income $700,000 500,000 40,000 U _ 540,000 160,000 60,000 $100,000 April $700,000 500,000 120,000 U 620,000 80,000 60,000 $ 20,000 Note to the Instructor: Because this exercise is quite straightforward and uncomplicated by variances for variable costs, it provides a basis for drawing attention to the essential differences between variable and absorption costing You may, for example, wish to ask the students if they can explain the differences between the incomes under the two methods The explanation might proceed as follows: Explanation of the differences in income in the two months March April Differences to be explained: Income under variable costing $ 40,000 $ 40,000 Income under absorption costing 100,000 20,000 Difference to be explained: Variable costing income smaller $ 60,000 Variable costing income larger $ 20,000 Prior month's fixed costs deferred to current month by inclusion in the beginning inventory: 30,000 x $2 60,000 Current month's fixed costs deferred to the next month by inclusion in the ending inventory: 30,000 x $2 60,000 13-4 20,000 x $2 Difference in income due to fixed costs in inventory 13-9 Actual Costing Income Statements 40,000 $ 60,000 $ 20,000 (15-20 minutes) Sales, 18,000 x $30, 22,000 x $30 Cost of sales: Beginning inventory Production costs: Variable, 20,000 x $10 Fixed Total available for sale Less ending inventory* Cost of sales Gross margin Selling and administrative expenses Income January February $540,000 $660,000 40,000 200,000 200,000 400,000 40,000 360,000 180,000 40,000 $140,000 200,000 200,000 440,000 440,000 220,000 40,000 $180,000 Inventory, $400,000/20,000 = $20 per unit, times 2,000 units = $40,000 There is no inventory at the end of February, so no calculation is needed Sales, 18,000 x $30, 22,000 x $30 Cost of sales, variable costs at $10/unit Contribution margin at $20 Fixed costs, $200,000 + $40,000 Income January February $540,000 180,000 360,000 240,000 $120,000 $660,000 220,000 440,000 240,000 $200,000 The cost of goods sold sections under variable costing appear below January February Beginning inventory Variable production costs, 20,000 x $10 Total available for sale Less ending inventory, 2,000 x $10 Cost of sales $ 200,000 200,000 20,000 $180,000 20,000 200,000 220,000 $220,000 January February Sales, 18,000 x $30, 22,000 x $30 $540,000 Cost of sales, material cost at $6 x production 120,000 Throughput 420,000 Other costs, $80,000 + $200,000 + $40,000 320,000 Income $100,000 13-10 Standard Fixed Cost and Volume Variance (15 minutes) (a) Normal $900,000 225,000 $4 Budgeted fixed manufacturing costs Divided by capacity measure Equals standard fixed cost per unit 13-5 $660,000 120,000 540,000 320,000 $220,000 (b) Practical $900,000 300,000 $3 (a) Standard fixed cost per unit Times number of units produced Fixed overhead applied to production Less budgeted fixed overhead Volume variance (unfavorable) (b) $4 240,000 $960,000 900,000 $ 60,000 $3 240,000 $720,000 900,000 ($180,000) Alternatively, the calculations could be made using the differences between actual production and the volume used to set the standard fixed cost Volume Used to Set Standard (a) (b) 225,000 300,000 13-11 Relationships (a) $10 per unit (b) $200,000 (b) $60,000 Actual Production Difference x Standard Fixed Cost (15,000) 60,000 x x $4 $3 240,000 240,000 = Volume Variance $ 60,000 F 180,000 U (20-25 minutes) $10,000 favorable variance/1,000 units above normal production 20,000 units x $10 20,000 units x $3 (c) 17,000 units $9,000 unfavorable variance/$3 per unit = 3,000 units below normal of 20,000 (a) (d) (a) (c) $2 per unit $40,000/20,000 $4,000 unfavorable $7 per unit (20,000 - 18,000) x $2 $140,000/20,000 22,000 units $14,000 favorable variance/$7 per unit = 2,000 units more than normal of 20,000 13-12 Effects of Changes in Production Standard Variable Costing (15 minutes) Production 40,000 units 41,000 units Sales (40,000 x $10) $400,000 $400,000 Variable cost of goods sold: Variable production costs 40,000 x $3 $120,000 41,000 x $3 $123,000 Ending inventory x $3 1,000 x $3 3,000 Variable cost of goods sold 40,000 x $3 120,000 120,000 Contribution margin 280,000 280,000 Fixed production costs 200,000 200,000 Income $ 80,000 $ 80,000 13-6 Note to the Instructor: We asked for income statements for both levels of production to allow you to highlight how increases in variable cost occurring because of increases in production are deferred in inventory, therefore having no effect on income Most students should see that income will be the same no matter what production is You might therefore reiterate that income can be computed as we did as early as Chapter Sales - variable costs - fixed costs = income (40,000 x $10) - (40,000 x $3) - $200,000 = $80,000 13-13 Effects of Changes in Production Standard Absorption Costing (15-20 minutes) Production 40,000 units 41,000 units Sales (40,000 x $10) $400,000 $400,000 Cost of goods sold: Variable production costs $120,000 $123,000 Applied fixed production costs 40,000 x $5 200,000 41,000 x $5 205,000 Cost of goods available for sale 320,000 328,000 Ending inventory x $8 1,000 x $8 8,000 Cost of goods sold (40,000 x $8) 320,000 320,000 Standard gross profit (40,000 x $2) 80,000 80,000 Volume variance, favorable (1,000 x $5) 5,000 Income $ 80,000 $ 85,000 Note to the Instructor: We asked for details of the cost of sales section so that you can show how increases in production lead to increases in applied fixed costs with a corresponding increase in ending inventory and a more favorable (or less unfavorable) volume variance The 1,000 unit increase in production leads to an increase in the fixed costs in inventory of $5,000, which is also the increase in income 13-14 "Now Wait a Minute Here." (20 minutes) This assignment shows the relationships of income to sales and production Sales at $10 Cost of sales at $7 Standard gross margin Volume variance Actual gross margin Sales 10,000 Prod 10,000 Sales 10,000 Prod 10,001 Sales 10,001 Prod 10,001 Sales 9,999 Prod 10,001 $100,000 70,000 30,000 $ 30,000 $100,000 70,000 30,000 6F $ 30,006 $100,010 70,007 30,003 6F $ 30,009 $99,990 69,993 29,997 6F $30,003 The highest profit is with sales and production at 10,001, but the lowest is with sales and production at 10,000 Sales of 9,999 with production of 10,001 gives a higher profit than sales of 10,000 with production of 10,000 Sales of 10,000 with production of 10,001 gives the second best profit In other words, production increases income more than does sales The company increases its profit by $6 for each additional unit it produces, while selling an additional unit gains $3 ($10 - $7), and producing and selling another unit gains $9, the $6 for producing and the $3 for selling 13-7 13-15 All Fixed Cost Company (25-30 minutes) This problem shows the effects on both income and the balance sheet of the two costing methods The reconciling factor between incomes in both years is the $80,000 absorption costing inventory, increase in 20X2, decrease in 20X3 20X2 20X3 Sales, 120,000 x $6 Cost of sales: Beginning inventory Costs applied at $4 Total available Ending inventory at $4 Standard cost of sales at $4 Standard gross margin Volume variance 140,000U Actual gross margin and profit $720,000 $720,000 $ 600,000 600,000 120,000 $120,000 360,000 480,000 480,000 240,000 100,000F 480,000 240,000 $340,000 $100,000 Volume variances are $600,000 - $500,000 and $360,000 - $500,000 Balance sheets 20X2 720,000 120,000 2,000,000 $2,840,000 Cash = cumulative sales Inventory, 30,000 x $4 Plant, net Total assets $ Stockholders' equity ($2,500,000 + $340,000) ($2,840,000 + $100,000) $2,840,000 20X3 $1,440,000 1,500,000 $2,940,000 $2,940,000 Sales Fixed costs Profit $720,000 500,000 $220,000 $720,000 500,000 $220,000 Balance sheets Cash = cumulative sales Plant, net Total assets $ Stockholders' equity ($2,500,000 + $220,000) ($2,720,000 + $220,000) $2,720,000 13-16 Basic Absorption Costing 720,000 2,000,000 $2,720,000 $2,940,000 (15-20 minutes) April Sales, 9,000 x $100 Standard cost of sales, 9,000 x $65 Standard gross margin, 9,000 x $35 Volume variance* Actual gross margin Selling and administrative expenses Profit $900,000 585,000 315,000 80,000 F 395,000 280,000 $ 115,000 * 13-8 $1,440,000 1,500,000 $2,940,000 Actual production Normal activity Difference Standard fixed cost Volume variance, favorable 12,000 10,000 2,000 $40 $80,000 An expanded cost of goods sold section appears as follows Beginning inventory Variable production costs, 12,000 x $25 Fixed production costs, 12,000 x $40 Total, 12,000 x $65 Less ending inventory, 3,000 x $65 Standard cost of sales, 9,000 x $65 $ $ 300,000 480,000 780,000 195,000 585,000 Note that the volume variance is also the difference between applied fixed overhead of $480,000 and budgeted fixed overhead of $400,000 May Sales, 11,000 x $100 Standard cost of sales, 11,000 x $65 Standard gross margin, 11,000 x $35 Volume variance* Actual gross margin Selling and administrative expenses Profit $1,100,000 715,000 385,000 40,000 U 345,000 280,000 $ 65,000 * Actual production Normal activity Difference Standard fixed cost Volume variance, unfavorable 9,000 10,000 1,000 $40 $40,000 Beginning inventory, 3,000 x $65 Variable production costs, 9,000 x $25 Fixed production costs, 9,000 x $40 Available for sale, 12,000 x $65 Less ending inventory, 1,000 x $65 Standard cost of sales, 11,000 x $65 $ $ 195,000 225,000 360,000 780,000 65,000 715,000 Note to the Instructor: You might wish to point out that profit dropped by $50,000, while sales increased 22.1% (from 9,000 to 11,000 units) You might remind students that Chapter showed how income increases more rapidly than sales when a company has fixed costs A manager looking at these statements must wonder why the increase in income lagged that of sales when the cost structure remained the same The next exercise in this series allows you to show how variable costing alleviates this problem 13-17 Basic Variable Costing (Continuation of 13-16) (15-20 minutes) Sales, 9,000 x $100 Standard variable cost of sales, 9,000 x $25 Contribution margin, 9,000 x $75 Fixed costs: Manufacturing $400,000 Selling and administrative 280,000 13-9 $ April 900,000 225,000 675,000 Total fixed costs Loss ($ 680,000 5,000) An expanded cost of goods sold section shows Beginning inventory Variable production costs, 12,000 x $25 Less ending inventory 3,000 x $25 Standard cost of sales 9,000 x $25 $ 300,000 75,000 $ 225,000 May $1,100,000 275,000 825,000 Sales, 11,000 x $100 Standard variable cost of sales, 11,000 x $25 Contribution margin, 11,000 x $75 Fixed costs: Manufacturing $400,000 Selling and administrative 280,000 Total fixed costs Profit $ 680,000 145,000 An expanded cost of goods sold section shows Beginning inventory, 3,000 x $25 Variable production costs, 9,000 x $25 Total, 12,000 x $25 Less ending inventory, 1,000 x $25 Standard cost of sales, 11,000 x $25 $ $ 75,000 225,000 300,000 25,000 275,000 Jasper should earn about $145,000 per month, the variable costing income Absorption costing income does not reflect long-run earning power when production and sales differ Over the long-run, sales and production would have to approximate one another, bringing total income to the variable costing equilibrium amount Note to the Instructor: In connection with the previous exercise, you might wish to show how income is affected under the two costing methods Using variable costing, we see the following Loss at 9,000 units Contribution margin on 2,000 units at $75 Income at 11,000 units ($ 5,000) 150,000 $145,000 Income under absorption costing is more complicated Both sales and production affect results The following analysis might be useful Income at 9,000 units Less inventory effect, (12,000 - 9,000) x $40 Loss at 9,000 units if production equals sales $115,000 120,000 ($ 5,000) Income at 11,000 units Plus inventory effect, (11,000 - 9,000) x $40 Income if production equals sales $ 65,000 80,000 $145,000 13-18 Throughput Costing (Continuation of 13-16) (15 minutes) Cost of sales is now the cost of materials used in production, and all other costs are expensed Material cost is $15 per unit, so direct labor and variable overhead are $10 ($25 - $15) April Sales, 9,000 x $100 $ 900,000 Cost of sales, 12,000 x $15 180,000 13-10 produced 13-44 Actual versus Standard Costs −Multiple Products Standard cost for each model: #108 0.5 $ 4.00 3.50 7.50 12.00 $27.00 Direct labor hours required Direct labor at $8 per hour Variable overhead at $7 per hour Fixed overhead at $15 per hour* Materials as given Total standard cost per unit * $90,000/6,000 hours #380 0.8 $ 6.40 5.60 12.00 14.00 $38.00 #460 1.5 $12.00 10.50 22.50 18.00 $63.00 Inventory of finished goods is $55,400 ($16,200 + $26,600 + $12,600) Units on hand (production minus sales) Standard cost per unit Inventory amounts (35 minutes) #108 600 $27 $16,200 #380 700 $38 $26,600 #460 200 $63 $12,600 Income statement for April Sales ($84,000 + $90,000 + $85,000) Standard cost of sales: #108 $27 x 2,400 #380 $38 x 1,800 #460 $63 x 1,000 Standard gross profit Fixed cost variances: Budget variance ($92,000 - $90,000) Volume variance* Actual gross profit Selling and administrative expenses Income $259,000 $ 64,800 68,400 63,000 2,000U 10,500U 196,200 62,800 12,500 50,300 28,000 $ 22,300 * The volume variance is 700 direct labor hours at $15 per hour standard direct labor hours were 5,300, computed as follows, #108 3,000 units x per unit #380 2,500 units x per unit #460 1,200 units x 1.5 per unit Total hours Actual and 1,500 2,000 1,800 5,300 Note to the Instructor: Class discussion can develop along the lines of the relative ease of application of standard costing (as opposed to the actual cost system in previous use) as well as its advantages for cost control and planning Allocating costs based on relative material costs does not provide good data In the three models the ratios of material costs not correspond to direct labor ratios and it is direct labor hours with which variable overhead (as well as direct labor) is variable Hence, relative material cost is a poor measure of activity 13-33 13-45 Income Statements and Balance Sheets 20X3 Income Statements (000s) (35 minutes) MicroCook January-June July-December Sales $9,000 (30,000 x $300) Cost of sales: Beg inv 225 Production costs: Variable 5,760 (32,000 x $180) Applied fixed 1,440 (32,000 x $45) Total 7,425 Ending inventory 675 (3,000 x $225) Cost of sales 6,750 (30,000 x $225) Gross profit 2,250 Underabsorbed or overabsorbed overhead 360 (8,000 x $45) S & A expenses Variable at 10% 900 Fixed 1,200 Total 2,460 Income (loss) ( $210) Total $12,000 (40,000 x $300) $21,000 675 225 7,560 (42,000 x $180) 1,890 (42,000 x $45) 10,125 1,125 (5,000 x $225) 9,000 3,000 13,320 3,330 16,875 1,125 15,750 5,250 (90) (2,000 x $45) 270 1,200 1,200 2,310 $ 690 2,100 2,400 4,770 $ 480 MicroCook Balance Sheets (In Thousands) June 30, 20X3 20X3 Cash* Inventory Plant and equipment (beginning less $400 and $800) Total assets $ 140 675 December 31, $ 780 1,125 2,600 $3,415 2,200 $4,105 Common stock Retained earnings (beginning balance less $210 loss, plus $690 profit) $3,000 $3,000 415 1,105 Total equities $3,415 $4,105 *Cash balances Beginning balance Sales Available Disbursements: Variable production costs Fixed production costs $1,800 - $400 depreciation Selling and administrative Total disbursements Ending balance 13-34 June 30 $ 400 9,000 9,400 December 31 $ 140 12,000 12,140 5,760 7,560 1,400 2,100 9,260 $ 140 1,400 2,400 11,360 $ 780 13-46 Pricing Dispute (15-20 minutes) Sales [(100,000 x $5) + (10,000 x Cost of goods sold at standard: Beginning inventory, given Variable production costs, given Fixed production costs, given Cost of goods available for sale Ending inventory (10,000 x $4) Cost of goods sold at standard Standard gross profit Volume variance (20,000 x $1.50) Selling and administrative expenses Income $4.50)] $545,000 $ 80,000 250,000 150,000 480,000 40,000 440,000 105,000 $ 30,000F 50,000 20,000 $ 85,000 This income statement, and the one given in the problem, contain more data than are necessary It would be sufficient to show standard cost of sales at $4 per unit The company does show $5,000 more gross profit than it did before considering the order, which is $0.50 per unit for 10,000 units The controller of Phelan Company could well argue that the $4.50 price provides $2 in gross profit, considering the variable cost of production ($2.50) as the only product cost Thus, $3 per unit ($2.50 variable cost plus $.50 gross profit) would be the rock-bottom price The problem is the meaning of "gross profit." Because Calligeris Company did not produce the additional 10,000 units, its gross profit and income increased by $5,000, which is the amount allowable under the agreement Had the company produced an additional 10,000 units, its income statement (abbreviated) would have appeared as follows: Sales Standard cost of goods sold (110,000 x $4) Standard gross profit Volume variance (30,000 x $1.50) $45,000F Selling and administrative expenses 50,000 Income $545,000 440,000 105,000 5,000 $100,000 Gross profit at standard cost would still be only $5,000 higher, but income would increase by $20,000 over that shown in the problem The increase is the contribution margin of $2 per unit ($4.50 - $2.50) At the very least the controller of Phelan Company would argue that the standard fixed cost per unit is based on too low an activity level The standard is based on 80,000 units because the volume variance is 20,000 units favorable at production of 100,000 units Even if the actual fixed cost per unit based on production of 100,000 units is used, which is $1.20 per unit ($1.50 x 80,000 = $120,000 fixed production cost/100,000 units = $1.20), the appropriate price would be $4.20 Note to the Instructor: One purpose of this problem is to show that the meanings of terms such as "cost" and "gross profit" are not fixed and constant Given the way Calligeris Company computes its gross profit, the $4.50 price does provide a gross profit and income of $5,000 If an additional 10,000 units had been produced, the company's gross profit at 13-35 standard would still have been increased by $5,000, its income by $20,000, as the income statement above shows Perhaps the moral is that the Phelan Company should have specified the meaning of "gross profit" more clearly than it did 13-47 Predetermined Overhead Rates Multiple Products (20 minutes) The predetermined overhead rate per direct labor hour is $6 ($300,000 budgeted fixed costs divided by 50,000 direct labor hours at normal activity) The standard costs are computed from this figure as follows Direct labor hours required Predetermined fixed overhead rate Standard fixed cost per unit Model 84 0.50 $6.00 $3.00 Model 204 0.80 $6.00 $4.80 Model 340 1.50 $6.00 $9.00 Variable production costs per unit Standard fixed cost per unit Total inventory cost per unit Ending inventory in units (production minus sales) Ending inventory in dollars Model 84 $4.00 3.00 $7.00 Model 204 $ 7.00 4.80 $11.80 5,000 $35,000 4,000 $47,200 Model 340 $11.00 9.00 $20.00 2,000 $40,000 Salmon Company Income Statement for 20X1 Sales ($250,000 + $280,000 + $450,000) Cost of sales at standard: Model 84 (25,000 x $7) Model 204 (20.000 x $11.80) Model 340 (18,000 x $20) Standard gross profit Volume variance, favorable (see below) Actual gross profit Selling and administrative expenses Income $980,000 $175,000 236,000 360,000 The volume variance can be calculated in either of two ways illustrated in the chapter is perhaps slightly simpler Production Standard fixed cost per unit Total fixed costs applied Model 84 30,000 $3.00 $90,000 771,000 209,000 85,200 294,200 140,000 $154,200 The method Model 204 24,000 $4.80 $115,200 Model 340 20,000 $9.00 $180,000 Total for the three products is $385,200, which is $85,200 more than budgeted Note to the Instructor: You may wish to illustrate the computation based on direct labor hours and the predetermined overhead rate of $6 per hour Production Direct labor hours required Direct labor hours worked Model 84 30,000 0.50 15,000 Model 204 24,000 0.80 19,200 Model 340 20,000 1.50 30,000 Total direct labor hours worked were 64,200 (15,000 + 19,200 + 30,000), 13-36 which is 14,200 more than the 50,000 hours used to set the predetermined rate Actual hours Hours at normal activity Difference Predetermined rate Favorable volume variance 13-48 64,200 50,000 14,200 $6 $85,200 Comprehensive Review, Budgeting, Overhead Application (75 minutes) Budgeted income statement Sales (880,000 x $20) Cost of sales [880,000 x ($6.50 + $3.50)] Gross profit Underabsorbed overhead* (100,000 x $3.50) Variable selling costs ($2 unit) Fixed selling and administrative expenses Profit before taxes Income taxes at 40% Net income $17,600,000 8,800,000 8,800,000 $ 350,000 1,760,000 5,550,000 7,660,000 1,140,000 456,000 $ 684,000 * $3,500,000/$3.50 = 1,000,000 unit base for overhead application Production of 900,000 units is 100,000 fewer than the base The easiest way to approach this part is to develop data for the end of the fourth quarter These data will also be used for the pro forma balance sheet Sales in fourth quarter (880,000 x 30% x $20) Divided by equals monthly sales Multiplied by gives accounts receivable at year-end $5,280,000 1,760,000 $3,520,000 Cash receipts Beginning accounts receivable Plus sales Subtotal Less ending accounts receivable Cash receipts $ 2,800,000 17,600,000 20,400,000 3,520,000 $16,880,000 Cash disbursements for commissions Sales in December (1/3 of fourth quarter) At 10% commission rate ($2/$20), ending balance $1,760,000 $ 176,000 Beginning liability, beginning balance sheet Commissions earned, income statement Subtotal Ending balance of liability, above Cash disbursements for commissions $ 120,000 1,760,000 1,880,000 176,000 $1,704,000 Cash disbursements direct labor Production in fourth quarter Direct labor cost at $2.00 Percentage unpaid at quarter end Accrued payroll at year end $ $ 13-37 210,000 420,000 10% 42,000 Beginning accrual, opening balance sheet Wages earned (900,000 units x $2.00 per unit) Subtotal Accrual at year end, above Cash disbursements direct labor $ 64,000 1,800,000 1,864,000 42,000 $1,822,000 Payments for raw materials Purchases in 1st month of fourth quarter (795,000/3) Price per pound Accounts payable at year end Beginning accounts payable, opening balance sheet Purchases (3,382,000 lbs x $0.80 per lb.) Subtotal Ending accounts payable, above Cash disbursements for materials 265,000 lbs $0.80 $212,000 $ 240,000 2,705,600 2,945,600 212,000 $2,733,600 Cash disbursements for taxes Year-end accrual ($456,000 x 25%) $114,000 Beginning accrual, opening balance sheet Expense for year, per income statement Subtotal Year-end accrual, above Cash disbursements-taxes $ 80,000 456,000 536,000 114,000 $ 422,000 Cash budget Beginning balance Receipts Total available Disbursements Materials Direct labor Other manufacturing costs: Fixed ($3,500,000 - $1,900,000) Variable [($6.50 - $3.20 - $2.00 = $1.30) x 900,000] Selling and administrative: Commissions Other Taxes Dividends Plant and equipment purchases Total disbursements Balance at year end $ 840,000 16,880,000 17,720,000 2,733,600 1,822,000 1,600,000 1,170,000 1,704,000 5,550,000 422,000 300,000 2,100,000 17,401,600 $ 318,400 Ruland Company Pro Forma Balance Sheet December 31, 20X2 (In Thousands of Dollars) Assets Equities 13-38 Cash (cash budget) Accounts receivable Inventory finished goods* Inventory materials* Plant and equipment Accumulated depreciation $ 318.4 3,520.0 1,660.0 249.6 18,300.0 (10,300.0) Total $13,748.0 Accounts payable Accrued commissions Accrued payroll Accrued taxes Long-term debt Common stock Retained earnings** Total $ 212.0 176.0 42.0 114.0 4,000.0 7,000.0 2,204.0 $13,748.0 * Inventories: Finished goods, beginning of year Production, $10 per unit Available for sale Cost of sales, per income statement Ending inventory Raw materials, beginning of year Purchases Available Used in production (900,000 x x $.80) Ending inventory Dollars $ 1,460,000 9,000,000 10,460,000 8,800,000 $ 1,660,000 Units 146,000 900,000 1,046,000 880,000 166,000 $ 530,000 3,382,000 3,912,000 3,600,000 312,000 424,000 2,705,600 3,129,600 2,880,000 $ 249,600 ** Beginning balance of $1,820,000 plus $684,000 net income less $300,000 dividend You could also prepare the pro forma balance sheet before the cash budget by calculating the ending balances in the asset and equity accounts, except for cash, and plugging cash The cash figure can then be checked for accuracy when the cash budget is prepared The major differences would be in the finished goods inventories and retained earnings Each would be lower by $581,000, the amount of fixed cost in the inventory (166,000 x $3.50) This answer assumes that the company would still have paid income taxes based on absorption costing income If variable costing were acceptable for tax purposes, the difference in retained earnings would be reduced by a lower tax liability 13-49 Standard Costs and Pricing (30-35 minutes) $2,740,000 Total manufacturing cost [$7,680,000 + (2,400,000 x $4.25)] Divided by 2,400,000 hours = hourly rate Multiplied by 1.50 = hourly price Revenues (2,400,000 x $11.175) Manufacturing costs Gross margin Selling and administrative expenses Profit $17,880,000 $ 7.45 $11.175 $26,820,000 17,880,000 8,940,000 6,200,000 $ 2,740,000 In this case, standard fixed cost per hour is $3.20 ($7,680,000/2,400,000) $4,015,000 Total manufacturing costs [$7,680,000 + (3,000,000 x $4.25)] Divided by 3,000,000 hours = hourly rate Multiplied by 1.50 = hourly price $10.215 13-39 $20,430,000 $ 6.81 Revenues (3,000,000 x $10.215) Manufacturing costs Gross margin Selling and administrative expenses Profit $30,645,000 20,430,000* 10,215,000 6,200,000 $ 4,015,000 In this case, standard fixed cost per hour is $2.56 ($7,680,000/3,000,000) The real issue is the likely level of sales at specific prices pricevolume relationships not the volume to use to compute standard costs Because of the company's pricing formula, the lower the volume used to set prices, the higher the prices it will set, so that a given level of sales will tend to be less achievable as long as there is a relationship between prices and volume But, simply using a particular higher level of volume to set prices does not guarantee that those prices will produce sales at that level Quite possibly, as the treasurer says, the $11.175 price (requirement 1) will mean a loss of sales But from what starting point? Sales at 3,000,000 hours? At 2,400,000 hours? The controller's comments suggest an expected sales level of something less than 3,000,000 (large underapplied overhead at that level) Would a price of $10.215 (requirement 2) raise sales expectations to the 3,000,000 hour level? If 3,000,000 hours is the basis for standard cost, the price is set at $10.215 per hour, and sales of only 2,400,000 hours materialize, income will be $436,000 [2,400,000 x ($10.215 - $4.25) - $7,680,000 - $6,200,000] From earlier chapters we know that at any given sales volume, the higher price (and contribution margin) will produce more profit Hence, the issue here is whether the lower price will produce sufficient volume to offset the decline in contribution margin In this particular case, to produce the same total contribution margin under either price, the sales volume at the lower price must be approximately 16% greater than at the higher price ($10.215 - $4.25)X X/Y = = ($11.175 - $4.25)Y 1.16 X = required volume, in hours, at lower price Y = required volume, in hours, at higher price The available facts are insufficient to allow determining an appropriate price (and, hence, absorption basis) 13-50 Product Costing Methods and CVP Analysis (30 minutes) 152,000 units ($630,000 + $434,000)/($16 - $7 - $2) costs of $7 per unit are $1,330,000/190,000 Variable production 123,500 units Gross profit using the $3 predetermined overhead rate ($630,000/210,000) is $6 ($16 - $7 - $3) and variable selling costs are $2 The company will have underabsorbed overhead of $60,000 [(210,000 - 190,000) x $3] and so the net $4 per unit ($6 - $2) must cover fixed selling and administrative costs of $434,000 plus the $60,000 underabsorbed overhead, a total of $494,000 This amount, when divided by $4, gives 123,500 As proof: Sales (123,500 x $16) Production costs: Variable Fixed ($3 x 190,000) $1,976,000 $1,330,000 570,000 13-40 Total Less ending inventory (66,500 units at $10) Gross profit Less: Underabsorbed overhead Variable selling costs Fixed selling and administrative expenses Income 1,900,000 665,000 1,235,000 741,000 60,000 247,000 434,000 $ 741,000 The answers differ in the amount of fixed costs that would be included in the ending inventory under absorption costing The ending inventory contains fixed costs of $199,500 ($3 x 66,500 units) These costs would be charged to the income statement under variable costing, requiring that much additional contribution margin At the contribution margin of $7 per unit ($16 - $7 - $2), the difference in units is 28,500 ($199,500/$7), which is the difference between the break-even points (152,000 - 123,500 = 28,500) The answer to requirement would be the same The beginning inventory would be $100,000 at $10 per unit The ending inventory would be 76,500 units, which is 10,000 units and $100,000 higher than currently Therefore, cost of sales would be the same and so would underabsorbed overhead Note to the Instructor: This problem illustrates one of the assumptions of break-even and cost-volume-profit analysis either that variable costing is used or that inventories not change Some extensions of the problem are to ask about the break-even point if production were to be 220,000 units, in which case overhead would be overabsorbed by $30,000 and break-even would fall to 101,000 units [($434,000 - $30,000)/$4] Or, a comparison of incomes at 152,000 units, absorption costing and variable costing, or at 123,500 units can easily be done At 152,000 units, the break-even point under variable costing, absorption costing would show the following, at production of 190,000 Sales (152,000 x $16) Cost of sales at $10 Gross profit at $6 Underabsorbed overhead (20,000 x $3) Variable selling costs (152,000 x $2) Fixed selling and administrative expenses Income $2,432,000 1,520,000 912,000 $ 60,000 304,000 434,000 $ 798,000 114,000 The $114,000 income is the fixed costs in the ending inventory, 38,000 units (190,000 - 152,000) at $3 A major point of this problem, then, is that if production is known, the overabsorbed or underabsorbed fixed costs are treated like fixed costs in cost-volume-profit calculations But "fixed costs" include only selling and administrative costs plus underabsorbed overhead or less overabsorbed overhead, and the divisor is: Selling price - variable production - fixed production costs costs per unit variable selling costs rather than contribution margin 13-51 Costing Methods and Evaluation of Performance (25 minutes) Wallace Division Income Statement, Second Quarter Sales (25,000 units) $2,500,000 13-41 Cost of sales: Beginning inventory (10,000 units) Production costs applied (50,000 x $62.50)* Available for sale Less ending inventory (35,000 x $62.50)* Standard cost of sales Standard gross profit Volume variance** Gross profit Selling and administrative expenses Income $ 625,000 3,125,000 3,750,000 2,187,500 1,562,500 937,500 125,000F 1,062,500 500,000 $ 562,500 * Variable cost per unit of $50 + fixed cost per unit of $12.50 ($500,000/ 40,000) = $62.50 total cost per unit ** $12.50 x (50,000 - 40,000) = $125,000 favorable The income statement for the second quarter reflects Boroff's skill at selecting a strategy that makes her performance appear better than it would if she pursued a more reasonable production-inventory policy An advocate of absorption cost accounting would argue that a buildup of inventory prior to an expected heavy selling period creates values that should be recognized in the cost assigned to inventory Such a buildup is not the case here; Boroff has no expectation of increasing sales to bolster her decision to double production for the second quarter The division now has what seems to be excessive inventory if 10,000 units has been sufficient to meet demand in the past Boroff has made a bad decision, but her performance improves when measured by income determined under absorption costing The use of variable costing would eliminate the possibility of such manipulations as Boroff performed Another way of proceeding is to keep the present costing method but require that managers justify large increases in production The company could also discourage the buildup of unneeded inventory by charging the managers a specified amount or percentage on inventory above a preset level Such a charge would offset, at least partially, the tendency to take actions such as Boroff's With respect to Boroff's fitness for the presidency, the prevailing answer is probably going to be no One might also wonder if she is one of the leading candidates because of apparent good performance in the past 13-52 Costing Methods and Performance Evaluation (25-30 minutes) This assignment is difficult, with limited information and several irrelevancies The explanation of results is that production changed greatly among the three months and so therefore did the volume variance Because the volume variance is not shown separately, it must be calculated from the cost of sales figures and the additional information The clue is that production in April was equal to the normal production used to set the standard fixed cost at $9 In April, then, cost of sales equals the total standard cost per unit because there is no volume variance Selling price is $20 per unit, which gives sales in units of 22,000 in April ($440,000/$20) Standard total cost is then $12 ($264,000/22,000) This gives a standard variable cost of $3 ($12 - $9) Production volume and volume variances for the months are calculated below March May Sales volume ($ sales/$20 per unit) 18,000 28,000 Standard cost of sales at $12 per unit 13-42 $216,000 $336,000 Cost of sales shown on statements Volume variance (unfavorable) ($45,000) Divided by standard fixed cost per unit of $9 = volume above (below) normal activity, 25,000 units (5,000) Actual production 198,000 $ 18,000 381,000 2,000 27,000 20,000 Part of the explanation, then, is the volume variance, which in April was zero, but which in March gave a boost to income of $18,000 and in May a drop in income of $45,000, in relation to what income would have been if 25,000 units had been produced each month Also, "other expenses" changed with sales volume, suggesting that there is a variable component These expenses increased from $142,000 in March to $150,000 in April, and to $162,000 in May The changes give a 10% of sales dollars ($2 per unit) variable component and $106,000 fixed amount calculated as follows For March to April, Change in cost = $8,000 = 10% Change in sales $80,000 and, for April to May, $12,000 $120,000 = 10% Done in units, the result will show a $2 variable cost per unit At any volume, the fixed component will be computed as $106,000 In March, variable costs are $36,000 ($360,000 x 10%, or 18,000 x $2), which when subtracted from the total cost of $142,000 leaves $106,000 Income statements using variable costing follow March Sales $360,000 $560,000 Variable costs ($3 production plus $2 other) (volumes of 18,000, 22,000, and 28,000) 90,000 140,000 Contribution margin at $15 per unit 270,000 420,000 Fixed costs ($225,000 production* plus $106,000 other) 331,000 331,000 Income (loss) ($ 61,000) 89,000 * April $440,000 May 110,000 330,000 331,000 ($ 1,000) $ $9 per unit x 25,000 units You might point out that the change in inventory over the period (4,000 units, computed below) times the $9 standard fixed cost per unit explains the $36,000 difference between the series of incomes computed under the two alternative approaches Income Units of Variable Absorption Sales Production Costing Costing March 18,000 27,000 ($61,000) $20,000 April 22,000 25,000 (1,000) 26,000 May 28,000 20,000 89,000 17,000 Totals 68,000 72,000 $27,000 $63,000 - 68,000 - 27,000 13-43 Inventory increase 4,000 Difference in income (due to inventory increase) $36,000 Note to the Instructor: One of the major points of this case is behavioral: Gannon does not want to explain to Progman why the results came out the way they did and uses the reasoning that generally accepted accounting principles for external reporting are used to prepare the internal statements It is possible to discuss the merits of using normal absorption costing for internal purposes without getting into the rationale for using absorption costing for external purposes Additionally, the case gives the data in relatively compact form, which should give the students an idea how difficult it can be to interpret income statements even without introducing a large number of categories on the statement As to the question whether Progman has turned the division around, it could be argued that he has, based on the results using variable costing and assuming that he has had little opportunity to implement his policies and procedures Income computed on a variable costing basis has increased by $150,000 from a loss of $61,000 to a profit of $89,000 We need more information to decide whether the corner had in fact been turned, including information about seasonality (whether April and May are high sales months), and about past performance It would also be important to know whether the apparent improvement has been purchased at the expense of reduced long-term prospects for the division or the company 13-53 Costing Methods and Product Profitability (30 minutes) Neither manager recognized the differing time requirements for different valves The relative profitabilities are as follows Contribution margin per unit Number produced in one hour Contribution margin per hour 101-27 $ 10 $40 101-34 $ $48 101-56 $ $36 The order of profitability does not depend on the contribution margin per unit in situations where all output can be sold and there is a fixed resource The 101-56 is the least profitable product and should be made only up to the committed requirements The 101-27 should also be made up to commitments, and all excess hours should be devoted to 101-34 In this case, the allocation suggested by Emerson does no harm, for if the profitability per hour of grinding time is computed on a full-cost basis, the same sequence of profitability is maintained Profit per unit, Emerson's example Hourly production Hourly profit 101-27 $ 3.00 10 $30.00 101-34 $ 4.75 $38.00 101-56 $ 6.50 $26.00 The hourly "profits" are all $10 less than hourly contribution margins, which is due to the $10 fixed cost per hour The reason that relative profitability is not distorted by this allocation is that the number of units used to determine the fixed cost per unit, which is one hour, is also the number of units used to determine the output because the analysis is done per grinding hour Because the company can use all available grinding hours, given the demand for the products, the highest profit-per-hour product should be made with the discretionary time available 13-44 Emerson was wrong in giving the selling prices of the products that would equalize their profitability, except in the sense that the prices she gave would equalize per-unit profit Neither per-unit contribution nor contribution per hour would be equalized using her method If an "equitable price" is one that provides the company with the same total profit for whichever product is made using its scarce resources, and if the $38 per hour profit now earned on 101- 34s is considered "fair," the following prices will achieve the result: 101-27 101-56 Desired hourly profit $38 $38 Divided by hourly production 10 Equals required profit per unit $ 3.80 $9.50 Full cost ($5.00 + $1.00) and ($8.40 + $2.50) 6.00 10.90 Required price $ 9.80 $20.40 The same results follow from using the required contribution margin of $48 per hour and ignoring the fixed costs 13-54 Budgeting, Cash Flow, Product Costing, Motivation (35 minutes) The break-even point is 1,406,250 units Fixed costs: Manufacturing Selling and administrative Total Contribution margin: Selling price Variable costs: Manufacturing Selling and administrative Total Contribution margin Break-even ($6,750,000/$4.80) $6,000,000 750,000 $6,750,000 $12.00 4.80 2.40 7.20 $ 4.80 1,406,250 units The new break-even point is 1,500,000 units Fixed costs old, as above new advertising campaign Total fixed costs Divided by contribution margin per unit, as above New break-even point $6,750,000 450,000 $7,200,000 $4.80 1,500,000 units Because 20X3 sales are 1,406,250 units, and the only change in cost structure is an additional outlay for advertising ($450,000), it should be immediately apparent that reported income for the year 20X8 ($420,000) is peculiar Sales are at the old break-even point, fixed costs are up, a provision has been made for a profit-sharing pool and income taxes, and the company is still reporting a profit A decline in variable costs could explain this but the variable costs per unit shown on the 20X3 income statement are the same as in the prior year The new break-even point, based on the change in fixed costs of $450,000, is 1,500,000 units ($7,200,000/$4.80 per unit), or 93,750 units more than were sold in 20X3 Hence, the profit reported in 20X3 is definitely peculiar Given the data regarding production and sales in units, 13-45 and the ending inventory, the next step is to determine the extent to which fixed costs in inventory are related to the reported profit in 20X3 Fixed manufacturing costs are $6,000,000, for a capacity of 1,875,000 units, giving a per-unit fixed cost, based on absorption at normal capacity, of $3.20 per unit Since the ending inventory contains 468,750 units, the fixed cost in inventory is $1,500,000 (468,750 x $3.20) (Note that the $3.20 per-unit fixed cost added to the per-unit variable manufacturing cost of $4.80 gives the inventory cost per unit of $8, as stated in the problem.) The $1,050,000 profit before profit-sharing and taxes in 20X3 is now understandable Contribution short of break-even (1,500,000 units - 1,406,250 units) x $4.80 Current costs carried in ending inventory (468,750 x $3.20) Reported profit ($ 450,000) 1,500,000 $1,050,000 Having determined that the 20X3 profit is a result of deferring fixed costs in inventory, the questions of continued profits, distribution of the profit-sharing pool, and even the payment of the declared dividend are particularly interesting Consider the cash forecast for the coming year Variable costs if production and sales are maintained at present levels: Manufacturing Selling Total Taxes to be paid Dividends to pay Total outlays without provision for additional advertising, out-of-pocket fixed costs, or profit-sharing pool Sales, if all collected Cash available for meeting out-of-pocket fixed costs and profit-sharing distribution profit-sharing pool Fixed costs (some of which must be cash costs) Maximum possible shortfall $ 9,000,000 3,375,000 12,375,000 420,000 200,000 12,995,000 16,875,000 $ 3,880,000 6,750,000 $ 2,870,000 Since the total fixed costs are not identified as to cash costs and noncash costs, we cannot determine whether the $3,880,000 is sufficient to cover cash costs It is unlikely that there will be sufficient cash flow to pay the dividend, the taxes, and the distribution from the pool Of course, we cannot predict what sales will be in 20X4 We can, however, suggest that discontinuance of the sales campaign should be considered carefully With an outlay of $450,000, sales increased by 206,250 units, bringing a contribution margin of $990,000 Thus, $1 spent on advertising returned $2.20 in contribution For the potential for future reported profits we can point out that if inventories remain at current levels, earning future profits depends on sales reaching levels higher than in the current year It seems clear from the case that the company has no system for implementing the management functions of planning and control A system of comprehensive budgeting encourages the interrelating of established goals Had such a system been in force, the production plan would have been 13-46 identified as out of line with sales forecasts The independent action of the president further underscores the absence of coordination at the highest levels of the firm There is no evidence that the profit-sharing plan, with its monetary incentive, has contributed to efficiency, cost reduction, or a return to profitable operations Fixed costs remained unchanged, as did per-unit variable costs, and the "profitable" operations have been explained earlier If inflation had been significant during the year and the company managed to maintain cost levels equal to last year's, the plan might have been successful The problems of motivating employees cannot be resolved, according to most current organizational behavior experts, simply by providing monetary incentives We not know enough in this case to identify all of the problems that might prevail at this company, but at least we can note that the beliefs of the chief executive are clearly considered as paramount If his personal beliefs about motivation cannot be shaken by thorough discussion with his peers (at the recent seminar), it seems unlikely that they will be influenced by comments of lower-level executives in his own company From the independent action of the president in urging production without limits and sales at a maximum effort, and given the comments of the executives, it appears that communication with the president is basically one-way That is, the production and sales managers might well have foreseen the results of the uncoordinated efforts but were unable to discuss this with the senior officer Given that the executives' performances were going to be measured (and rewarded) based on their ability to follow the senior officer's instructions, it should not be surprising that they followed the instructions The comments among the lower-level executives at the time of the last directors' meeting also identify a seldom discussed but not uncommon problem nepotism This practice can create motivation problems with unrelated employees (including executives) There are, of course, some good effects that may come from this practice For example, employees may take a proprietary interest in the firm One final note with respect to motivation Despite the apparent lack of success of the profit-sharing plan, it is obvious that management should go ahead with the distribution because failing to so would create even more serious problems 13-47 ... February standard cost of sales $192,000 Divided by February sales 24,000 Standard cost of sales $8 Less standard fixed cost of $6 = standard variable cost $2 Fixed costs = $120,000 selling and administrative... Absorption Costing (20-25 minutes) Standard cost calculations: Standard fixed cost per unit: Fixed production costs Production basis Standard fixed cost per unit: Fixed production costs Production... $40) Standard variable cost of sales: Applied variable production costs (45,000 x $22) $990,000 Ending inventory (5,000 x $22) 110,000 Standard variable cost of sales (40,000 x $22) Standard variable