CHAPTER 8

ALTERNATIVE INVENTORY COSTING METHODS: A DECISION-MAKING PERSPECTIVE

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES

Bloom’s: AP = Application C = Comprehension K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: F = Financial Reporting MA = Management Accounting

* Related to Appendix 8A: Normal Costing

** Related to Appendix 8A: Throughput Costing

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES (CONT’D)

Bloom’s: AP = Application C = Comprehension K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: F = Financial Reporting MA = Management Accounting

* Related to Appendix 8A: Normal Costing

** Related to Appendix 8A: Throughput Costing

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True-False C = Completion BE = Brief Exercise

MC = Multiple Choice Ex = Exercise SAE = Short-Answer Essay

MP = Multi-Part

* Related to Appendix 8A: Normal Costing

** Related to Appendix 8B: Throughput Costing

CHAPTER LEARNING OBJECTIVES

1. Explain the difference between absorption costing and variable costing.

Under absorption costing, fixed manufacturing costs are product costs. Under variable costing, fixed manufacturing costs are period costs.

2. Discuss the effect that changes in the production level and sales level have on net income measured under absorption costing versus under variable costing.

If the production volume is greater than the sales volume, net income under absorption costing will be greater than net income under variable costing by the amount of fixed manufacturing costs included in the ending inventory. If the production volume is less than the sales volume, net income under absorption costing will be less than it is under variable costing by the amount of fixed manufacturing costs included in the units sold during the period that were not produced during the period.

3. Discuss the advantages of variable costing versus absorption costing for management decision making.

The use of variable costing is consistent with cost-volume-profit analysis and incremental analysis. Net income under variable costing is not affected by changes in production levels. Instead, it is closely tied to changes in sales. The presentation of fixed costs in the variable-costing approach makes it easier to identify fixed costs and to evaluate their impact on the company’s profitability.

4. Discuss the effect of a normal absorption costing method on net income reported under absorption costing and variable costing (Appendix8A).

Under absorption costing, fixed manufacturing overhead is allocated to the product costs based on a predetermined overhead rate instead of actual overhead costs, and the production-volume variance is expensed to the cost of goods sold in the accounting period in which it occurs. Under variable costing, in contrast, the fixed manufacturing cost is still a period cost and is therefore expensed in the accounting period in which it occurs.

5. Discuss the effect of the throughput-costing method on net income reported under variable costing (Appendix 8B).

Under throughput costing, the product cost is only direct material costs, and inventory is valued using only direct material costs. All other manufacturing costs are treated as expenses in the accounting period in which they occur.

TRUE-FALSE STATEMENTS

1. Variable costing is the approach used for external reporting under generally accepted accounting principles.

2. Some fixed manufacturing costs of the current period are deferred to future periods through ending inventory under variable costing.

3. Net income under variable costing is unaffected by changes in production levels.

*4. If normal-absorption costing is used when preparing an absorption costing income statement, the fixed manufacturing overhead assigned to inventory is based on a predetermined fixed manufacturing overhead rate.

**5. Throughput costing is also called super absorption costing.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

6. Which of the following statements if false?

a) In full or absorption costing, all manufacturing costs are charged to the product.

b) Fixed manufacturing costs are not charged to the product under variable costing.

c) Fixed manufacturing overhead is a period cost under absorption costing.

d) Full costing is equivalent to absorption costing.

7. When comparing absorption and variable costing which of the following is false?

a) The difference between absorption costing and variable costing is the treatment of fixed manufacturing overhead.

b) Selling and administrative costs are period costs under both absorption and variable costing.

c) Companies that use just-in-time processing techniques will have significant differences between absorption and variable-costing net income.

d) Absorption costing will show a higher net income than variable costing whenever there are more units produced than sold.

8. A customer wants to purchase a large quantity of your product at a price below your normal selling price. You have a labour-intensive production process. Which of the following would be most helpful in assessing the offer?

a) throughput costing

b) either variable or absorption costing

c) absorption costing

d) variable costing

9. How are fixed manufacturing costs handled under variable costing?

a) They are subtracted from the variable cost of goods sold to determine the ending inventory value that will be recorded on the Balance Sheet.

b) They are not recorded, which is why variable costing is not used for external reporting.

c) They are recorded directly on the Balance Sheet.

d) They are treated as period costs.

10. Which of the following statements about variable costing is true?

a) As manufacturing output increases, the per-unit manufacturing cost remains constant.

b) As manufacturing output increases, the per-unit manufacturing cost decreases.

c) As manufacturing output increases, the per-unit manufacturing cost increases.

d) As manufacturing output increases, the change in the per-unit manufacturing cost is negated by the change in the per-unit selling cost.

11. Which of the following statements about absorption costing is true?

a) As manufacturing output increases, the per-unit manufacturing cost remains constant.

b) As manufacturing output increases, the per-unit manufacturing cost decreases.

c) As manufacturing output increases, the per-unit manufacturing cost increases.

d) As manufacturing output increases, the change in the per-unit manufacturing cost is negated by the change in the per-unit selling cost.

Use the following information for items 12–15.

Obama Company sells its product for $25 per unit. During 2022, it produced 20,000 units and sold 15,000 units (there was no beginning inventory). Costs per unit are: direct materials $5, direct labour $4, and variable overhead $3. Fixed costs are: $300,000 manufacturing overhead, and $50,000 selling and administrative expenses.

12. The per-unit manufacturing cost under absorption costing is

a) $12.

b) $27.

c) $29.50.

d) $32.

13. The per-unit manufacturing cost under variable costing is

a) $12.

b) $27.

c) $29.50.

d) $32.

14. Cost of goods sold under absorption costing is

a) $180,000.

b) $405,000.

c) $442,500.

d) $540,000.

15. Ending inventory under variable costing is

a) $60,000.

b) $240,000.

c) $360,000.

d) $410,000.

16. Under absorption costing, what amount of fixed overhead is deferred to a future period?

a) $70,000

b) $75,000

c) $225,000

d) $300,000

17. Under variable costing

a) only direct variable manufacturing costs are inventoriable.

b) only direct fixed manufacturing costs are inventoriable.

c) all manufacturing costs are inventoriable.

d) no manufacturing costs are inventoriable.

18. Under absorption costing

a) only direct variable manufacturing costs are inventoriable.

b) only direct fixed manufacturing costs are inventoriable.

c) all manufacturing costs are inventoriable.

d) no manufacturing costs are inventoriable.

19. Under variable costing

a) only the quantity of products sold determines cost of goods sold.

b) only the quantity of products produced determines cost of goods sold.

c) both the quantity of products produced and sold determines cost of goods sold.

d) neither the quantity of products produced or sold determines cost of goods sold.

20. Under absorption costing

a) only the quantity of products sold determines cost of goods sold.

b) only the quantity of products produced determines cost of goods sold.

c) both the quantity of products produced and sold determines cost of goods sold.

d) neither the quantity of products produced or sold determines cost of goods sold.

21. Under absorption costing

a) selling and administration overhead costs are inventoried.

b) selling and administration overhead costs are expensed as incurred.

c) only variable selling and administration costs are expensed while fixed selling and administration costs are inventoried.

d) only fixed selling and administration costs are expensed while variable selling and administration costs are inventoried.

22. Which of the following is false?

a) When units produced exceed units sold, income under absorption costing is higher than income under variable costing.

b) When units sold exceed units produced, income under absorption costing is higher than income under variable costing.

c) Net income under variable costing is closely tied to changes in sales levels.

d) When units produced equal units sold, income under absorption costing and variable costing will be the same.

23. Which of the following terms would be found on an income statement using absorption costing but not on an income statement prepared using variable costing?

a) contribution margin

b) variable manufacturing overhead

c) fixed manufacturing overhead

d) gross profit

24. Which of the following terms would be found on an income statement using variable costing but never not on an income statement prepared using absorption costing?

a) contribution margin

b) variable manufacturing overhead

c) fixed manufacturing overhead

d) gross profit

25. When production is greater than sales

a) net income under absorption costing will be greater than or less than net income under variable costing depending on the selling and administration costs.

b) net income under absorption costing will be equal to net income under variable costing.

c) net income under absorption costing will be less than net income under variable costing.

d) net income under absorption costing will be greater than net income under variable costing.

26. EKP’s unit production cost under variable costing is $5, and $7 under absorption costing. Net income under variable costing was $10,000 and $12,000 under absorption costing last year. EKP sold 15,000 units. How many units did it produce?

a) 16,000

b) 14,000

c) 17,000

d) 13,000

27. Income under absorption costing for 2021 is

a) $ 8,000.

b) $14,000.

c) $16,000.

d) $22,000.

28. Income under absorption costing for 2022 is

a) $33,000.

b) $39,000.

c) $41,000.

d) $47,000.

29. Income under variable costing for 2021 is

a) $ 8,000.

b) $14,000.

c) $16,000.

d) $22,000.

30. Income under variable costing for 2022 is

a) $33,000.

b) $39,000.

c) $41,000.

d) $47,000.

31. M&H’s unit production cost under variable costing is $25, and $32 under absorption costing. Net income under variable costing was $250,000 and $187,000 under absorption costing last year. Production equalled 63,000 units. How many units did M&H sell?

a) 72,000

b) 54,000

c) 70,000

d) 56,000

32. When production exceeds sales

a) ending inventory under variable costing will exceed ending inventory under absorption costing.

b) ending inventory under absorption costing will exceed ending inventory under variable costing.

c) ending inventory under absorption costing will be equal to ending inventory under variable costing.

d) ending inventory under absorption costing may either exceed, be equal to, or be less than ending inventory under variable costing.

33. In income statements prepared under absorption costing and variable costing, where would you find the terms contribution margin and gross profit?

Contribution margin Gross profit

a) in absorption-costing income statement in variable-costing income statement

b) in absorption-costing income statement in both income statements

c) in variable-costing income statement in absorption-costing income statement

d) in both income statements In variable-costing income statement

34. The computation of absorption-costing gross profit always involves subtracting

a) all current-year fixed manufacturing overhead.

b) some, but not all, current-year fixed manufacturing overhead.

c) all fixed manufacturing overhead applied to units sold in the current year.

d) no fixed manufacturing overhead.

35. When units produced exceeds units sold

a) net income under absorption costing is higher than net income under variable costing.

b) net income under absorption costing is lower than net income under variable costing.

c) net income under absorption costing equals net income under variable costing.

d) the relationship between net income under absorption costing and net income under variable costing cannot be predicted.

36. When units sold exceeds units produced

a) net income under absorption costing is higher than net income under variable costing.

b) net income under absorption costing is lower than net income under variable costing.

c) net income under absorption costing equals net income under variable costing.

d) the relationship between net income under absorption costing and net income under variable costing cannot be predicted.

37. Under absorption costing when production exceeds sales in a year,

a) inventory values and cost of goods sold are higher than under variable costing.

b) inventory values and cost of goods sold are lower than under variable costing.

c) inventory values are lower and cost of goods sold are higher than under variable costing.

d) inventory values are higher and cost of goods sold are lower than under variable costing.

38. Under absorption costing when production equals sales in a year,

a) inventory values and cost of goods sold are higher than under variable costing.

b) inventory values and cost of goods sold are lower than under variable costing.

c) inventory values and cost of goods sold are the same as under variable costing.

d) inventory values are higher and cost of goods sold is lower than under variable costing.

39. Under absorption costing when inventory increases in a year,

a) there are more fixed costs charged to income.

b) there are less fixed costs charged to income.

c) fixed costs in inventory remain the same regardless of inventory changes.

d) fixed costs in inventory are reduced.

40. Under GAAP,

a) absorption costing is required to be used for the costing of inventory for external reporting purposes.

b) net income highlights differences between variable and fixed costs.

c) measured net income is often used externally to evaluate performance, justify cost increases, or evaluate new projects.

d) measured net income is often used internally to evaluate performance, justify cost increases or evaluate new projects.

41. When absorption costing is used

a) for external reporting, variable costing can still be used for internal reporting purposes.

b) management may be tempted to overproduce in a given period in order to decrease net income.

c) it facilitates cost-volume-profit analysis.

d) and production exceeds sales, absorption costing reports a lower net income than variable costing.

42. Absorption costing

a) is preferred to variable costing for external reporting purposes, but either method is acceptable.

b) normally results in higher net income than variable costing, and is therefore required for income tax purposes.

c) is not allowed for external reporting purposes.

d) is required under GAAP.

43. Management may be tempted to overproduce

a) when using variable costing, in order to increase net income.

b) when using variable costing, in order to decrease net income.

c) when using absorption costing, in order to increase net income.

d) when using absorption costing, in order to decrease net income.

44. If a division manager’s compensation is based upon the division’s net income, the manager may decide to meet the net income targets by increasing production

a) when using variable costing, in order to increase net income.

b) when using variable costing, in order to decrease net income.

c) when using absorption costing, in order to increase net income.

d) when using absorption costing, in order to decrease net income.

Use the following information for items 45–48.

The Colin Division of Mochrie Company sells its product for $30 per unit. Variable costs per unit include: manufacturing, $12; and selling and administrative, $2. Fixed costs are: $200,000 manufacturing overhead, and $50,000 selling and administrative. There was no beginning inventory. Expected sales for next year are 40,000 units. Ryan Stiles, the manager of the Colin Division, is under pressure to improve the performance of the Division. As part of the planning process, he has to decide whether to produce 40,000 units or 50,000 units next year..

45. What would the manufacturing cost per unit be under absorption costing for each alternative?

40,000 units 50,000 units

a) $12.00 $12.00

b) $14.00 $14.00

c) $16.00 $17.00

d) $17.00 $16.00

46. What would the manufacturing cost per unit be under variable costing for each alternative?

40,000 units 50,000 units

a) $12.00 $12.00

b) $14.00 $14.00

c) $16.00 $17.00

d) $17.00 $16.00

47. What would the net income be under absorption costing for each alternative?

40,000 units 50,000 units

a) $390,000 $390,000

b) $390,000 $550,000

c) $390,000 $440,000

d) $430,000 $390,000

48. What would the net income be under variable costing for each alternative?

40,000 units 50,000 units

a) $390,000 $390,000

b) $390,000 $550,000

c) $390,000 $440,000

d) $430,000 $390,000

49. Expected sales for next year for the Brady Division are 120,000 units. Drew Carey, the manager of the Brady Division, is under pressure to improve the performance of the Division. As part of the planning process, he has to decide whether to produce 120,000 units or 140,000 units next year. The Brady Division will have higher net income, if Drew Carey decides to

a) produce 140,000 units if income is measured under absorption costing.

b) produce 140,000 units if income is measured under variable costing.

c) produce 120,000 units if income is measured under absorption costing.

d) produce 120,000 units if income is measured under variable costing.

50. Which of the following is not a potential advantage of variable costing relative to absorption costing?

a) Net income calculated under variable costing is unaffected by changes in production levels.

b) It is easier to understand the impact of fixed and variable costs on the computation of net income when variable costing is used.

c) The use of variable costing is consistent with cost-volume-profit analysis.

d) Net income calculated under variable costing is not closely tied to changes in sales levels.

*51. Absorption-costing net income can be reconciled to variable-costing net income by

a) deducting deferred ending inventory fixed manufacturing overhead from the absorption-costing net income.

b) deducting deferred ending inventory variable manufacturing overhead from the variable-costing net income.

c) adding deferred ending inventory fixed manufacturing overhead from the absorption-costing net income.

d) adding deferred ending inventory variable manufacturing overhead from the variable-costing net income.

*52. A production-volume variance occurs whenever

a) actual production equals budgeted production.

b) actual sales equals budgeted production.

c) actual production deviates from budgeted production.

d) budgeted sales deviates actual production.

*53. A production-volume variance is

a) usually expensed to cost of goods sold and only occurs under variable costing.

b) never expensed and only occurs under absorption costing.

c) never expensed and only occurs under variable costing.

d) usually expensed to cost of goods sold and only occurs under absorption costing.

*54. Normal-absorption costing uses

a) actual costs for direct materials, direct labour and variable and fixed overhead.

b) actual costs for direct materials, and direct labour, and a predetermined overhead rate for allocating variable and fixed overhead costs to production units.

c) actual costs for direct materials, direct labour and variable overhead, and a predetermined overhead rate for fixed overhead.

d) variable costing for direct materials, direct labour and variable overhead and a predetermined overhead rate for fixed overhead.

*55. The use of normal costing with absorption costing

a) is used because it is easier than actual costing with absorption costing.

b) is used because it is more practical than actual costing.

c) is essentially the same as using actual costing; accountants have created the term for the sake of semantics.

d) means that only normal costs are used in assigning costs to production; any unexpected costs that occur are immediately expenses as period costs.

*56. Using normal-absorption costing to cost units of production, Steven Harper Co. has gathered the following information:

Fixed manufacturing overhead was estimated to be $120,000 for the year.

Actual production was 40,000 units.

Actual fixed manufacturing overhead costs incurred were $125,000.

What is the result of this difference between the estimated fixed overhead and actual fixed overhead?

a) The difference is expensed as a period cost the way variable costing immediately expenses fixed overhead as a period cost.

b) The difference is over or under-applied overhead that if immaterial, will be closed out to cost of goods sold at year end.

c) The difference will be held in inventory and taken to cost of goods sold when the units are sold next year.

d) There is no difference.

*57. Under normal-absorption costing

a) only direct variable manufacturing costs are inventoriable.

b) only direct fixed manufacturing costs are inventoriable.

c) a predetermined overhead rate is used to allocate overheads.

d) overhead costs are charged directly as incurred.

**58. Which of the following criteria should be met before a company chooses throughput costing?

a) Conversion costs are fixed costs and do not vary proportionately with the units of production.

b) Use of assembly-line and continuous processes that are not highly automated.

c) Conversion costs are variable and remain constant with the units of production.

d) Management favour towards cost accounting information that is helpful for the long term.

**59. Under throughput costing,

a) product costs are only direct labour costs.

b) inventory is valued using only direct material costs.

c) all manufacturing costs are treated as expenses.

d) all manufacturing costs are treated as product costs.

**60. Choose the answer that is false regarding throughput costing.

a) Throughput costing treats all costs as period costs except direct labour.

b) Throughput costing treats all costs as period costs except direct materials.

c) Throughput costing is also known as super-variable costing for its close relationship to variable costing.

d) Assembly line and continuously automated companies are most likely to choose this method of costing than other companies.

**61. Advantages of throughput costing include all of the following except

a) throughput costing reduces management’s tendency to build inventory levels over which to spread fixed manufacturing costs of production.

b) throughput costing motivates managers to reduce operating costs such as direct labour and variable overhead, which are treated as period costs rather than product costs.

c) throughput costing is simpler than normal costing or absorption costing since all manufacturing overhead is expensed as a period cost immediately.

d) throughput costing motivates managers to reduce operating costs such as direct materials and variable overhead, which are treated as period costs rather than product costs.

**62. A major conceptual difference between throughput costing and variable costing is

a) under variable costing, direct labour and variable manufacturing overhead are charged to income as period expenses.

b) under throughput costing, direct labour and variable manufacturing overhead are deferred in inventory rather than charged to income as period expenses.

c) under throughput costing, direct labour and variable manufacturing overhead are charged to income as period expenses.

d) there are no conceptual differences between the two methods.

**63. Under throughput costing

a) only direct variable manufacturing costs are inventoriable.

b) only direct fixed manufacturing costs are inventoriable.

c) only direct material costs are inventoriable.

d) only direct labour costs are inventoriable.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

BRIEF Exercises

Brief Exercise 64

Huskie Company produces footballs. It incurred the following costs this year:

Direct materials $ 75,000

Direct labour 80,000

Fixed manufacturing overhead 125,000

Variable manufacturing overhead 60,000

Fixed selling and administrative expenses 90,000

Variable selling and administrative expenses 33,000

What are the total product costs for the company under variable costing?

Solution 64 (3–5 min.)

Direct materials $ 75,000

Direct labour 80,000

Variable manufacturing overhead 60,000

Total product costs under variable costing $215,000

Brief Exercise 65

Huskie Company produces footballs. It incurred the following costs this year:

Direct materials $ 75,000

Direct labour 80,000

Fixed manufacturing overhead 125,000

Variable manufacturing overhead 60,000

Fixed selling and administrative expenses 90,000

Variable selling and administrative expenses 33,000

What are the total product costs for the company under absorption costing?

Solution 65 (3–5 min.)

Direct materials $ 75,000

Direct labour 80,000

Fixed manufacturing overhead 125,000

Variable manufacturing overhead 60,000

Total product costs under variable costing $340,000

Brief Exercise 66

In 2022, the ABC Company produced 90,000 units but only sold 70,000 units. Costs incurred were:

Direct materials $ 20,000

Direct labour 30,000

Variable manufacturing overhead 15,000

Variable selling and administration 18,000

Fixed manufacturing overhead 25,000

Fixed selling and administration 15,000

Total $123,000

Instructions

a) Calculate the value of inventory at the end of the year assuming ABC uses absorption costing.

b) Calculate the value of inventory at the end of the year assuming ABC uses variable costing.

Solution 66

a) b)

Absorption Variable

Direct materials $ 20,000 $20,000

Direct labour 30,000 30,000

Variable manufacturing overhead 15,000 15,000

Variable selling and administration 0 0

Fixed manufacturing overhead 25,000 0

Fixed selling and administration 0 0

$90,000 $65,000

Amount produced 90,000 90,000

Unit cost $1.00 $0.722

Amount in inventory 20,000 20,000

Inventory value $20,000 $14,440

Brief Exercise 67

During 2022 EKP Ltd. produced 40,000 units and sold 30,000 for $15 per unit. Variable manufacturing costs were $7 per unit. Annual fixed manufacturing overhead was $40,000 ($1 per unit). Variable selling and administrative costs were $2 per unit sold, and fixed selling and administrative costs were $70,000. Prepare a variable-costing income statement.

Solution 67 (5–7 min.)

Sales (30,000 x $15) $450,000

Variable cost of goods sold (30,000 x $7) $210,000

Variable selling and administrative expense (30,000 x $2) 60,000 270,000

Contribution margin 180,000

Fixed manufacturing overhead 40,000

Fixed selling and administrative expense 70,000 110,000

Net income $70,000

Brief Exercise 68

During 2022 EKP Ltd. produced 40,000 units and sold 30,000 for $15 per unit. Variable manufacturing costs were $7 per unit. Annual fixed manufacturing overhead was $40,000 ($1 per unit). Variable selling and administrative costs were $2 per unit sold, and fixed selling and administrative costs were $70,000. Prepare an absorption-costing income statement.

Solution 68 (5–7 min.)

Sales (30,000 x $15) $450,000

Cost of goods sold (30,000 x $8) 240,000

Gross margin 210,000

Variable selling and administrative expense (30,000 x $2) 60,000

Fixed selling and administrative expense 70,000 130,000

Net income $ 80,000

Brief Exercise 69

Simplex Computer Systems has crews of computer repair people that it sends out to job sites. It has the following information on its activities in the previous year:

Total corporate overhead incurred $1,250,000

Total corporate overhead estimated for next year $1,500,000

Hours worked by computer technicians 120,000

Budgeted technician hours for the next year 150,000

Instructions

Calculate the company’s predetermined overhead rate for the next year.

Solution 69

$1,500,000 ÷150,000 = $10.00 per hour worked

Brief Exercise 70

During 2022, Gortle Industries is intending to sell 50,000 units for $10 per unit. Variable manufacturing costs are $3 per unit. Annual fixed manufacturing overhead is $200,000. Variable selling and administrative costs are $1 per unit sold, and fixed selling and administrative costs are $30,000. Allan Wong, the company manager, is trying to decide whether to produce 50,000 units or 60,000 units in 2022.

Instructions

Prepare an absorption-costing income statement for 2022 for both levels of production.

Solution 70

At production level of 50,000 units:

Sales (50,000 × $10) $500,000

Cost of goods sold (50,000 × $3) + (50,000 x (200,000 / 50,000)) 350,000

Gross margin 150,000

Variable selling and administrative expenses (50,000 × $1) $50,000

Fixed selling and administrative expenses 30,000 80,000

Net income $70,000

At production level of 60,000 units:

Sales (50,000 × $10) $500,000

Cost of goods sold (50,000 × $3) + (50,000 x (200,000 / 60,000)) 316,667

Gross margin 183,333

Variable selling and administrative expenses (50,000 × $1) $50,000

Fixed selling and administrative expenses 30,000 80,000

Net income $103,333

Brief Exercise 71

During 2022, Gortle Industries is intending to sell 50,000 units for $10 per unit. Variable manufacturing costs are $3 per unit. Annual fixed manufacturing overhead is $200,000. Variable selling and administrative costs are $1 per unit sold, and fixed selling and administrative costs are $30,000. Allan Wong, the company manager, is trying to decide whether to produce 50,000 units or 60,000 units in 2022.

Instructions

1. Prepare a variable-costing income statement for 2022 for both levels of production.
2. Explain the results.

Solution 71

At production level of 50,000 units:

Sales (50,000 × $10) $500,000

Variable Cost of goods sold (50,000 × $3) 150,000

Variable selling and administrative expenses (50,000 × $1) 50,000

Contribution margin 300,000

Fixed manufacturing overhead 200,000

Fixed selling and administrative expenses 30,000

Net income $70,000

At production level of 60,000 units:

Sales (50,000 × $10) $500,000

Variable Cost of goods sold (50,000 × $3) 150,000

Variable selling and administrative expenses (50,000 × $1) 50,000

Contribution margin 300,000

Fixed manufacturing overhead 200,000

Fixed selling and administrative expenses 30,000

Net income $70,000

1. Under variable costing, net income is not affected by the number of units produced. Net income is $70,000 whether 50,000 or 60,000 units are produced because fixed manufacturing overhead is treated as a period expense. Unlike under absorption costing, under variable costing, no fixed manufacturing overhead is deferred through inventory buildup.

*Brief Exercise 72

Assuming that Senior Industries is in its first month of production, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

Compute the unit product cost assuming that Senior Industries uses absorption costing.

*Solution 72

Direct materials $ 240

Direct labour 280

Variable manufacturing overhead 100

Fixed manufacturing overhead ($800,000 ÷ 20,000 units produced) 40

Manufacturing cost per unit $660

*Brief Exercise 73

Assuming that Senior Industries is in its first month of production, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

Compute the unit product cost assuming that Senior Industries uses variable costing.

*Solution 73

Direct materials $ 240

Direct labour 280

Variable manufacturing overhead 100

Fixed manufacturing overhead 0

Manufacturing cost per unit $620

*Brief Exercise 74

Assuming that Senior Industries is in its first month of production, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

How much of the ending inventory consists of fixed manufacturing overhead cost deferred in inventory to the next period?

*Solution 74

4,000 ending inventory units x ($800,000 / 20,000) = $160,000

*Brief Exercise 75

Whiff Candles estimated overhead costs at the start of 2022 to be $3,600,000 for the year. In 2022, Whiff planned for and produced 1,800,000 candles with variable manufacturing costs of $0.25 per candle and total actual fixed overhead costs of $3,200,000. It sold 1,550,000 candles for $5 each during the year. Fixed selling and admin costs for 2022 totalled $456,000.

Instructions

Calculate net income for Whiff Candles in 2022 using a normal-absorption costing approach.

*Solution 75

Sales ($5 x 1,550,000) $7,750,000

Variable manufacturing costs ($0.25 x 1,550,000) 387,500

Fixed manufacturing cost

($3,600,000 / 1,800,000 =$2 x 1,550,000) 3,100,000

Gross Margin $4,262,500

Selling and Admin 456,000

Net income $3,806,500

*Brief Exercise 76

Malcolm Widgets estimated overhead costs at the start of 2022 to be $2,160,000 for the year. In 2022, Malcolm planned for and produced 1,080,000 widgets with variable manufacturing costs of $0.35 per widget and total actual fixed overhead costs of $1,920,000. It sold 930,000 widgets for $3 each during the year. Fixed selling and admin costs for 2022 totalled $273,600.

Instructions

Calculate net income for Whiff Candles in 2022 using a normal- absorption costing approach.

*Solution 76 (5-7 minutes)

. Sales ($3 x 930,000) $2,790,000

Variable manufacturing costs ($0.35 x 930,000) 325,500

Fixed manufacturing cost

($2,160,000 / 1,080,000 =$2 x 930,000) 1,860,000

Gross Margin $604,500

Selling and Admin 273,600

Net income $330,900

.

*Brief Exercise 77

Explain why manufacturing costs per unit are higher under absorption costing than variable costing.

*Solution 77

Manufacturing costs per unit are higher under absorption costing than variable costing because fixed manufacturing costs are allocated to units produced based on the predetermined rate under absorption costing. Under variable costing, in contrast, fixed manufacturing costs are still a period cost and are therefore expensed.

**Brief Exercise 78

Assuming that Senior Industries is in its first month of production, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

Compute the unit product cost using throughput costing and variable costing.

**Solution 78

Throughput costing Variable costing

Direct materials $240 $240

Direct labour 280

Variable manufacturing - 100

Fixed manufacturing overhead - -

Manufacturing cost per unit $240 $620

**Brief Exercise 79

Assuming that Senior Industries is in its first month of production, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

How much is the value of ending inventory under throughput costing versus variable costing?

**Solution 79

Throughput costing: 4,000 ending inventory units x $240 = $960,000

Variable costing: 4,000 ending inventory units x ($240 + $280 + $100) = $2,480,000

**Brief Exercise 80

Assuming that Senior Industries is in its first month of production, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

How much is the throughput contribution for the month?

**Solution 80

Revenue ($800 x 16,000) $12,800,000

Direct materials $240 x 16,000) 3,840,000

Throughput contribution $ 8,960,000

**Brief Exercise 81

Habitat Home Security’s controller has prepared the following budgeted income statement for 2022. She has based her estimates on sales of 50,000 security systems.

Budgeted sales $6,500,000

Budgeted costs:

Raw materials 900,000

Direct labour 1,400,000

Variable factory overhead 1,350,000

Fixed factory overhead 1,150,000

Fixed selling & admin 350,000

Total budgeted costs $5,150,000

Budgeted operating income $1,350,000

Instructions

Habitat Home is now estimating sales to increase to 55,000 units in 2022. Recalculate Habitat Home’s operating income for 2022 using throughput costing if this increase does occur.

**Solution 81

Budgeted Sales $7,150,000

Budgeted Costs:

Raw materials 990,000*

Direct labour 1,400,000

Variable factory overhead 1,350,000

Fixed factory overhead 1,150,000

Fixed selling & admin 350,000

Total budgeted costs $5,240,000

Budgeted operating income $1,910,000

*($900,000 / 50,000 = $18 per unit x 55,000)

Exercises

Exercise 82

Determine whether each of the following would be a product cost or a period cost under an absorption or a variable system for K&N Company:

Absorption Variable

Product Period Product Period

a) Direct Materials ________ ________ ________ ________

b) Variable Indirect Materials ________ ________ ________ ________

c) Direct Labour ________ ________ ________ ________

d) Factory Utilities (variable) ________ ________ ________ ________

e) Factory Rent ________ ________ ________ ________

f) Indirect Labour ________ ________ ________ ________

g) Factory Supervisory Salaries ________ ________ ________ ________

h) Factory Maintenance (variable) ________ ________ ________ ________

i) Factory Depreciation ________ ________ ________ ________

j) Delivery Truck Insurance ________ ________ ________ ________

k) Sales salaries ________ ________ ________ ________

l) Sales commissions ________ ________ ________ ________

Solution 82 (10–15 min.)

Absorption Variable

Product Period Product Period

a) Direct Materials ___X____ ________ ___X____ ________

b) Variable Indirect Materials ___X____ ________ ___X____ ________

c) Direct Labour ___X____ ________ ___X____ ________

d) Factory Utilities (variable) ___X____ ________ ___X____ ________

e) Factory Rent ___X____ ________ ________ ___X____

f) Indirect Labour ___X____ ________ ___X____ ________

g) Factory Supervisory Salaries ___X____ ________ ________ ___X____

h) Factory Maintenance (variable) ___X____ ________ ___X____ ________

i) Factory Depreciation ___X____ ________ ________ ___X____

j) Delivery Truck Insurance ________ ___X____ ________ ___X____

k) Sales salaries ________ ___X____ ________ ___X____

l) Sales commissions ________ ___X____ ________ ___X____

Exercise 83

Fresh Air Products manufactures and sells a variety of camping products. Recently the company opened a new plant to manufacture a deluxe portable cooking unit. Cost and sales data for the first month of operations are shown below:

Manufacturing Costs

Fixed overhead $ 150,000

Variable overhead $ 7 per unit

Direct labour $ 15 per unit

Direct material $ 33 per unit

Beginning inventory 0 units

Units produced 15,000

Units sold 11,000

Selling and administrative costs

Fixed $ 121,000

Variable $ 3 per unit sold

The portable cooking unit sells for $90. Management is interested in the opening month’s results and has asked for an income statement.

Instructions

Assume the company uses absorption costing. Calculate the production cost per unit, and prepare an income statement for the month of June 2022.

Solution 83 (8–12 min.)

Per Unit

Direct materials $33

Direct labour 15

Variable overhead 7

Fixed overhead ($150,000 ÷ 15,000) 10

Total cost $65

FRESH AIR PRODUCTS

Income Statement (Absorption Costing)

For the Month Ending June 30, 2022

Sales (11,000 x $90) $990,000

Less: Cost of goods sold (11,000 x $65) 715,000

Gross profit 275,000

Less: Selling & administrative costs

Variable (11,000 x $3) $ 33,000

Fixed 121,000 154,000

Net income $121,000

Exercise 84

Fresh Air Products manufactures and sells a variety of camping products. Recently the company opened a new plant to manufacture a deluxe portable cooking unit. Cost and sales data for the first month of operations are shown below:

Manufacturing Costs

Fixed overhead $ 150,000

Variable overhead $ 7 per unit

Direct labour $ 15 per unit

Direct material $ 33 per unit

Beginning inventory 0 units

Units produced 15,000

Units sold 11,000

Selling and administrative costs

Fixed $ 121,000

Variable $ 3 per unit sold

The portable cooking unit sells for $90. Management is interested in the opening month’s results and has asked for an income statement.

Instructions

Assume the company uses variable costing.

a) Calculate the production cost per unit, and prepare an income statement for the month of June 2022.

b) Explain the amount by which absorption costing income would differ from variable costing income. (Calculate difference without computing absorption-costing income.)

Solution 84 (9–13 min.)

a)

Per Unit

Direct materials $33

Direct labour 15

Variable overhead 7

Total cost $55

FRESH AIR PRODUCTS

Income Statement (Variable Costing)

For the Month Ending June 30, 2022

Sales (11,000 x $90) $990,000

Less: Variable costs

Variable cost of goods sold

(11,000 x $55) $605,000

Variable selling & administrative costs

(11,000 x $3) 33,000 638,000

Contribution margin 352,000

Less: Fixed costs

Fixed overhead 150,000

Fixed selling & administrative costs 121,000 271,000

Net income $ 81,000

b) When production exceeds sales, absorption-costing net income will exceed variable-costing net income by an amount equal to the fixed overhead rate times the number of units in ending inventory. The ending inventory for June was 4,000 units and the fixed overhead rate was $10 per unit ($150,000 ÷ 15,000). Therefore, absorption-costing income would exceed variable-costing income by $40,000 (4,000 x $10).

Exercise 85

Momentum Bikes manufactures a basic road bicycle. Production and sales data for the most recent year are as follows (no beginning inventory):

Variable production costs $85 per bike

Fixed production costs $530,000

Variable selling & administrative costs $17 per bike

Fixed selling & administrative costs $480,000

Selling price $195 per bike

Production 21,200 bikes

Sales 19,000 bikes

Instructions

a) Prepare a brief income statement using absorption costing.

b) Calculate the amount to be reported for inventory in the year end absorption-costing balance sheet.

Solution 85 (8–12 min.)

a)

Sales (19,000 x $195) $3,705,000

Less: Cost of goods sold (19,000 x $110*) 2,090,000

Gross profit 1,615,000

Less: selling & administrative costs

[(19,000 x $17) + $480,000] 803,000

Net income $ 812,000

*Variable production costs $ 85 per bike

Fixed production costs ($530,000 ÷ 21,200) 25 per bike

Total cost of goods sold per unit $110 per bike

b) (21,200 – 19,000) x $110 = $242,000

Exercise 86

Momentum Bikes manufactures a basic road bicycle. Production and sales data for the most recent year are as follows (no beginning inventory):

Variable production costs $85 per bike

Fixed production costs $530,000

Variable selling & administrative costs $17 per bike

Fixed selling & administrative costs $480,000

Selling price $195 per bike

Production 21,200 bikes

Sales 19,000 bikes

Instructions

a) Prepare a brief income statement using variable costing.

b) Calculate the amount to be reported for inventory in the year end variable-costing balance sheet.

Solution 86 (8–12 min.)

a)

Sales (19,000 x $195) $3,705,000

Less: Variable costs

Variable cost of goods sold

(19,000 x $85) $1,615,000

Variable selling & admin. costs

(19,000 x $17) 323,000 1,938,000

Contribution margin 1,767,000

Less: Fixed costs

Fixed production costs 530,000

Fixed selling & administrative costs 480,000 1,010,000

Net income $ 757,000

b) (21,200 – 19,000) x $85 = $187,000

Exercise 87

Conan Company produces sporting equipment. In 2021, the first year of operations, Conan produced 25,000 units and sold 18,000 units. In 2022, the production and sales results were exactly reversed. In each year, selling price was $100, variable manufacturing costs were $40 per unit, variable selling expenses were $8 per unit, fixed manufacturing costs were $540,000, and fixed administrative expenses were $200,000.

Instructions

a) Calculate net income under variable costing for each year.

b) Calculate net income under absorption costing for each year.

c) Reconcile the differences each year in income from operations under the two costing approaches.

Solution 87 (20–25 min.)

a) 2021: [18,000 x ($100 – $40 – $8)] – ($540,000 + $200,000) = $196,000

2022: [25,000 x ($100 – $40 – $8)] – ($540,000 + $200,000) = $560,000

b) 2021: [18,000 x ($100 – $40 – $21.60)] – [$200,000 + (18,000 x $8)] = $347,200

2022: {(25,000 x $100) – [7,000 x ($40 + $21.60)] – [18,000 x ($40 + $30)]} – [$200,000 + (25,000 x $8)] = $408,800

c) The variable costing and the absorption-costing income can be reconciled as follows:

2021 variable-costing income $196,000

Fixed manufacturing costs deferred at 12/31/21

under absorption costing (7,000 x $21.60) 151,200

2021 absorption costing income $347,200

2022 variable-costing income $560,000

2021 fixed manufacturing costs expensed in 2022

under absorption costing (7,000 x $21.60) (151,200)

2022 absorption-costing income $ 408,800

Exercise 88

Conan Company produces sporting equipment. In 2021, the first year of operations, Conan produced 25,000 units and sold 18,000 units. In 2022, the production and sales results were exactly reversed. In each year, selling price was $100, variable manufacturing costs were $40 per unit, variable selling expenses were $8 per unit, fixed manufacturing costs were $540,000, and fixed administrative expenses were $200,000.

Instructions

a) Prepare an income statement for 2021 using variable costing.

b) Prepare an income statement for 2021 using absorption costing.

c) Reconcile the differences each year in income from operations under the two costing approaches.

Solution 88 (15–20 min.)

a)

CONAN COMPANY

Income Statement (Variable Costing) 2021

Sales (18,000 x $100) $1,800,000

Less: Variable costs

Variable cost of goods sold

(18,000 x $40) $720,000

Variable selling & administrative costs

(18,000 x $8) 144,000 864,000

Contribution margin 936,000

Less: Fixed costs

Fixed manufacturing costs 540,000

Fixed selling & administrative costs 200,000 740,000

Net income $ 196,000

b)

CONAN COMPANY

Income Statement (Absorption Costing) 2021

Sales (18,000 x $100) $1,800,000

Less: Cost of goods sold (18,000 x $61.60) 1,108,800

Gross profit 691,200

Less: Selling & administrative costs

Variable (18,000 x $8) $ 144,000

Fixed 200,000 344,000

Net income $ 347,200

c) The variable costing and the absorption-costing income can be reconciled as follows:

2021 variable-costing income $196,000

Fixed manufacturing costs deferred at 12/31/21

under absorption costing (7,000 X $21.60) 151,200

2021 absorption-costing income $347,200

Exercise 89

E&P Ltd. produced 20,000 units last year. Under absorption costing, operating income was $3,000 more than it was under variable costing. Variable manufacturing costs per unit were $17, variable selling and administration costs per unit were $5, total fixed manufacturing overhead was $150,000, and total fixed selling and administration costs were $78,000. Determine how many units were sold last year.

Solution 89 (4–6 min.)

The difference between operating income under absorption costing and operating income under variable costing is caused by the difference between the number of units produced and the number sold multiplied by the fixed manufacturing cost per unit.

In this case, fixed manufacturing cost per unit equals $150,000 ÷ 20,000 units, or $7.50. Therefore, $3,000 ÷ $7.50/unit = 400 units.

If operating income under absorption costing is greater than under variable costing, it means that production exceeded sales. Therefore, if production equalled 20,000 units, sales equalled 19,600 units.

Exercise 90

ABC Company uses the FIFO method for costing its inventory. During the year it has the following information:

Opening inventory 300 units

Units produced 600

Units sold 600

Prior year fixed overhead costs $50 per unit

Current-year fixed overhead costs $44 per unit

Instructions

Calculate the difference between operating income in the current year if the company uses variable or absorption costing.

Solution 90 (4–6 min.)

Difference: 300 units x ($50 – $44) = $1,800

Absorption costing will result in $1,800 less income in the current year since the current overhead rate is lower than last year’s and more fixed overhead is released into income.

Exercise 91

McCartney Pumps is a division of UK Controls Corporation. The division manufactures and sells a pump used in a wide variety of applications. During the coming year it expects to sell 25,000 units for $17 per unit. George Harrison manages the division. He is considering producing either 25,000 or 35,000 units during the period. Other information is presented in the schedule.

Division information – 2022

Beginning inventory 0

Expected sales in units 25,000

Selling price per unit $17.00

Variable manufacturing cost per unit $6.00

Fixed manufacturing overhead cost (total) $140,000

Fixed manufacturing overhead costs per unit

Based on 25,000 units $ 5.60 per unit ($140,000 ÷ 25,000)

Based on 35,000 units $ 4.00 per unit ($140,000 ÷ 35,000)

Manufacturing cost per unit

Based on 25,000 units $ 11.60 per unit ($6.00 variable + $5.60 fixed)

Based on 35,000 units $ 10.00 per unit ($6.00 variable + $4.00 fixed)

Selling and administrative expense (all fixed) $37,000

Instructions

a) Prepare an absorption-costing income statement with one column showing the results if 25,000 units are produced, and one column showing the results if 35,000 units are produced.

b) Why is income different for the two production levels, when sales are 25,000 units either way?

Solution 91 (15–20 min.)

a)

MCCARTNEY PUMPS DIVISION

Income Statement

For the Year Ended 2022

Absorption Costing

25,000 35,000

Produced Produced

Sales (25,000 units x $17) $425,000 $425,000

Cost of goods sold 290,000 (25,000 x $11.60) 250,000 (25,000 x $10)

Gross profit 135,000 175,000

Fixed selling and

administrative expenses 37,000 37,000

Net income $ 98,000 $138,000

b) Net income is $40,000 higher when 35,000 units are produced, because under absorption costing $40,000 of fixed manufacturing costs (10,000 x $4) are deferred to the next year.

Exercise 92

McCartney Pumps is a division of UK Controls Corporation. The division manufactures and sells a pump used in a wide variety of applications. During the coming year it expects to sell 25,000 units for $17 per unit. George Harrison manages the division. He is considering producing either 25,000 or 35,000 units during the period. Other information is presented in the schedule.

Division information – 2022

Beginning inventory 0

Expected sales in units 25,000

Selling price per unit $17.00

Variable manufacturing cost per unit $6.00

Fixed manufacturing overhead cost (total) $140,000

Fixed manufacturing overhead costs per unit

Based on 25,000units $ 5.60 per unit ($140,000 ÷ 25,000)

Based on 35,000 units $ 4.00 per unit ($140,000 ÷ 35,000)

Manufacturing cost per unit

Based on 25,000 units $ 11.60 per unit ($6.00 variable + $5.60 fixed)

Based on 35,000 units $ 10.00 per unit ($6.00 variable + $4.00 fixed)

Selling and administrative expense (all fixed) $37,000

Instructions

Prepare a variable-costing income statement with one column showing the results if 25,000 units are produced, and one column showing the results if 35,000 units are produced.

Solution 92 (15–20 min.)

MCCARTNEY PUMPS DIVISION

Income Statement

For the Year Ended 2022

Variable Costing

25,000 35,000

Produced Produced

Sales (25,000 units x $17) $425,000 $425,000

Variable cost of goods sold

(25,000 x $6) 150,000 150,000

Contribution margin 275,000 275,000

Fixed manufacturing overhead 140,000 140,000

Fixed selling and

administrative expenses 37,000 37,000

Net income $ 98,000 $ 98,000

Exercise 93

Bob’s Burgers makes burger patties for large supermarket chains. The burgers are frozen and can last in storage for months. Cost information on the burgers is as follows:

Meat used for burgers $200,000

Wages used to make burgers 100,000

Overhead of the factory – variable 50,000

– fixed 70,000

Office staff 60,000

Sales staff 120,000

Bob’s salary 50,000

Bob made 500,000 burgers this past year but only sold 450,000 to his customers. He sells them for $1.50 per burger patty. Bob tells you that the office and sales staff are variable costs while his salary is fixed.

Instructions

a) Calculate Bob’s income assuming he uses variable costing.

b) Calculate Bob’s income assuming he uses absorption costing.

c) What are two reasons Bob might prefer to use variable costing for his internal business decisions?

Solution 93 (11–13 min.)

Absorption Variable

Direct materials (meat) $ 200,000 $200,000

Direct labour (wages) 100,000 100,000

Overhead of the factory – variable 50,000 50,000

– fixed 70,000 0

Office staff 0 0

Sales staff 0 0

Fixed selling and admin expenses (Bob) 0 0

$420,000 $350,000

Amount produced 500,000 500,000

Unit cost $0.84 $0.70

a) Absorption-Costing Income Statement

Sales (450,000 x $1.50) $675,000

Cost of sales: 450,000 x $0.84 378,000

Gross profit $297,000

Variable costs – office staff $60,000

– sales staff $120,000

Fixed admin – Bob’s salary $50,000 230,000

Net income $ 67,000

b) Variable-Costing Income Statement

Sales (450,000 x $1.50) $675,000

Variable cost of goods sold 450,000 x $0.70 $315,000

Variable selling and admin 180,000 495,000

Contribution margin $180,000

Fixed costs – factory 70,000

– Bob’s salary 50,000

Net income $ 60,000

c) Bob might prefer to use variable costing, even though it reports lower net income, because:

• It is helpful to understand the breakdown of fixed and variable costs for his business. This will allow him to do CVP analysis when making decisions.
• Using variable costing is affected mainly by changes in sales volumes, not production volumes, which provides a more realistic presentation of income for the period.

*Exercise 94

Assuming that Senior Industries is in its first month of production ending April 30, 2022, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Budgeted fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

Prepare the income statement using a normal-absorption costing approach where budgeted fixed manufacturing overhead is allocated based on a budgeted volume of 25,000 units.

*Solution 94

SENIOR INDUSTRIES

Income Statement

Month Ended April 30, 2022

Sales (16,000 × $800) $12,800,000

Cost of goods sold

Inventory, April 1 $ 0

Cost of goods manufactured (20,000 units × $652*) 13,040,000

Cost of goods available for sale 13,040,000

Inventory, April 30 (4,000 units × $652*)  2,608,000

Cost of goods sold (16,000 units × $652*) 10,432,000

Unfavourable volume variance ($32 x (25,000-20,000)) 160,000

Gross profit 2,208,000

Variable selling & administrative expenses 640,000

Fixed selling & administrative expenses 600,000

Net Income $968,000

Manufacturing cost per unit

Direct materials $240

Direct labour 280

Variable manufacturing overhead 100

*Fixed manufacturing overhead ($800,000 ÷ 25,000 units produced) 32

*Manufacturing cost per unit $652

*Exercise 95

Briefly explain how absorption-costing net income and variable-costing net income differ.

*Solution 95

Absorption-costing net income includes the fixed manufacturing overhead that is included in inventory. This component of beginning inventory must be added, and this component of ending inventory must be deducted, when calculating variable-costing net income.

*Exercise 96

The following costs of McIntosh Company are available for the year ended December 31, 2022. The company has no beginning inventory. In 2022, the company produced 75,000 units but sold only 60,000 units. The unit selling price was $90 per unit. Costs and expenses were as follows:

Variable costs per unit

Direct materials $50

Direct labour 24

Variable manufacturing overhead 3

Variable selling and administrative expenses 5

Annual fixed costs and expenses

Fixed manufacturing overhead based on a budgeted volume of 100,000 units $250,000

Selling and administrative expenses $150,000

The company expenses production-volume variance to cost of goods sold in the accounting period in which it occurs.

Instructions

a) Calculate the manufacturing cost of one unit of product using normal-absorption costing.

b) Prepare a 2022 income statement for McIntosh Company using normal costing.

*Solution 96

a)

Manufacturing cost per unit

Direct materials $ 50

Direct labour 24

Variable manufacturing overhead 3

Fixed manufacturing overhead ($250,000 ÷ 100,000 units budgeted) 2.50

*Manufacturing cost per unit $79.50

b)

MCINTOSH COMPANY

Income Statement

Year Ended December 31, 2022

Sales (60,000 × $90) $5,400,000

Cost of goods sold (60,000 units × $79.50*) $4,770,000

Plus unfavourable volume variance ($2.5** x 25,000) 62,500

Adjusted Cost of goods sold 4,832,500

Gross profit 567,500

Variable selling & administrative expenses 300,000

Fixed selling & administrative expenses 150,000

Net Income $ 117,500

*Exercise 97

The predetermined fixed overhead rate at Rudy’s Ribs is $2 per package of frozen ribs. Actual costs for the 2022 year are as follows:

Raw ingredients $2.50 per order

Labour $0.50 per order

Selling and Admin Costs $38,000 per year (all fixed)

Fixed overhead $82,000 per year

In 2022, Rudy’s produced 40,000 packages of ribs and sold 38,000 packages. It had no opening inventory at the beginning of 2022. Each package of ribs is sold for $7.50 per package.

Instructions

Calculate the net income income for Rudy’s Ribs in 2022, using normal-absorption costing approach.

*Solution 97 (5–7 min.)

Manufacturing cost per unit:

Materials $2.50

Labour $0.50

FOH $2.00 *using predetermined overhead rate

Total $5.00

Sales $285,000

COGS

Beginning inventory $0

Plus units produced $200,000 *40,000 x $5

Less ending inventory $(10,000) *2,000 x $5

Total COGS $190,000

Selling and Admin 38,000

Net income $57,000

**Exercise 98

Assuming that Senior Industries is in its first month of production ending April 30, 2022, the following reflects select company data for the period:

Units

Beginning inventory 0

Units produced 20,000

Units sold 16,000

Ending inventory 4,000

Unit price $800

Variable unit costs

Direct materials $240

Direct labour $280

Variable manufacturing overhead $100

Variable selling & administrative $ 40

Fixed costs

Fixed manufacturing overhead $800,000

Fixed selling & administrative $600,000

Instructions

Prepare a throughput-costing format income statement.

**Solution 98

SENIOR INDUSTRIES

Income Statement

Month Ended April 30, 2022

Sales (16,000 × $800) $12,800,000

Variable cost of goods sold

Inventory, April 1 $ 0

Direct material costs (20,000 units × $240) 4,800,000

Cost of goods available for sale 4,800,000

Inventory, April 30 (4,000 units × $240)   960,000

Variable cost of goods sold (16,000 units × $240) 3,840,000

Throughput contribution margin 8,960,000

Other operating costs

Direct labour costs (20,000 units x $280) 5,600,000

Variable overhead costs (20,000 units x $100) 2,000,000

Variable selling & administrative expenses (16,000 x $40) 640,000

Fixed manufacturing overhead 800,000

Fixed selling & administrative expenses 600,000

Total other operating costs 9,640,000

Net Income/(Loss) ($ 680,000)

**Exercise 99

Briefly explain how throughput-costing net income and variable-costing net income differ.

**Solution 99

Throughput-costing net income excludes the variable manufacturing overhead and direct labour costs that are included in inventory. These components of beginning inventory must be added, and these components of ending inventory must be deducted, when calculating variable-costing net income.

**Exercise 100

The following costs of McIntosh Company are available for the year ended December 31, 2022. The company has no beginning inventory. In 2022, the company produced 75,000 units but sold only 60,000 units. The unit selling price was $90 per unit. Costs and expenses were as follows:

Variable costs per unit

Direct materials $50

Direct labour 24

Variable manufacturing overhead 3

Variable selling and administrative expenses 5

Annual fixed costs and expenses

Fixed manufacturing overhead based on a budgeted volume of 100,000 units $250,000

Selling and administrative expenses $150,000

Instructions

a) Prepare a 2022 throughput format income statement for McIntosh Company.

b) Reconcile throughput costing net income to variable-costing net income.

**Solution 100

a)

MCINTOSH COMPANY

Income Statement

Year Ended December 31, 2022

Sales (60,000 × $90) $5,400,000

Variable cost of goods sold

Inventory, Jan 1 $ 0

Direct material costs (75,000 units × $50) 3,750,000

Cost of goods available for sale 3,750,000

Inventory, December 31 (15,000 units × $50)   750,000

Variable cost of goods sold (60,000 units × $50) 3,000,000

Throughput contribution margin 2,400,000

Other operating costs

Direct labour costs (75,000 units x $24) 1,800,000

Variable overhead costs (75,000 units x $3) 225,000

Variable selling & administrative expenses (60,000 x $5) 300,000

Fixed manufacturing overhead 250,000

Fixed selling & administrative expenses 150,000

Total other operating costs 2,725,000

Net Income/(Loss) ($ 325,000)

b)

Throughput-costing net income ($325,000)

Add: Direct labour costs (15,000 × $24) $ 360,000

Variable manufacturing overhead (15,000 x $3) 45,000

Variable-costing net income $ 80,000

**Exercise 101

Jordan’s Carpets produces beautiful tapestry carpets that sell for $2,000 each. The technique used to produce the carpets is highly automated. The company uses throughput costing since materials are the main variable cost. The following applies to the month of March:

Beginning Inventory 0

Units produced 45

Units sold 42

Direct material cost per unit $850

Labour cost per unit $15

Overhead costs per unit $400

Instructions

Calculate the income for March using throughput costing.

**Solution 101 (5–7 min.)

Sales $84,000

Variable Costs

DM 35,700

Contribution Margin $48,300

Fixed costs

Labour 675

Overhead 18,000

Net Income $29,625

**Exercise 102

Explain why variable costing will show a higher net income than throughput costing?

Instructions

**Solution 102

There is one major difference between throughput costing and variable costing: under throughput costing, the direct labour and variable manufacturing overhead are charged as expenses in the current period. Therefore, they are not deferred to future periods through the ending inventory. As a result, variable costing will show a higher net income than throughput costing whenever there are more units produced than sold.

**Exercise 103

Explain why manufacturing costs per unit are lower under throughput costing than variable costing.

**Solution

Manufacturing costs per unit are lower under throughput costing than variable costing because all manufacturing costs except direct material costs are treated as period costs and are

therefore expensed. Under variable costing, in contrast, direct labour and variable manufacturing overhead costs are treated as product costs.

COMPLETION STATEMENTS

104. Under ___ all manufacturing costs are charged to, or absorbed by, the product.

105. Only direct materials, direct labour, and variable manufacturing costs are considered product costs when using ___.

106. Fixed manufacturing costs are treated as period costs under ___.

107. The use of absorption costing is required by ___ for ___ financial reports.

108. When production exceeds sales, a portion of the ___ is deferred to a future period as part of the cost of ending inventory under absorption costing, but not under variable costing.

109. The one primary difference between variable costing and absorption costing is that under variable costing, fixed manufacturing overhead is recorded as a(an) ___ in the current period.

110. When units produced exceed units sold, income under absorption costing is ___ than income under variable costing.

111. The amount remaining after deducting total variable costs from revenue is called the ___.

112. Management may be tempted to overproduce in a given period in order to increase net income if ___ is used for internal decision making.

*113. In normal-absorption costing, fixed manufacturing costs are based on the predetermined rate under ___ costing. Under ___ costing, in contrast, fixed manufacturing costs are still a period cost and are therefore expensed.

*114. Under normal-absorption costing, the predetermined overhead rate is based on ___ production volume, rather than ___ production volume.

**115. ___ costing, which is also called super-variable costing, treats all costs as period expenses except for direct materials.

ANSWERS TO COMPLETION STATEMENTS

104. absorption costing

105. variable costing

106. variable costing

107. GAAP, external

108. fixed manufacturing overhead

109. expense

110. higher

111. contribution margin

112. absorption costing

*113. absorption, variable

*114. budgeted, actual

**115. throughput

MATCHING

**116. Match the items below by entering the appropriate code letter in the space provided.

A. Normal costing

B. Absorption costing

C. Throughput cost

____ 1. A modified form of a variable-costing system that treats direct labour and variable manufacturing overhead as period expenses.

____ 2. A system, which uses actual direct manufacturing costs and actual production units with a predetermined overhead rate.

____ 3. The costing approach where production-volume variances are usually expensed to the costs of goods sold.

ANSWERS TO MATCHING

1. C

2. A

3. B

SHORT-ANSWER ESSAY QUESTIONS

SAE 117

Define variable costing and absorption costing. What are some of the benefits to a manager from using variable costing instead of absorption costing for internal decision making?

Solution 117

Variable costing is a system for determining product costs that is used primarily for making managerial decisions. This system determines product costs by considering only direct materials, direct labour, and variable manufacturing overhead. In contrast, absorption costing is used by some managers and also for external reporting. Under absorption costing, product costs include direct material, direct labour, and both fixed and variable manufacturing overhead costs. Absorption costing must be used under GAAP for external financial reporting.

Some of the benefits to a manager from using variable costing instead of absorption costing for internal decision making include: variable costing already has to be used when constructing a contribution margin income statement, variable costing puts greater focus on cost behaviours, fixed costs do not get tied up in inventory under variable costing, variable costing is better suited for cost-volume-profit analysis, variable costing produces income statements that are closer to net cash flows than absorption costing, and the method ties in with standard costing and flexible budgeting more effectively.

SAE 118

How do differences in production and sales levels affect income under absorption and variable costing?

Solution 118

If production equals sales in any given period, the net incomes under both absorption and variable costing will be equal. Under this scenario, fixed manufacturing overhead will not differ, because the direct cost expense under variable costing will be equal to the product cost component of fixed overhead under absorption costing.

If production exceeds sales, absorption costing net income will be greater than variable-costing net income. Absorption-costing net income is higher because some fixed manufacturing overhead costs will be deferred in the inventory account until the products are sold; whereas, under variable costing all fixed manufacturing overhead costs will be expensed.

If sales exceed production, absorption costing net income will be less than variable-costing net income. Absorption-costing net income is less because some fixed manufacturing overhead costs from the previous period will now be expensed when the older product is sold; whereas, under variable costing only fixed manufacturing overhead costs of the current period will be expensed.

SAE 119

Explain why either absorption or variable costing is best for a company to use as its costing system for internal decision making. Why do many firms maintain accounting records under both systems?

Solution 119

Variable costing is generally preferred over absorption costing for internal decision making. Net income calculated using GAAP (absorption costing) does not highlight differences between variable and fixed costs, as does variable costing, and can lead to poor business decisions. Managers may be tempted to over produce in a given period in order to increase net income when absorption costing is used. Net income under variable costing is unaffected by changes in production levels. In addition, the use of variable costing is consistent with cost-volume-profit analysis and other decision-making tools.

Many firms maintain accounting records under both systems because while they want to use variable costing for internal decision making, GAAP does require the use of absorption costing for external financial reports. Also, absorption costing must be used on tax returns.

SAE 120

Explain four potential advantages of variable costing compared with absorption costing.

Solution

Variable costing has the following potential advantages compared with absorption costing:

1. The use of variable costing is consistent with the cost-volume-profit and incremental analysis.

2. Net income calculated under variable costing is not affected by changes in production

levels. As a result, it is much easier to understand the impact of fixed and variable costs

on the calculation of net income when using variable costing.

3. Net income calculated under variable costing is greatly affected by changes in sales

levels (not production levels), and it therefore provides a more realistic assessment of the

company’s success or failure during a period.

4. Because the fixed and variable cost components are shown in the variable-costing income

statement, it is easier to identify these costs and understand their effect on the business.

Under absorption costing, the allocation of fixed costs to inventory makes it difficult to

evaluate the impact of fixed costs on the company’s results.

**SAE 121

What practical points should a company consider before adopting throughput costing?

**Solution 121

Users of throughput costing should be highly automated, process-oriented companies in which direct labour and manufacturing overhead are fixed costs that do not vary with the number of units produced. Car companies with unionized employees provide a good example of this. Whether cars are produced or not; on a given day of the month, the car company still incurs direct labour and manufacturing overhead costs. The logic of this is that since the direct labour and manufacturing overhead costs are fixed, they can be treated as period costs, rather than product costs, for internal reporting purposes.

The other consideration is that users of throughput costing must acknowledge that they are doing so for short-term incremental analysis. Users of throughput costing should therefore be cautioned that use of this method in the long term (without any other costing method employed for longer term planning) could have negative consequences.

MULTI-PART QUESTION

**122. Fireplug Industries produces spark plugs for use in cars and trucks. Information about the company’s activities is as follows:

Budgeted production and sales

volume for the year 100,000 plugs

Factory capacity 120,000 plugs

Opening inventory 0

Budgeted sales $7,200,000

Budgeted costs:

Raw materials 900,000

Direct labour 1,200,000

Variable factory overhead 1,500,000

Fixed factory overhead 1,800,000

Variable selling & admin 600,000

Fixed selling & admin 600,000

Total budgeted costs $6,600,000

Budgeted operating income $ 600,000

Instructions

a) Calculate the combined predetermined overhead rate for fixed and variable overhead to be used by the company.

b) If the company produces 100,000 spark plugs but only sells 70,000, calculate its operating income if the company uses normal absorption costing.

c) Using the same information as part b) calculate the operating income if the company uses throughput costing.

**Solution 122

a) ($1,500,000 + $1,800,000) ÷ 100,000 = $33.00

b) Contribution margin per plug: $3,000,000 ÷ 100,000 = $30

Operating income = 70,000 x $30 – (1,800,000 x 70%) – 600,000

= $2,100,000 – $1,260,000 – $ 600,000

= $240,000

c) Contribution margin per plug: ($7,200,000 – $900,000) / 100,000 = $63

Contribution margin: 70,000 x $63 $4,410,000

Less: Direct labour $1,200,000

Variable factory overhead 1,500,000

Fixed factory overhead 1,800,000

Variable selling & admin 600,000

Fixed selling & admin 600,000 5,700,000

Operating income (loss) ($1,290,000)

CM:

Opening Inventory 0

DM costs $900,000

Closing inventory (900,000 ÷ 100,000) x 30,000 270,000

Variable cost of goods sold $630,000

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