9.Hilton 9E Global Edition Solutions Manual Chapter08(exercise+problem).pdf

CHAPTER 8

Absorption and Variable Costing ANSWERS TO REVIEW QUESTIONS 8-1

Under absorption costing, fixed manufacturing-overhead costs are assigned to units of product as product costs. Under variable costing, fixed manufacturing-overhead costs are not assigned to units of product as product costs; rather they are treated as period costs and expensed during the period in which they are incurred.

8-2

Timing is the key in distinguishing between absorption and variable costing. All manufacturing costs will ultimately be expensed under either absorption costing or variable costing. The difference between the two methods lies in the time period during which fixed manufacturing-overhead costs are expensed. Under variable costing, the fixed manufacturing-overhead costs are expensed during the period in which they are incurred. Under absorption costing, fixed manufacturing-overhead costs are held in inventory as product costs until the period during which the units are sold. Then those costs flow into cost-of-goods-sold expense.

8-3

The term direct costing is a misnomer. Variable costing is a better term for this product-costing method. Under variable costing, the variable costs of direct material, direct labor, and variable overhead are treated as product costs. Fixed manufacturing-overhead costs are not treated as product costs. Thus, the important characteristic of a cost that determines whether it is treated as a product cost under variable costing is its cost behavior. Direct costing is a misnomer because variableoverhead costs are not direct costs, but they are treated as product costs under the variable-costing method.

8-4

When inventory increases, the income reported under absorption costing will be greater than the income reported under variable costing. This difference results from the fact that under absorption costing, some of the fixed manufacturing costs incurred during the period will not be expensed. In contrast, under variable costing all of the fixed manufacturing costs incurred during the period will be expensed during that period.

8-5

Many managers prefer variable costing over absorption costing because income statements prepared under variable costing more closely reflect operations. For example, when sales increase, other things being equal, income will also increase under variable costing. Under absorption costing, however, income will not necessarily increase when sales increase.

McGraw-Hill/Irwin Managerial Accounting, 9/e Global Edition

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The McGraw-Hill Companies, Inc. 8-1

8-6

Under absorption costing, all manufacturing-overhead costs (including fixed costs) are assigned to units of product as product costs. Under variable costing, fixed manufacturing-overhead costs are not assigned to units of product as product costs; rather they are treated as period costs and expensed during the period in which they are incurred. Under throughput costing, only the unit-level unit-level spending for direct costs is assigned as a product cost.

8-7

Some managerial accountants believe that absorption costing may provide an incentive for managers to overproduce inventory so that the fixed manufacturing overhead costs may be spread over a larger number of product units, thereby lowering the reported product cost per unit. Throughput costing avoids this potential problem by not assigning fixed manufacturing overhead as a product cost.

8-8

Variable and absorption costing will not result in significantly different income measures in a JIT setting. Under JIT inventory and production management, inventories are minimal and as a result inventory changes are also minimal. Variable and absorption costing result in significantly different income measures only when inventory changes significantly from period to period.

8-9

Many managers prefer absorption-costing data for cost-based pricing decisions. They argue that fixed manufacturing overhead is a necessary cost of production. To exclude this fixed cost from the inventoried cost of a product, as is done under variable costing, is to understate the cost of the product. This, in turn, could lead to setting cost-based prices too low.

8-10

Proponents of variable costing argue that a p roduct’s variable cost provides a better basis for the pricing decision. They point out that any price above a product’s variable cost makes a positive contribution toward covering fixed cost and profit.

8-11

Variable costing is consistent with cost-volume-profit cost-volume-profit analysis analysis because it properly reflects the cost behavior of variable and fixed costs. Only variable manufacturing costs are treated as inventoriable product costs. Fixed manufacturing costs are recorded as a lump sum and expensed during the period incurred. CVP analysis also properly maintains the cost-behavior distinction between variable and fixed costs. In contrast, absorption costing is inconsistent with CVP analysis, because fixed overhead is applied to manufactured goods as a product cost on a p er-unit basis.

McGraw-Hill/Irwin 8-2

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The McGraw-Hill Companies, Inc. Solutions Manual

8-6

Under absorption costing, all manufacturing-overhead costs (including fixed costs) are assigned to units of product as product costs. Under variable costing, fixed manufacturing-overhead costs are not assigned to units of product as product costs; rather they are treated as period costs and expensed during the period in which they are incurred. Under throughput costing, only the unit-level unit-level spending for direct costs is assigned as a product cost.

8-7

Some managerial accountants believe that absorption costing may provide an incentive for managers to overproduce inventory so that the fixed manufacturing overhead costs may be spread over a larger number of product units, thereby lowering the reported product cost per unit. Throughput costing avoids this potential problem by not assigning fixed manufacturing overhead as a product cost.

8-8

Variable and absorption costing will not result in significantly different income measures in a JIT setting. Under JIT inventory and production management, inventories are minimal and as a result inventory changes are also minimal. Variable and absorption costing result in significantly different income measures only when inventory changes significantly from period to period.

8-9

Many managers prefer absorption-costing data for cost-based pricing decisions. They argue that fixed manufacturing overhead is a necessary cost of production. To exclude this fixed cost from the inventoried cost of a product, as is done under variable costing, is to understate the cost of the product. This, in turn, could lead to setting cost-based prices too low.

8-10

Proponents of variable costing argue that a p roduct’s variable cost provides a better basis for the pricing decision. They point out that any price above a product’s variable cost makes a positive contribution toward covering fixed cost and profit.

8-11

Variable costing is consistent with cost-volume-profit cost-volume-profit analysis analysis because it properly reflects the cost behavior of variable and fixed costs. Only variable manufacturing costs are treated as inventoriable product costs. Fixed manufacturing costs are recorded as a lump sum and expensed during the period incurred. CVP analysis also properly maintains the cost-behavior distinction between variable and fixed costs. In contrast, absorption costing is inconsistent with CVP analysis, because fixed overhead is applied to manufactured goods as a product cost on a p er-unit basis.


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8-12

An asset is a thing of value owned by the organization with future service potential. By accounting convention, assets are valued at their cost. Since fixed costs comprise part of the cost of production, advocates of absorption costing argue that inventory (an asset) should be valued at its full (absorption) cost of production. Moreover, they argue that these costs have future service potential since the inventory can be sold in the future to generate sales revenue. Proponents of variable costing argue that the fixed-cost component of a product’s absorption-costing absorption -costing value has no future service potential. Their reasoning is that the fixed manufacturing-overhead costs during the current period will not prevent these costs from having to be incurred again next period. Fixed-overhead costs will be incurred every period, regardless of production levels. In contrast, the incurrence of variable costs in manufacturing a product does allow the firm to avoid incurring these costs again.


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SOLUTIONS TO EXERCISES EXERCISE 8-13 (15 MINUTES) 1.

a. Inventory increases by 2,000 units, so income is greater under absorption costing. b.

Fixed overhead rate per unit

=

Difference in reported income =

2.

110,000

$7.40

= $7.40

2,000 = $14,800

a. Inventory decreases by 5,000 units, so income is greater under variable costing.

b.

Fixed overhead rate per unit

=

Difference in reported income =

3.

$814,000

$814,000 90,000

$9.04

= $9.04 (rounded)

5,000 = $45,200

a. Inventory remains unchanged, so there is no difference in reported income under the two methods of product costing. b. No difference.


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EXERCISE 8-14 (10 MINUTES) 1.

Inventoriable costs under variable costing: Direct material used ............................................................................... Direct labor ................................................... .......................................... Variable manufacturing overhead .................................................. ...... Total ........................................................................................................

2.

Inventoriable costs under absorption costing: Direct material used ............................................................................... Direct labor ................................................... .......................................... Variable manufacturing overhead .................................................. ...... Fixed manufacturing overhead .............................................. ............... Total ........................................................................................................

3.

$290,000 100,000 50,000 $440,000

$290,000 100,000 50,000 80,000 $520,000

Inventoriable costs under throughput costing: Direct material used* ............................................................................. Total ........................................................................................................

$290,000 $290,000

*Under this scenario, direct material cost is the only throughput cost.

EXERCISE 8-15 (15 MINUTES) Inventory calculations (units): Finished-goods inventory, January 1 ................................................ ... Add: Units produced ............................................... .............................. Less: Units sold .............................................. ....................................... Finished-goods inventory, December 31 .............................................


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2,000 20,000 21,000 1,000

units units units units


EXERCISE 8-15 (CONTINUED) 1.

Variable costing: Inventoriable costs under variable costing:

Direct material used ............................................................................... Direct labor incurred .............................................................................. Variable manufacturing overhead .................................................. ...... Total ........................................................................................................

$ 600,000 300,000 200,000 $1,100,000

Cost per unit produced = $1,100,000/20,000 units = $55 per unit Ending inventory: 1,000 units

$55 per unit ....................................

$55,000

2. Absorption costing: Predetermined fixed-overhead rate

fixed manufactur ing overhead $420,000 = planned production 20,000 units = $21 per unit =

Difference in fixed overhead expensed under absorption and variable costing

=

=

change in

predetermined

inventory

fixed-overhead

in units

rate

(1,000 units)

($21 per unit)

= $21,000 Difference in reported income: Since inventory decreased during the year, income reported under absorption costing will be $21,000 lower than income reported under variable costing.


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EXERCISE 8-16 (25 MINUTES) Inventory calculations (units): Finished-goods inventory, January 1 ................................................ ... Add: Units produced ............................................... .............................. Less: Units sold .............................................. ....................................... Finished-goods inventory, December 31 ............................................. 1.

0 12,000 9,000 3,000

units units units units

Variable costing: Inventoriable costs under variable costing:

Direct material used ............................................................................... Direct labor incurred .............................................................................. Variable manufacturing overhead .................................................. ...... Total ........................................................................................................

$240,000 60,000 18,000 $318,000

Cost per unit produced = $318,000/12,000 units = $26.50 per unit Ending inventory: 3,000 units

2.

$26.50 per unit ...............................

$79,500

Absorption costing: Predetermined fixed-overhead rate =

fixed manufactur ing overhead $42,000 = = $3.50 per unit 12 , 000 units planned production

Difference in fixed overhead expensed under absorption and variable costing

=

=

change in

predetermined

inventory

fixed-overhead

in units

rate

(3,000 units)

($3.50 per unit)

= $10,500 Difference in reported income: Since inventory increased during the year, income reported under absorption costing will be $10,500 higher than income reported under variable costing. McGraw-Hill/Irwin Managerial Accounting, 9/e Global Edition

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EXERCISE 8-16 (CONTINUED)

3.

Throughput costing: Inventoriable costs under throughput costing:

Direct material used ............................................................................... Total ........................................................................................................

$240,000 $240,000

Cost per unit produced = $240,000/12,000 units = $20.00 per unit Ending inventory: 3,000 units

$20.00 per unit ...............................

$60,000


a. Inventory decreases by 3,000 units, so income is greater under variable costing. b.

Fixed overhead rate per unit Difference in reported income

2.

=

$2,200,000 = $110 20,000

=

$110

3,000 = $330,000

a. Inventory remains unchanged, so there is no difference in reported income under the two methods of product costing. b. No difference.

3.

a. Inventory increases by 2,000 units, so income is greater under absorption costing. b.

Fixed overhead rate per unit Difference in reported income


=

$2,200,000 = $200 11,000

=

$200

2,000 = $400,000

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Cost-volume profit graph: Dollars (in millions)

$5

$4

Break-even point: 14,667 units

Total cost

Revenue $3

$2

Fixed cost ($2,200,000)

$1

5


10

15

Units (in thousands)

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EXERCISE 8-18 (CONTINUED) 2.

Calculation of break-even point:

Break-even point

3.

=

fixed cost unit contribution margin

=

$2,200,000 $350 $200

=

14,667 units (rounded)

Variable costing is more compatible with the cost-volume-profit chart, because it maintains the distinction between fixed and variable costs as does CVP analysis. Absorption costing, in contrast, does not maintain the separation of fixed and variable costs. Fixed costs are unitized in the fixed overhead rate and inventoried as product costs along with variable manufacturing costs.


Inventoriable costs under absorption costing : Direct material used ............................................................................... Direct labor ................................................... .......................................... Variable manufacturing overhead .................................................. ...... Fixed manufacturing overhead .............................................. ............... Total ........................................................................................................

2.

$420,000 90,000 75,000 240,000 $825,000

Inventoriable costs under variable costing : Direct material used ............................................................................... Direct labor ................................................... .......................................... Variable manufacturing overhead .................................................. ...... Total ........................................................................................................


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$420,000 90,000 75,000 $585,000


EXERCISE 8-20 (30 MINUTES) The specifics of the answer will vary, depending on the company and product selected. However, the relative merits of absorption, variable and throughput costing as the basis for pricing decisions are generally the same, regardless of the company and product. Many managers prefer absorption-costing data for cost-based pricing decisions. They argue that fixed manufacturing overhead is a necessary cost of production. To exclude this fixed cost from the inventoried cost of a product, as is done under variable costing, is to understate the cost of the product. This, in turn, could lead to setting cost-based prices too low. Proponents of variable costing argue that a product’s variable co st provides a better basis for the pricing decision. They point out that any price above a product’s variable cost makes a positive contribution toward covering fixed cost and profit. Proponents of throughput costing take the variable-costing argument a step further and argue that a product’s throughput cost provides the best basis for a cost -based pricing decision. They argue that any price above a product’s unit -level spending for direct costs (e.g., throughput costs) makes a positive contribution toward covering fixed cost and p rofit.


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SOLUTIONS TO PROBLEMS PROBLEM 8-21 (45 MINUTES) Calculation of predetermined fixed overhead rate: Predetermined fixed overhead rate

=

budgetedfixed overhead budgetedproduction

=

$300,000 = $2 per unit 150,000

Cost per Unit Direct material .............................................. .......................................... Direct labor ................................................... .......................................... Variable overhead .................................................. ................................ a. Cost per unit under variable costing ............................................. Fixed overhead per unit under absorption costing ....................... b. Cost per unit under absorption costing ........................................ 2.

a.

$ 6 4 3 $13 2 $15

DELIZIOSO S.P.A. ABSORPTION -COSTING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X1

Sales revenue (130,000 units sold at $20 per unit) ........................ Less: Cost of goods sold (at absorption cost of $15 per unit) ................................................... Gross margin ................................................... ................................ Less: Selling and administrative expenses: Variable (at $1 per unit) ................................................. ...... Fixed ..................................................................................... Operating income ............................................................................


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$2,600,000 1,950,000 $ 650,000 130,000 150,000 $ 370,000


PROBLEM 8-21 (CONTINUED) b.

DELIZIOSO S.P.A. VARIABLE-COSTING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X1

Sales revenue (130,000 units sold at $20 per unit) ........................ Less: Variable expenses: Variable manufacturing costs (at variable cost of $13 per unit) ....................................... Variable selling and administrative costs (at $1 per unit) .................................................................... Contribution margin ................................................. ....................... Less: Fixed expenses: Fixed manufacturing overhead ........................................... Fixed selling and administrative expenses ....................... Operating income ............................................................................ 3.

4.

$2,600,000 1,690,000 130,000 $ 780,000 300,000 150,000 $ 330,000

Cost of goods sold under absorption costing ..................................... Less: Variable manufacturing costs under variable costing ............ Subtotal ............................................... ................................................... Less: Fixed manufacturing overhead as period expense under variable costing ................................................ ............... Total ........................................................................................................

300,000 $ (40,000 )

Operating income under variable costing ........................................... Less: Operating income under absorption costing .......................... Difference in operating income ............................................................

$ 370,000 330,000 $ (40,000 )

Difference in reported income

=

= =

$1,950,000 1,690,000 $ 260,000

difference in fixed overhead expensed under absorption and variable costing

change in inventory,

predetermined fixed

in units

overhead rate per unit

(20,000 units)

($2 per unit)

= $40,000 As shown in requirement (2), reported income is $40,000 lower under variable costing. McGraw-Hill/Irwin Managerial Accounting, 9/e Global Edition

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PROBLEM 8-21 (CONTINUED) 5.

In the electronic version of the solutions manual, press the CTRL key and click on the following link: Build a Spreadsheet 08-21.xls

PROBLEM 8-22 (25 MINUTES) 1.

Delizioso S.p.A. produced 150,000 units (i.e., containers) and sold 130,000, which leaves an ending finished-goods inventory of 20,000 units. Because only direct material qualifies as a throughput cost, the cost of the ending inventory is $120,000 (20,000 containers x $6).

2. DELIZIOSO S.P.A. THROUGHPUT-COSTING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X1

Sales revenue (130,000 units x $20 ) ………………………………….. Less: Cost of goods sold (130,000 units x $6 )……………………… Gross margin……………………………………………………………… Less: Operating costs: Direct labor (150,000 units x $4 )…………………………………… Variable manufacturing overhead (150,000 units x $3)……….. Fixed manufacturing overhead……………………………………. Variable selling and administrative costs (130,000 units x $1)……………………………………………… Fixed selling and administrative costs…………………………... Total operating costs…………………………………………… Operating income………………….……………………………………

$2,600,000 780,000 $1,820,000 $ 600,000 450,000 300,000 130,000 150,000 1,225,000 $ 190,000

3.

Gross margin is computed by subtracting cost of goods sold from sales revenue. The “cost” of a unit differs and depends on whether a firm uses absorption costing or throughput costing. With absorption costing, the product cost consists of four elements: direct material, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. Throughput costing, on the other hand, assigns only the unit-level spending for direct costs (in this case, direct material) as the cost of a product.

4.



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Since the planned production volume was 100,000 units, actual production was also 100,000 units. Beginning inventory ............................................................................. Production ............................................................................................. Ending inventory ................................................................................... Sales ......................................................................................................

0 units 100,000 units (20,000 ) units 80,000 units

Since inventory increased during the year, reported income is higher under absorption costing.

Difference in reported income

=

$20,000

=

change in

fixed overhead

inventory

per unit

20,000 units

fixed overhead 100,000 units

Solving this equation: fixed overhead = $100,000 Now we can compute the contribution margin: Reported income under variable costing ............................................. Fixed overhead ...................................................................................... Total contribution margin .....................................................................


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$220,000 100,000 $320,000


PROBLEM 8-23 (CONTINUED) Contribution margin per unit

Break-even point in units


=

total contribution margin sales in units

=

$320,000 = $4 per unit 80,000 units

=

fixed cost (overhead) unit contribution margin

=

$100,000 = 25,000 units $4 per unit

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Profit-volume graph: Dollars $250,000 Profit = $220,000 at 80,000 unit sales volume

$200,000

$150,000

$100,000

Break-even point 25,000 units

$50,000 Profit Loss

0

25,000

50,000

75, 000

100,000

Sales in units

$(50,000)

$(100,000)

$(150,000)


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PROBLEM 8-24 (25 MINUTES) Outback Corporation’s reported 20x1 income will be higher under absorption costing because actual production exceeded actual sales. Therefore, inventory increased and some fixed costs will remain in inventory under absorption costing which would be expensed under variable costing. 1.

Beginning inventory (in units) ............................................... ............... Actual production (in units) ................................................... ............... Available for sale (in units) ................................................................... Sales (in units) ............................................. .......................................... Ending inventory (in units) ....................................................................

35,000 130,000 165,000 125,000 40,000

Budgeted manufacturing costs: Direct material .............................................. .......................................... Direct labor ................................................... .......................................... Variable manufacturing overhead .................................................. ...... Fixed manufacturing overhead .............................................. ............... Total ....................................................................................................

Total budgetedmanufactur ing costs (variable and fixed) Total planned production(in units)

Value of ending inventory

=

quantity

=

40,000 units

$1,680,000 1,260,000 560,000 700,000 $4,200,000

$4,200,000 140,000 = $30 per unit

=

cost per unit $30 per unit

= $1,200,000 2.

Budgeted variable manufacturing costs: Direct material .............................................. .......................................... Direct labor ................................................... .......................................... Variable manufacturing overhead .................................................. ...... Total ........................................................................................................

$1,680,000 1,260,000 560,000 $3,500,000

Total budgeted variable manufactur ing costs $3,500,000 = Total planned production(in units) 140,000 = $25 per unit


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PROBLEM 8-24 (CONTINUED) Value of ending inventory

=

quantity

=

40,000 units

cost per unit $25 per unit

= $1,000,000 3.

Increase in inventory (in units)

=

production – sales

=

130,000 units – 125,000 units

=

5,000 units $700,000 140,000 units

Budgeted fixed manufacturing overhead per unit = = $5 per unit Difference in reported income = budgeted fixed overhead per unit = $5

change in inventory (in units)

5,000 units = $25,000

Income reported under absorption costing will be higher than that re ported under variable costing, because inventory increased during the year. 4.

If Outback Corporation had adopted a JIT program at the beginning of 20x1: a. It is unlikely that the company would have manufactured 5,000 more units than it sold. Under JIT, production and sales would be nearly equal. b. Reported income under variable and absorption costing would most likely be nearly the same. Differences in reported income are caused by changes in inventory levels. Under JIT, inventory levels would be minimal. Therefore, the change in these levels would be minimal.


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Cost per unit: (a) Absorption Costing

(b) Variable Costing

Direct material ............................. $35 ................................................. ...... $35 Direct labor .................................. 16 ................................................. ...... 16 Manufacturing overhead Variable ..................................... 10 ................................................. ...... 10 Fixed ($210,000 ÷ 30,000) ........ 7 Total absorption cost per unit….. $68 Total variable cost per unit .............................................................................. $61 2.

a.

STARS ABOVE LTD. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X1 ABSORPTION COSTING

Sales revenue (27,000 at $95 per unit) ........................................... Less: Cost of goods sold (27,000 units at absorption cost of $68 per unit) ................................................... Gross margin ................................................... ................................ Less: Selling and administrative expenses: Variable (27,000 at $1 per unit) ........................................... Fixed ..................................................................................... Operating income ............................................................................


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$2,565,000 1,836,000 729,000 27,000 230,000 $ 472,000


PROBLEM 8-25 (CONTINUED) b.

STARS ABOVE LTD. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X1 VARIABLE COSTING

Sales revenue (27,000 units at $95 per unit) .................................. Less: Variable expenses: Variable manufacturing costs (27,000 units at variable cost of $61 per unit) .................. Variable selling and administrative costs (27,000 units at $1 per unit) ............................................... Contribution margin ................................................. ....................... Less: Fixed expenses: Fixed manufacturing overhead ........................................... Fixed selling and administrative costs .............................. Operating income ............................................................................ 3.

4.

$2,565,000 1,647,000 27,000 891,000 210,000 230,000 $ 451,000

Change in inventory (in units)

predetermined fixed overhead rate

=

absorption-costing income minus variable-costing income

3,000 unit increase

$7

=

$21,000

If Stars Above had implemented JIT and installed a flexible manufacturing system at the beginning of 20x1, it is unlikely that reported income would have differed by as great a magnitude. Under this scenario, production and sales would have been nearly the same. As a result, reported income under variable and absorption costing would have been nearly equal. Differences in reported income are caused by significant changes in inventory levels, which do not occur under JIT because inventory is minimal.


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Throughput cost per unit: Direct material cost per unit* ...... $35 Total throughput cost per unit ............................... $35 *Direct material is the only throughput cost.

2.

STARS ABOVE LTD. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X1 THROUGHPUT COSTING

Sales revenue (27,000 units at $95 per unit) .................................. Less: Cost of goods sold (at throughput cost, the direct-material cost, 27,000 x $35 per sold unit) Gross margin ................................................... ................................ Less: Operating costs: Direct labor (at $16 per planned unit)a ................................. Variable overhead (at $10 per planned unit)b ...................... Variable selling and administrative costs (at $1 per planned unit)c ............................................... ...... Fixed manufacturing overhead ........................................... Fixed selling and administrative costs .............................. Operating income ............................................................................ aSpending

$2,565,000 945,000 1,620,000 480,000 300,000 30,000 210,000 230,000 $ 370,000

for direct labor is committed at the 30,000 unit level.

bSpending

on variable manufacturing overhead costs is committed at the level needed to produce 30,000 units. cVariable

selling and administrative costs are committed at a level that will support the potential sale of 30,000 units.


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For throughput costing: Some managerial accountants believe that absorption costing may provide an incentive for managers to overproduce inventory so that the fixed manufacturing overhead costs may be spread over a larger number of product units, thereby lowering the reported product cost per unit. Throughput costing avoids this potential problem by not assigning fixed manufacturing overhead as a product cost. Against throughput costing: Many managers prefer absorption-costing data for cost-based pricing decisions. They argue that fixed manufacturing overhead is a necessary cost of production. To exclude this fixed cost from the inventoried cost of a product, as is done under throughput (and variable) costing, is to understate the cost of the product. This, in turn, could lead to setting cost-based prices too low.


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Reported income will be lower under variable costing, because inventory is expected to increase by 1,000 units during the year. (Twenty thousand units will be produced in the last two months, but 19,000 units will be sold.)

2.

a. Variable costing: Total contribution during first 10 months is equal to the fixed costs plus profit for that period. Fixed costs during first 10 months ...................................................... Profit during first 10 months ................................................................ Total contribution margin .................................................. ................... Contribution margin per unit =

$2,200,000 100,000

$2,000,000 200,000 $2,200,000

= $22 per unit

Projected total sales for the year are 119,000 units (100,000 in first 10 months plus 19,000 units in last 2 months). We can compute projected income for the year as follows: Projected total contribution margin ($22 119,000) ......................... Projected fixed costs ($200,000 12) ................................................ Projected income .................................................................................

$2,618,000 2,400,000 $ 218,000

The operating income projected for the year under variable costing is $218,000. Note: The problem states that the prior period’s cost rates are the same as those of the current period. Absorption costing: The gross margin for the first 10 months is $200,000. Notice that income and gross margin are the same, since there are no selling or administrative expenses. Therefore, during the first 10 months: Gross margin per unit =


$200,000 = $2 per unit 100,000 units

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PROBLEM 8-27 (CONTINUED) Projected sales for the year are 119,000 units, so we can compute projected income for the year as follows: Projected gross margin ($2

119,000) ..............................................

$238,000

There are no selling and administrative costs, so projected operating income for the year under absorption costing is also $238,000. Check: Our conclusions can be checked by noting the following relationship:

Reportedincome under reported income under – variable costing absorptioncosting = increase in inventory = 1,000 units

fixed-overhead rate

$20 per unit = $20,000

Therefore, reported income will be $20,000 lower under variable costing than under absorption costing.


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Advantages and disadvantages of absorption and variable costing: (a) Pricing decisions: Many managers prefer to use absorption-costing data in costbased pricing decisions. They argue that fixed manufacturing overhead is a necessary cost incurred in the production process. To exclude this fixed cost from the inventoried cost of a product, as is done under variable costing, is to understate the cost of the product. For this reason, most companies that use cost-based pricing base their prices on absorption-costing data.

Proponents of variable costing argue that a product’s variable cost provides a better basis for pricing decisions. They point out that any price above a product’s variable cost makes a positive contribution to covering fixed cost and profit. (b) Definition of an asset : Another controversy about absorption and variable costing hinges on the definition of an asset. An asset is a thing of value owned by the organization with future service potential. By accounting convention, assets are valued at their cost. Since fixed costs comprise part of the cost of production, advocates of absorption costing argue that inventory (an asset) should be valued at its full (absorption) cost of production. Moreover, they argue that these costs have future service potential since the inventory can be sold in the future to generate sales revenue.

Proponents of variable costing argue that the fixed-cost component of a product’s absorption-costing value has no future service potential. Their reasoning is that the fixed manufacturing-overhead costs during the current period will not prevent these costs from having to be incurred again next period. Fixed-overhead costs will be incurred every period, regardless of production levels. In contrast, the incurrence of variable costs in manufacturing a product does allow the firm to avoid incurring these costs again. (c) Cost-volume-profit analysis : Some managers find the inconsistency between absorption costing and CVP analysis troubling enough to warrant using variable costing for internal income reporting. Variable costing dovetails much more closely than absorption costing with any operational analyses that require a separation between fixed and variable costs. (d) External reporting : For external reporting purposes, generally accepted accounting principles require that income reporting be based on absorption costing.


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Total cost: Direct material (10,000 units x $12)…………... $120,000 Direct labor……………………………………….. 45,000 Variable manufacturing overhead……………. 65,000 Fixed manufacturing overhead……………….. 220,000 Variable selling and administrative costs (9,600 units x $8)…………………………….. 76,800 Fixed selling and administrative costs……… 118,000 Total……………………………………………. $644,800

2.

The cost of the year-end inventory of 400 units (10,000 units produced – 9,600 units sold) is computed as follows:

Direct material………………………….. Direct labor……………………………… Variable manufacturing overhe ad….. Fixed manufacturing overhead……… Total product cost………………… Cost per unit (total ÷ 10,000 units)… Year-end inventory (400 units x cost per unit)……………………………... 3.

Absorption Costing

Variable Costing

Throughput Costing

$120,000 45,000 65,000 220,000 $450,000 $45

$120,000 45,000 65,000

$120,000

$230,000 $23

$120,000 $12

$18,000

$9,200

$4,800

The total costs would be allocated between the current period’s income statement and the year-end inventory on the balance sheet. Thus: Absorption costing: $644,800 - $18,000 = $626,800 Variable costing: $644,800 - $9,200 = $635,600 Throughput costing: $644,800 - $4,800 = $640,000


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PROBLEM 8-28 (CONTINUED Alternatively, these amounts can be derived as follows: Absorption Costing Cost of goods sold: 9,600 units x $45……………………… 9,600 units x $23……………………… 9,600 units x $12……………………… Direct labor………………………………… Variable manufacturing overhead…….. Fixed manufacturing overhead………… Variable selling and administrative costs…………………………………….. Fixed selling and administrative costs.. Total……………………………………... 4.

Variable Costing

Throughput Costing

$432,000 $220,800

76,800 118,000 $626,800

220,000

$115,200 45,000 65,000 220,000

76,800 118,000 $635,600

76,800 118,000 $640,000

Throughput-costing income statement: Sales revenue (9,600 units x $72)……………….. Less: Cost of goods sold ………………………... Gross margin……………………………………….. Less: Operating costs: Direct labor …………………………………….. Variable manufacturing overhead …………. Fixed manufacturing overhead……………… Variable selling and administrative costs ... Fixed selling and administrative costs……. Total operating costs…………………….. Operating income…………………………………..

$691,200 115,200 $576,000 $ 45,000 65,000 220,000 76,800 118,000 $524,800 $ 51,200*

*As a check: Operating income = sales revenue - all costs expensed = $691,200 - $640,000 (from req. 3) = $51,200 5.



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a. Absorption-costing income statements:

Sales revenue (at $50 per case) .............................. Less: Cost of goods sold (at absorption cost of $42 per case*) ......................... Gross margin ........................................................... Less: Selling and administrative expenses: Variable (at $1 per case) .............................. Fixed ............................................................. Operating income ....................................................

Year 1 $4,000,000

Year 2 $3,000,000

Year 3 $4,500,000

3,360,000 $ 640,000

2,520,000 $ 480,000

3,780,000 $ 720,000

80,000 75,000 $ 485,000

60,000 75,000 $ 345,000

90,000 75,000 $ 555,000

*The absorption cost per case is $42, calculated as follows:

variable manufactur ing

Budgeted fixed manufactur ing overhead Planned production

+

$800,000 80,000

+

$32

$10

+

$32 = $42


cost per case

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PROBLEM 8-29 (CONTINUED) b. Variable-costing income statements: Year 1 Sales revenue (at $50 per case) ................................. $4,000,000 Less: Variable expenses: Variable manufacturing costs (at variable cost of $32 per case) 2,560,000 Variable selling and administrative costs (at $1 per case) ................................... 80,000 Contribution margin ................................................... $1,360,000 Less Fixed expenses: Fixed manufacturing overhead ...................... 800,000 Fixed selling and administrative expenses ....................................................... 75,000 Operating income ....................................................... $ 485,000 2.

Year 3 $4,500,000

1,920,000

2,880,000

60,000 $1,020,000

90,000 $1,530,000

800,000

800,000

75,000 $ 145,000

75,000 $ 655,000

Reconciliation:

Reported Income Year 1 2 3

Year 2 $3,000,000

Absorption Variable Costing Costing $485,000 $485,000 345,000 145,000 555,000 655,000

Difference In Difference Predetermined Fixed Overhead in Change in Fixed Expensed Under Reported Inventory Overhead Absorption and Income (in units) Rate* Variable Costing -0-0$10 0 $200,000 20,000 10 $200,000 (100,000) (10,000) 10 (100,000)

*Predetermined fixed manufacturing overhead rate =


$800,000 80,000

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a. In year 4, the difference in reported operating income will be $100,000, calculated as follows: Change in inventory (in units)

Predetermined fixed overhead rate

(10,000)

$10

=

$(100,000)

Income reported under absorption costing will be lower, because inventory will decline during year 4. b. Over the four-year period, the total of all reported operating income will be the same under absorption and variable costing. This result will occur because inventory does not change over the four-year period. It starts out at zero on January 1 of year 1, and it ends up at zero on December 31 of year 4.


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9.Hilton 9E Global Edition Solutions Manual Chapter08(exercise+problem).pdf

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