CASE 3: Landau Company I. Point of View The point of view taken in this analysis is that of a third party consultant.

Statement of the Problem: Landau Company is divided on which costing system to use due to the various pros and cons that must be considered for both full and variable cost system to be in decision making. III. Objective/s: The objective of the Consultant is to provide an educated suggestion about which costing system will be used within Landau Company. IV. Areas of consideration: 1) The Terry Silver, New VP for marketing, has challenged the way that the company is computing for monthly income statement emphasizing on why lower margins were reflected in the income statement despite the increase in sales volume. 2) The Ms. Meredith Wilcox, Landaus Chief Accountant, has presented a revised income statement to Silver using variable costing system. Silver had positive response to the new income statement and suggested the shift from using absorption costing to variable costing during the executive committee meeting. 3) The controller has supported the proposal of Silver saying that since variable costing segregated the cost of materials, direct labor and variable overhead from fixed overhead costs, managements costs control efforts would be enhanced. 4) Variable costing is not acceptable for financial reporting and taxation purposes. 5) In a variable costing system a monthly income statement is related directly to a companys monthly sales volume while in full costing income is affected by both sales and production volume. 6) The treasure spoke up and said that if the new approach will be taken marketing might sell at their usual mark up over variable costs and asked how the company will pay for the fixed costs then? The treasurer highly objected the idea of changing the method of reporting income internally.

II.

7) The Consultant has computed the income in both variable and full costing supposing that a decision on which product to sell more was based on a full cost system. Amounts used in computation can be found in exhibit 1. The following information was gathered (in this case product 129 was sold more since it had higher margin that 243: a. Net income for variable costing system is lower than the reported income in the full cost system. b. Losses were incurred in product 129 which had the highest margin in the context of variable costing system.
Exhibit 1 Full Costing Product Selling Price 129 243

Standard Production Unit Margin Margin Percent Cost 4.34 2.54 1.8 41.47% 5.89 3.05 2.84 48.22%

Variable Costing Product Selling Price 129 243

Standard Production Unit Margin Margin Percent Cost 4.34 1.38 2.96 68.20% 5.89 2.37 3.52 59.76%

The following amounts are assumed for the purpose of this calculations. Product 129 Product 243 Normal Capacity 30,000 25,000 Fixed overhead Cost 34,800 17,000 Selling and administrative Costs 8000 10000 Predetermined OH rate 1.16 0.68

sales Volume Revenue Standard Production cost Fixed Production Overhead Selling and administrative Net Income net income/Sales

129 10000 43,400 25,400 8,000 10,000 23%

Full 243 20000 117,800 61,000 10,000 46,800 40%

total 30000 161,200 86,400 18,000 56,800 35%

129 10000 43,400 13,800 34,800 8,000 (13,200) -30%

Variable 243 20000 117,800 47,400 17,000 10,000 43,400 37%

total 30000 161,200 61,200 51,800 18,000 30,200 19%

8) The Consultant has computed the income in both variable and full costing supposing that a decision on which product to sell more was based on a variable cost system. Amounts used in computation can be found in exhibit 1. The following information was gathered (in this case product 243 was sold more since it had higher margin that 129 a. Net income in variable costing system is still lower that the reported income in the full cost system
Full 243 10000 58900 30500 10000 18400 31% Variable 243 10000 58900 23700 17,000 10000 8200 14%

sales Volume Revenue Variable Cost of goods sold Fixed Production Overhead Selling and administrative Net Income net income/Sales

129 20000 86800 50800 8000 28000 32%

total 30000 145700 81300 0 18000 46400 32%

129 20000 86800 27600 34,800 8000 16400 19%

total 30000 145700 51300 51800 18000 24600 17%

9) From the information in areas of consideration 7 and 8 it can be noticed that full costing income for the decision that was based on the full cost system has bigger net income as compared when a decision was derived from an absorption cost system. 10) If sales prices were revised based on absorption costing retaining the same mark up on costs the following will follow: a. Provided sales equal production income for revised sales price is significantly lower. This can be attributed to the lack of provision for per unit fixed overhead in the sales price. Please see details on table below.
Product Revised Selling Price Standard Production Cost Unit Margin Margin Percent 129 2.36 1.38 0.98 41.47% 243 4.58 2.37 2.21 48.22%
income statement using revised sales price income statement using OLD sales price 129 243 total 129 243 total 30,000 25,000 55,000 30,000 25,000 55,000 70,738.58 114,420.49 185,159.07 130,200.00 147,250.00 277,450.00 76,200.00 76,250.00 152,450.00 76,200.00 76,250.00 152,450.00 8,000.00 10,000.00 18,000.00 8,000.00 10,000.00 18,000.00 (13,461.42) 28,170.49 14,709.07 46,000.00 61,000.00 107,000.00 -19% 25% 8% 35% 41% 39%

sales Volume Revenue Variable Cost of goods sold Fixed Production Overhead Selling and administrative Net Income net income/Sales

V.

Alternative Courses of Action: a. Propose the change in income statement presentation to variable costing system. This will enhance the companys efforts in controlling the variable aspects of manufacturing. This method will also prove to be conservative since costs will be expensed when incurred thus revenues will be reduced by the expenses which were incurred during the month. However, this system will prove to be less effective when the company will move from the labor intensive to capital intensive manufacturing where basically majority of the part of operation will be overhead. Moreover, when sales price are computed only to cover variable costs there is no provision made for the fixed costs incurred. As seen in areas of consideration 10 income decreased as compared to the income when sales prices were computed based on full cost. b. Propose the keeping of full cost system. Sales price decisions based on this system will provide provision for per unit fixed overhead. Moreover, full Costing is a function of production. Thus, efficiency in manufacturing can be well watched since any decrease in production as compared to sales will alarm management since lesser income is recognized due to an increased inventory costs. Ease in accounting is also an advantage for full costing since in reality determining the fixed part of overhead can be cumbersome. However, some departments can increase reported income by building up inventory. In this way, much of the overhead costs though incurred for a certain period may be carried out as an assets and hide it in the inventory accounts. Recommendation a. The recommended alternative course of action is action B. the use of Variable costing might lead decision makers to lean towards having more emphasis on contribution margins while neglecting nonvariable costs which are equally important and may even be more important in capital intensive firms. Moreover, Variable costing is not accepted in tax reporting and financial reporting.

VI.

Solutions to Problems Problem 19-1. Veronica Company A) Overhead Rate Total Estimated Ave. Monthly Overhead Cost Ave. Monthly direct labor hours $180,000.00 = 20,000 $9.00

Veronica's Average Overhead rate is $ 9.00

B) Computation for Production Costs Job G $10,000.00 $28,000.00 $21,600.00 $59,600.00 $25,200.00 $67,200.00 Job H $10,000.00 $32,000.00

Direct Material Cost Direct Labor Cost Overhead Cost* 2,400X$9 2,800X$9 Total Product Cost *overhead rate x Direct labor hours

C) Veronica company can charge customers the following amounts: Job G Job H $59,600.00 $67,200.00 1.8 1.8 $107,280.00 $120,960.00

Total Product Cost Amount to charge customers (180% of Product Costs)

Problem 19-2. VT Sugar Enterprises

A) Total Cost of Syrup is $110,280.00 Sugar $2,000.00 $280.00 $1,720.00 $100,000.00 $12,000.00 $1,720.00 $110,280.00

Sales After Split off costs Gross margin of Sugar Joint Cost after Split Off Cost Less Gross Margin of Sugar Total cost of Syrup

B) Product Costs Syrup Sugar $300,000.00 $2,000.00 $12,000.00 $280.00 $288,000.00 $1,720.00 $99,406.32 $593.68 Total $302,000.00 $12,280.00 $289,720.00 $100,000.00

Sales After Split off costs Margin Joint Cost

Product Costs Joint Costs After Split off costs Total Product Cost

Syrup $99,406.32 $12,000.00 $111,406.32

Sugar Total $593.68 $100,000.00 $280.00 $12,280.00 $873.68 $112,280.00

Problem 19-3 Monrad Corporation a) Adjusting Journal Entries Inventory (462,000*3,000/33,000) Cost of Goods sold (462,000*30,000/33,000)

$ 42,000.00 $ 420,000.00

b) In a variable costing system, income will be lower that absorption costing system by 42,000 since in variable costing s c) ystem fixed portions of manufacturing costs is recognized as expense in the year it is incurred. However, in absorption costing such costs are inventoried and thus are not part of the Cost of Goods sold. d) Ending FG balance: Finished Goods Inventory at variable cost Non Variable Product cost-Finished goods portion Finished Goods Inventory- in Absorption costing

$ 75,000.00 $ 42,000.00 $ 117,000.00

Problem 19-4 Nemad Company a) Direct material cost per assembly for next year is $ 4.16

each assemble requires 8 Levers 10% of items produced are often discarded not being able to meet standards No of Levers Monrad has to produce to make 8 Good Levers

8 90% 8 8/9

No of Levers Monrad has to produce to make 8 Good Levers Cost per piece of Each lever Direct material cost for the year increase in Material cost due to 4% inflation
Direct material cost per assembly for the next year

8.8889 $ 0.45 4 $ 0.16 $ 4.16

b) Direct labor cost per assembly for next year $4.0659

Total Work Week Hours Two Daily 15-minute breaks @5 days Non producing working time (15% of normal working time) Total Productive Hours Standard labor Time required for 1 unit (in minutes)(12 minutesx 90%) Total standard units produced per work week Average weekly pay (40*$18) Total standard units produced per work week Direct labor cost per assembly for next year

Hours 40.00 2.50 5.63 31.88 0.18 177.08 $720 177.08 $4.0659