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CHAPTER 8

Alternative Inventory Costing Methods:


A Decision-Making Perspective
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives

Questions

Brief
Exercises

1.

Explain the difference


between absorption
costing and variable
costing.

1, 2, 3, 4,
7, 8, 9, 10,
11

1, 2, 4, 5,
7, 8, 10,
11

12, 14,
15

16, 17, 18,


19, 20, 22,
23, 24, 25

26A, 27A, 28A,


29A, 31A, 32A,
34A, 35A, 36B,
38B 44B

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.

6, 8, 9, 10,
11, 12

10, 11

13

22

26A, 27A, 28A,


29A, 31A, 32A,
34A, 35A, 36B,
38B 44B

3.

Discuss the advantages of


variable costing versus
absorption costing for
management decisionmaking.

13, 14, 15,


16

12, 13

19, 22, 23,


24, 25

27A, 28A, 29A,


31A, 32A, 34A,
35A, 38B, 39B,
40B, 41B, 42B,
44B

*4.

Discuss the effect of a


normal costing method on
income reported under
absorption costing and
variable costing (Appendix
8A).

14

18, 21

30A, 33A, 37B

*5.

Discuss the effect of the


throughput costing method
on income reported under
variable costing (Appendix
8A).

3, 6, 7

15

16, 25

26A, 29A, 32A,


36B, 40B

1, 4, 5,

Do It!
Review

Exercises

A&B
Problems

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ASSIGNMENT CHARACTERISTICS TABLE


Problem
Number
26A

27A
28A

29A

30A

31A

32A

33A
34A

35A

36B

37B
38B

39B

Description
Calculate the product cost; prepare an income statement under variable
costing, absorption costing and throughput costing and reconcile the
differences.
Prepare income statements under absorption costing and variable
costing for a company with beginning inventory.
Prepare absorption- and variable costing income statements; reconcile
the differences between absorption- and variable-costing income
statements when sales and production levels change; and discuss the
usefulness of absorption costing versus variable costing.
Prepare an income statement under variable costing, absorption costing,
and throughput costing and reconcile the differences; discuss the
usefulness of absorption costing versus variable costing.
Calculate the product cost; and prepare income statements under normal
costing.
Calculate product cost; prepare income statements under variable
costing and absorption costing and reconcile the difference when sales
and production levels change.
Calculate the product cost; prepare income statements under variable
costing, absorption costing, and throughput costing, and reconcile the
differences.
Calculate the product cost; and prepare income statements under normal
costing.
Explain variable costing and absorption costing and reconcile the
differences when sales and production levels change.
Prepare income statements under variable costing, absorption costing,
and throughput costing and reconcile the differences when sales and
production levels change; discuss the usefulness of absorption costing
versus variable costing.
Calculate the product cost; prepare income statements under variable
costing, absorption costing, and throughput costing, and reconcile the
differences.
Calculate the product cost; and prepare income statements under normal
costing.
Prepare income statements under absorption costing and variable
costing for a company with beginning inventory.
Prepare absorption- and variable-costing income statements; reconcile
the differences between the two income statements when sales and
production levels change; discuss the usefulness of the two approaches
to costing.

Difficulty
Level

Time
Allotted (min.)

Easy

30-40

Moderate

40-50

Easy

30-40

Moderate

30-40

Moderate

20-30

Easy

20-30

Moderate

30-40

Easy

20-30

Moderate

20-30

Challenging

40-50

Moderate

30-40

Moderate

15-20

Moderate

50-60

Moderate

30-40

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ASSIGNMENT CHARACTERISTICS TABLE (Continued)


Problem
Number
41B

Description
Calculate the product cost; prepare income statements under variable
costing and absorption costing, and reconcile the differences when sales
and production levels change.

42B

Calculate the product cost contribution margin under variable costing and
the gross margin under absorption costing.

43B

Prepare an income statement under variable costing; discuss the


advantages of variable costing over absorption costing.

44B

Calculate product cost; prepare income statements under variable


costing and absorption costing and reconcile the difference when sales
and production levels change; discuss the usefulness of absorption
costing versus variable costing.

Difficulty
Level

Time
Allotted (min.)

Challenging

40-50

Moderate

15-20

Easy

15-20

Challenging

40-50

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Study Objective

Knowledge Comprehension

*1.

Explain the difference between Q1, Q2, Q3, Q4, Q9, Q10,
absorption costing and variable Q7, BE1,
Q11
costing.
BE2

*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.

*3.

Discuss the advantages of


variable costing versus
absorption costing for
management decision-making.

*4.

*5.

Application
Q8,
BE4
BE5
BE7

BE8
BE10
BE11
D12

E17
E19
E20
P42B

Analysis
D14
D15
E16
E18
E22
E23
E24

E25
P26A
P27A
P28A
P29A
P32A
P34A

Q6, Q9, Q10,


Q11, Q12

Q8
BE10
BE11
P42B

D13
E22
E23
E24
E25
P26A

P27A
P28A
P29A
P32A
P34A
P35A

Q13, Q15, Q16

D12
E19
P42B

D13
E22
P27A
P28A
P29A

P32A
P35A
P38B
P39B
P40B

Discuss the effect of a normal


costing method on income
reported under absorption
costing and variable costing
(Appendix 8A).

BE9

D14 P37B
E18
E21
P30A
P33A

Discuss the effect of the


Q1, Q5, BE3 Q4
throughput costing method on
income reported under variable
costing (Appendix 8A).

BE6
BE7

D15 P36B
E16 P40B
E25
P26A
P29A
P32A

Q14

P35A
P36B
P38B
P39B
P40B
P41B
P43B
P44B
P36B
P38B
P39B
P40B
P41B
P44B

Synthesis
P31A
P34A

P31A
P34A

P41B P31A
P44B P34A

Evaluation

BLOOMS TAXONOMY TABLE

2011For Instructor Use Only

Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems

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ANSWERS TO QUESTIONS
1.

Variable costing is a system for determining product costs that is used primarily for making
managerial decisions. Under variable costing, direct materials, direct labour, and variable
manufacturing overhead are considered product costs. In contrast, absorption costing is required
for external reporting purposes and is used by some managers for internal decisions. Under
absorption costing, product costs include direct material, direct labour, and manufacturing
overhead (both fixed and variable) costs.
Throughput costing treats all costs as period expenses except for direct materials. It is suitable
only for companies engaged in a manufacturing process in which conversion costs such as direct
labour and manufacturing overhead are fixed costs and do not vary proportionately with the units
of production. Assembly-line and continuous processes that are highly automated are most likely
to meet this criterion.

2.

The costs that are included as product costs under a variable costing system are direct materials,
direct labour, and variable manufacturing overhead.

3.

Fixed manufacturing overhead costs are treated as a period cost, similar to selling and
administrative costs. These costs are expensed each period, as they are incurred.

4.

Under variable costing, direct materials, direct labour and variable manufacturing overhead are
included as product costs. Under throughput costing, only direct material costs are considered
product costs.

5.

In throughput costing, the conversion costsdirect labour and variable manufacturing overhead
are considered to be fixed, and are expensed in the month they are incurred.

6.

Some of the fixed manufacturing overhead costs are deferred to a future period in the inventory
account under absorption costing when inventory increases.

7.

The main difference is the timing of some expenses. Variable costing treats fixed manufacturing
overhead costs as a period cost and therefore expenses these costs each period. Absorption
costing treats fixed manufacturing overhead costs as a product cost and therefore will defer
some of these costs to future periods when production exceeds sales. Conversely, when sales
exceeds production, more fixed costs will be charged to cost of goods sold than under variable
costing.

8.

The difference is going to be in the value of the ending inventory. Under absorption costing the
fixed manufacturing overhead will be included, so ending inventory will be $210,000 (10,500 units
$20). Variable costing does not include fixed manufacturing overhead as a period cost, so the
per unit cost of inventory will be $15, and the value of the ending inventory will be $157,500. The
difference is $52,500, that is, absorption costing will report a $52,500
higher net income than
variable costing because a portion of the
fixed manufacturing overhead costs are deferred in
inventory.

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Questions Chapter 8 (Continued)


9.

If production equals sales in any given period, the net incomes under both methods will be equal.
In this case, there is no increase or decrease in the ending inventory when compared to the
beginning inventory. So fixed manufacturing overhead costs in the current period are not deferred
to future periods through an increase in the ending inventory, or released into expenses in the
current period in the case of an inventory decrease.

10.

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

11.

In the long run, neither method will produce a higher net income amount. Over a long period of
time, sales can never exceed production, nor should production exceed sales by significant
amounts. For this reason, over the lifetime of a corporation, variable costing and absorption
costing will tend to yield the same net income amounts.

12.

Production changes do not affect the amount of fixed manufacturing overhead costs in a given
period. However, production changes affect the expensing of fixed manufacturing overhead
costs. When production exceeds sales, a portion of fixed manufacturing overhead is deferred to a
future period when using absorption costing. If variable costing is used, all fixed manufacturing
overhead incurred in the period is expensed in the current period.

13.

No, variable costing is generally just a managerial technique. Under generally accepted
accounting principles (GAAP), variable costing is not allowed for external financial statements.

14.

Some of the benefits include:


(1) Net income computed under variable costing is unaffected by changes in production levels.
As a result, it is much easier to understand the impact of fixed and variable costs on the
computation of net income when variable costing is used.
(2) The use of variable costing is consistent with cost-volume-profit analysis and incremental
analysis.
(3) Net income computed under variable costing is closely tied to changes in sales levels (not
production levels), and therefore provides a more realistic assessment of the companys
success or failure during a period.
(4) The presentation of fixed and variable cost components on the face of the variable costing
income statement makes it 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 companys results.

15.

The differences between absorption costing and variable costing techniques occur when
inventory levels change between two periods of time. Since just-in-time inventory management
reduces finished goods inventory, the differences between absorption and variable costing are
greatly reduced, if not totally offset.

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Questions Chapter 8 (Continued)


16.

Both systems can be useful to management but variable costing has several advantages for
internal decision making. Variable costing is consistent with cost-volume-profit analysis and
incremental analysis. It also makes it easier to understand the impact of fixed and variable costs
on net income. Since net income computed under variable costing is closely tied to changes in
sales levels (not production levels as is the case with absorption costing), it provides a more
realistic assessment of success or failure during a period.
Companies that use variable costing for internal decision making must also maintain absorption
costing systems for external reporting as required under GAAP.

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SOLUTIONS TO BRIEF EXERCISES


BRIEF EXERCISE 8-1
Variable costing:
Commission fees for salespersons
Glue for wooden chairsvariable
Fabric for T-shirts
Labour costs for producing TVs
Factory rent expensefixed
Factory utility costsvariable
Car mileage costs for salespersons
Administrative expensesfixed
Administrative Internet connection fees
Wagesassembly line

Product
Cost

Period
Cost
X

X
X
X
X
X
X
X
X
X

BRIEF EXERCISE 8-2


Absorption costing:
Commission fees for salespersons
Glue for wooden chairsvariable
Fabric for T-shirts
Labour costs for producing TVs
Factory rent expensefixed
Factory utility costsvariable
Car mileage costs for salespersons
Administrative expensesfixed
Administrative Internet connection fees
Wagesassembly line

Product
Cost

Period
Cost
X

X
X
X
X
X
X
X
X
X

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*BRIEF EXERCISE 8-3


Throughput costing:

Product
Cost

Commission fees for salespersons


Glue for wooden chairsvariable
Fabric for T-shirts
Labour costs for producing TVs
Factory rent expensefixed
Factory utility costsvariable
Car mileage costs for salespersons
Administrative expensesfixed
Administrative Internet connection fees
Wagesassembly line

Period
Cost
X
X

X
X
X
X
X
X
X
X

BRIEF EXERCISE 8-4


Variable Costing
Direct materials
Direct labour
Variable manufacturing overhead
Total product costs

$28,980
51,060
64,840
$144,880

BRIEF EXERCISE 8-5


Absorption Costing
Direct materials
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead
Total product costs

$28,980
51,060
64,840
20,000
$164,880

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*BRIEF EXERCISE 8-6


Throughput Costing
Direct materials
Total product costs

$28,980
$28,980

*BRIEF EXERCISE 8-7


(a) Absorption Costing
Direct materials
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead ($120,000 12,000)
Total product cost per unit

Per Unit
$20.00
12.00
15.00
10.00
$57.00

(b) Variable Costing


Direct materials
Direct labour
Variable manufacturing overhead
Total product cost per unit

Per Unit
$20.00
12.00
15.00
$47.00

(c) Throughput Costing


Direct materials
Total product cost per unit

Per Unit
$20.00
$20.00

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BRIEF EXERCISE 8-8


Rafael Corp.
Income StatementVariable Costing
For the Year Ended December 31, 2012
_______________________________________________________________
Sales (40,000 units $15)
Less: variable costs
Variable COGS (40,000 units $6)
Variable S&A expenses (40,000 units $2)
Contribution margin
Less: fixed costs
Fixed manufacturing overhead
Fixed selling and administration expenses
Operating income before tax

$600,000
$240,000
80,000
80,000
20,000

320,000
280,000
100,000
$180,000

*BRIEF EXERCISE 8-9


(a)

(b)

Manufacturing cost per unit:


Variable costs
Fixed costs ($80,000 50,000 units)

$6.00
1.60
$ 7.60

Rafael Corp.
Income StatementNormal Costing
For the Year Ended December 31, 2012

Sales (40,000 units $15)


Cost of goods sold:
Beginning inventory
Plus: Cost of goods manufactured (50,000 $7.60)
Goods available for sale
Less: Ending inventory (10,000 $7.60)
Cost of goods sold
Plus: volume variance [$80,000 (40,000 $1.60)]
Gross Margin
Less: S&A [Variable (40,000 $2) + Fixed ($20,000)]

$600,000

$380,000
380,000
76,000
304,000
16,000

320,000
280,000
100,000

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Operating income before tax

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$180,000

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BRIEF EXERCISE 8-9 (Continued)


(c) Rafael Corp.s production exceeded its sales by 10,000 units (50,000
40,000). It had fixed manufacturing costs per unit of $1.60. Under
variable costing, fixed manufacturing overhead is expensed in the year
incurred, while under absorption costing it is included in inventory.
Therefore, $16,000 (10,000 $1.60) of fixed manufacturing overhead is
included in Rafaels inventory under normal costing. As a result,
absorption costing income exceeds variable costing income by
$16,000. The statement shows both net incomes to be the same
because the volume variance (which also amounted to $16,000) was
added back to the normal cost of goods sold.
BRIEF EXERCISE 8-10
(a)
Rafael Corp.
Income StatementAbsorption Costing
For the Year Ended December 31, 2012
Sales (40,000 units $15)
Cost of goods sold:
Beginning inventory
Plus: Cost of goods manufactured (50,000 $7.60)
Goods available for sale
Less: ending inventory (10,000 $7.60)
Gross Margin
Less: S&A [Variable (40,000 x $2) + Fixed ($20,000)]
Operating income before tax

$600,000

$380,000
380,000
76,000

304,000
296,000
100,000
$196,000

(b)
Variable costing net income
Plus: fixed manufacturing overhead costs deferred
in ending inventory (10,000 units $1.60)
Absorption costing operating income

$180,000
16,000
$196,000

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BRIEF EXERCISE 8-11


When production is greater than sales, absorption costing net income is
greater than variable costing net income by an amount equal to the number
of units in ending inventory times the fixed overhead rate per unit.
Fixed overhead rate per unit = $190,000 20,000 units = $9.50 per unit
Absorption costing operating income
Less: Fixed overhead in ending inventory (2,000 $9.50)
Variable costing operating income

$25,000
19,000
$ 6,000

SOLUTIONS TO DO IT! REVIEW


DO IT! REVIEW 8-12
(a)

(b)

Manufacturing cost per unitabsorption costing


Direct material
Direct labour
Variable overhead
Fixed overhead ($108,000 12,000 units)

$30.00
12.00
3.00
9.00
$54.00

Fresh Air Products


Income StatementAbsorption Costing
For the first month of operations

Sales (10,000 units $110)


Cost of goods sold:
Beginning inventory
Plus: Cost of goods manufactured (12,000 $54)
Goods available for sale
Less: ending inventory (2,000 $54)
Gross Margin
Less: S&A [(10,000 $4) + $200,000]
Operating income before tax

$1,100,000

$648,000
648,000
108,000

540,000
560,000
240,000
$320,000

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DO IT! REVIEW 8-13


(a)(1)

(a)(2)

Manufacturing cost per unitvariable costing


Direct material
Direct labour
Variable overhead

$30.00
12.00
3.00
$45.00

Fresh Air Products


Income StatementVariable Costing
For the first month of operations

Sales (10,000 units $110)


Less: variable costs
Variable COGS (10,000 units $45)
Variable S&A expenses (10,000 units $4)
Contribution margin
Less: fixed costs
Fixed manufacturing overhead
Fixed selling and administration expenses
Operating income before tax

$1,100,000
$450,000
40,000
108,000
200,000

(b) Variable costing operating income


Plus: fixed manufacturing overhead costs deferred
in ending inventory (2,000 units $9)
Absorption costing operating income

490,000
610,000
308,000
$302,000

$302,000
18,000
$320,000

DO IT! REVIEW 8-14


(a)(1) Manufacturing cost per unitabsorption costing
Direct material
Direct labour
Variable overhead
Fixed overhead ($108,000 13,500 units)

$30.00
12.00
3.00
8.00
$53.00

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DO IT! REVIEW 8-14 (Continued)


(a)(2)

Fresh Air Products


Income StatementNormal Costing
For the first month of operations

Sales (10,000 units $110)


Cost of goods sold:
Beginning inventory
Plus: Cost of goods manufactured (12,000 $53)
Goods available for sale
Less: ending inventory (2,000 $53)
Cost of goods sold
Plus: volume variance [$108,000 (12,000 $8)]
Gross Margin
Less: S&A [(10,000 $4) + $200,000]
Operating income before tax

$1,100,000

$636,000
636,000
106,000
530,000
12,000

(b) Normal costing operating income


Plus:
Costs deferred in ending inventory [2,000 ($9 $8)]
Absorption costing operating income

542,000
558,000
240,000
$318,000

$318,000
2,000
$320,000

DO IT! REVIEW 8-15


(a)(1) Manufacturing cost per unitthroughput costing
Direct material

$30.00
$30.00

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DO IT! REVIEW 8-15 (Continued)


(a)(2)

Fresh Air Products


Income StatementThroughput Costing
For the first month of operations

Sales (10,000 $110)


Variable cost of goods sold:
Beginning inventory
Direct material costs (12,000 $30)
Cost of goods available for sale
Ending inventory (2,000 $30)
Throughput contribution margin
Other operating costs
Direct labour costs (12,000 $12)
Variable overhead costs (12,000 $3)
Variable S & A expenses (10,000 $4)
Fixed manufacturing overhead
Fixed selling and admin
Operating income

$ 1,100,000
$

360,000
360,000
60,000

$144,000
36,000
40,000
108,000
200,000

(b) Throughput costing operating income


Plus: costs deferred in ending inventory (2,000 $15)
Variable costing operating income

300,000
800,000

528,000
$272,000

$272,000
30,000
$302,000

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SOLUTIONS TO EXERCISES
*EXERCISE 8-16
(a)

Manufacturing Cost Per UnitVariable costing


Direct materials
Direct labour
Variable manufacturing overhead
Total product cost per unit

$ 800
1,500
300
$2,600

(b)

WU EQUIPMENT COMPANY
Income Statement
For the Year-Ended December 31, 2012
Variable Costing
_______________________________________________________________
Sales (1,200 units $4,500)
Less: variable costs
Variable COGS (1,200 units $2,600)
Variable S&A expense (1,200 units $70)
Contribution margin
Less: fixed costs
Fixed manufacturing overhead
Fixed S&A expense
Net Income

(c)

$5,400,000
$3,120,000
84,000
1,200,000
100,000

3,204,000
2,196,000
1,300,000
$ 896,000

Manufacturing Cost Per UnitThroughput costing


Direct materials
Total product cost per unit

$800
$800

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EXERCISE 8-16 (Continued)


(d)

WU EQUIPMENT COMPANY
Income Statement
For the Year-Ended December 31, 2012
Throughput Costing
_______________________________________________________________
Sales (1,200 units $4,500)
Less: COGS (1,200 units $800)
Throughput contribution margin
Less: Operating expenses
Direct labour (1,500 $1,500)
Variable MOH (1,500 $300)
Variable S&A (1,200 $70)
Fixed MOH
Fixed selling and administration expenses
Net Income

$5,400,000
960,000
4,440,000
$2,250,000
450,000
84,000
1,200,000
100,000

4,084,000
$356,000

(e) When production is greater than sales, variable costing net income is
greater than throughput costing net income by an amount equal to the
number of units in ending inventory times the per unit variable
conversion costs (direct labour and variable overhead).
Per unit cost = $1,500 + $300 = $1,800
Ending inventory = 1,500 produced 1,200 sold = 300 units
Costs deferred in ending inventory = 300 $1,800 = $540,000
Variable costing net income
Less: conversion costs deferred in ending inventory
Throughput costing net income

$896,000
540,000
$356,000

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EXERCISE 8-17
(a)

Absorption costing:
First determine per unit absorption costing COGS
Variable manufacturing costs
Fixed manufacturing costs ($100,000 10,000)
Per unit absorption costing COGS:

$40.00
10.00
$50.00

ASIAN WINDOWS
Income Statement
For the Year Ended December 31, 2012
Absorption Costing
_______________________________________________________________
Sales (8,500 shades $90)
Less: COGS (8,500 shades $50)
Gross profit
Less: selling and administration expenses
Variable (8,500 $9)
Fixed
Net Income
(b)

$765,000
425,000
340,000
$76,500
250,000

326,500
$13,500

ASIAN WINDOWS
Income Statement
For the Year Ended December 31, 2012
Variable Costing

Sales (8,500 shades $90)


Less: variable costs
Variable COGS (8,500 shades $40)
Variable S&A (8,500 units $9)
Contribution margin
Less: fixed costs
Fixed manufacturing overhead
Fixed S&A expense
Net Income before tax

$765,000
$340,000
76,500
100,000
250,000

416,500
348,500
350,000
$(1,500)

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EXERCISE 8-18
(a)(1) Variable manufacturing costs
Fixed manufacturing costs ($100,000 8,000)
Per unit normal cost
(a)(2)

$40.00
12.50
$52.50

ASIAN WINDOWS
Income StatementNormal Costing
For the year ended December 31, 2012

Sales (8,500 units $90)


Cost of goods sold:
Beginning inventory
Plus: Cost of goods manufactured (10,000 $52.50)
Goods available for sale
Less: ending inventory (1,500 $52.50)
Cost of goods sold
Less: volume variance [$100,000 (10,000 $12.50)]
Gross Margin
Less: S&A [(8,500 x $9) + $250,000]
Net Income

$765,000

$525,000
525,000
78,750
446,250
25,000

(b) Normal costing net income


Less:
Costs deferred in ending inventory [1,500 ($12.50 $10)]
Absorption costing net income

421,250
343,750
326,500
$17,250

$17,250
3,750
$13,500

EXERCISE 8-19
(a)

Manufacturing Cost Per UnitVariable Costing


Direct material
Direct labour
Variable manufacturing overhead
Manufacturing cost per unit

$6.50
2.75
5.75
$15.00

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EXERCISE 8-19 (Continued)


(b)

BOBS COMPANY
Income StatementVariable Costing
For the Year Ended December 31, 2012

Sales (80,000 $25)


Less: variable costs
Variable COGS (80,000 $15)
Variable S&A (80,000 $3.90)
Contribution margin
Less: fixed costs
Fixed manufacturing overhead
Fixed S&A expense
Net Income before tax

$2,000,000
$1,200,000
312,000
285,000
240,100

1,512,000
488,000
525,100
$(37,100)

EXERCISE 8-20
(a)

(b)

Absorption costing per unit manufacturing cost:


Direct materials
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead ($285,000 95,000)
Absorption manufacturing cost per unit

$ 6.50
2.75
5.75
3.00
$18.00

BOB'S COMPANY
Income StatementAbsorption Costing
For the Year Ended December 31, 2012

Sales (80,000 lures $25)


Less: COGS (80,000 lures $18.00)
Gross profit
Less: selling and administration expenses
Variable (80,000 lures $3.90)
Fixed

$2,000,000
1,440,000
560,000
$312,000
240,100

552,100

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Net Income

$7,900

EXERCISE 8-21
(a)(1) Normal costing per unit manufacturing cost:
Direct materials
Direct labour
Variable manufacturing overhead
Pre-determined overhead rate ($285,000 93,860)
Normal manufacturing cost per unit
(a)(2)

$ 6.50
2.75
5.75
3.04
$18.04

BOBS COMPANY
Income StatementNormal Costing
For the year ended December 31, 2012

Sales (80,000 lures $25)


Cost of goods sold:
Beginning inventory
Plus: Cost of goods manufactured
(95,000 $18.04)
Goods available for sale
Less: ending inventory (15,000 $18.04)
Cost of goods sold
Plus: volume variance
[$285,000 (95,000 $3.04)]
Gross Margin
Less: S&A [(80,000 $3.90) + $240,100]
Net Income

$2,000,000

$1,713,800
1,713,800
270,600
1,443,200
3,800

(b) Normal costing net income


Less:
Costs deferred in ending inventory [15,000 ($18.04 $18)]
Absorption costing net income

1,439,400
560,600
552,100
$
8,500
$

8,500
600
$7,900

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EXERCISE 8-22
(a) & (b) Manufacturing Cost Per Unit
Direct material
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead
($96,459 260,700)
Manufacturing cost per unit
(c)

Absorption
$0.26
0.34
0.38

Variable
$0.26
0.34
0.38

0.37
$1.35

$0.98

EMPEY MANUFACTURING
Income Statement
For the Year Ended December 31, 2012
Absorption Costing

Sales (260,700 units $2)


Less: COGS (260,700 units $1.35)
Gross profit
Less: selling and administration expenses
Variable (260,700 units $0.26)
Fixed
Net Income

$521,400
351,945
169,455
$67,782
81,125

148,907
$20,548

(d) Net income is the same under both costing methods, $20,548. The net
incomes are the same because production equals sales for the year.
When this condition occurs, both methods deduct all of the fixed
manufacturing overhead costs in the current year. There is no ending
inventory in which fixed manufacturing overhead costs can be
deferred.
(e) It would be beneficial for Empey Manufacturing to prepare both a
variable costing income statement and an absorption costing income
statement for a variety of reasons. First, to satisfy the requirements of
generally accepted accounting principles, the company is required to
prepare an absorption costing income statement.
EXERCISE 8-22 (Continued)

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However, management frequently requests a variable costing income


statement because it provides useful information for decision making
purposes. The variable costing income statement provides information
that is necessary for cost-volume-profit analysis as well as
incremental analysis. In addition, net income calculated in a variable
costing income statement more closely follows changes in sales, thus
it is a better indicator of performance.
Also, net income calculated in a variable costing income statement is
not affected by changes in production the way absorption costing net
income is. Finally, variable costing statements are more closely
matched to the actual cash flow in an organization as the
manufacturing overhead costs are expensed in the month in which the
cash outlay occurs.
EXERCISE 8-23
(a)

Manufacturing Cost Per UnitVariable Costing


Direct material ($70,000 10,000 units produced)
Direct labour ($30,000 10,000 units)
Variable manufacturing overhead ($25,000 10,000 units)
Manufacturing cost per unit

$7.00
3.00
2.50
$12.50

Finished goods inventory = (10,000 8,500 units) $12.50 = $18,750


(b) Absorption costing would show a higher net income because a portion
of the fixed costs are deferred to future periods in the ending
inventory. As illustrated below, FGI will be $6,000 higher under
absorption costing which will cause its net income to be $6,000 higher.
Manufacturing Cost Per UnitAbsorption Costing
Variable costing per unit (from (a))
Fixed Manufacturing overhead ($40,000 10,000)
Manufacturing cost per unit

$12.50
4.00
$16.50

Finished goods inventory cost = (10,000 8,500 units) $16.50 = $24,750

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EXERCISE 8-23 (Continued)


Inventory (absorption costing)
Inventory (variable costing)
Fixed overhead deferred in ending inventory

$24,750
18,750
$6,000

Or, fixed manufacturing overhead per unit x ending inventory


$40,000 10,000 = $4.00 1,500 = $6,000
EXERCISE 8-24
(a) Variable utility expense:
$3,000
(12 months x 500 hours per month x $0.50 per hour)
Fixed utility expense: $24,000
(12 months $2,000 per month)
Manufacturing cost using variable approach:
Direct material
$54,000
Direct labour
37,000
Indirect material (nails)
350
Utilities (variable)
3,000
$94,350
(b) Manufacturing cost using absorption approach:
Variable cost from (a)
$94,350
Utilities (fixed)
24,000
Rent
21,400
$139,750
(c) The entire difference in costs between the two methods results from
having fixed overhead included as part of manufacturing costs only
under the absorption costing method. This difference amounts to
$45,400 (Fixed utilities cost, $24,000 + Fixed rent, $21,400).

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EXERCISE 8-25
First determine unit manufacturing costs:
Direct materials
Direct labour
Variable MOH
Fixed MOH ($18,000 3,000)
Unit manufacturing cost

TPC

VC

$8.00

$8.00
9.00
12.00

$8.00

$29.00

AC
$8.00
9.00
12.00
6.00
$35.00

Then determine the value of ending inventory:


TPC
Beginning inventory (100 units)
Finished goods added (3,000 units)
Goods available for sale (3,100 units)
Cost of goods sold (2,800 units)
Value of ending inventory (300 units)

$800
24,000
24,800
22,400
$2,400

VC
$2,90
0
87,000
89,900
81,200
$8,700

AC
$3,500
105,000
108,500
98,000
$10,500

(a) Therefore, absorption costing net income will be $1,800 more than net
income using variable costing: FMOH deferred in ending inventory
equals 300 units $6.00 FMOH per unit, or ($10,500 $8,700).
(b) And, variable costing net income will be $6,300 more than net income
using throughput costing:
conversion costs deferred in ending
inventory equals 300 units $21.00 per unit, or ($8,700 $2,400).

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SOLUTIONS TO PROBLEMSSet A
*PROBLEM 8-26A
(a) (1) Manufacturing Cost Per UnitAbsorption Costing
Variable manufacturing costs ($40 + $16 + $4)
Fixed Manufacturing overhead ($200,000 10,000)
Manufacturing cost per unit

$60.00
20.00
$80.00

(2)

BLUE MOUNTAIN PRODUCTS


Absorption Costing Income Statement
For the Month Ended June 30, 2012
_______________________________________________________________
Sales (9,000 units $150)
Less: COGS (9,000 units $80)
Gross profit
Less: selling and administration expenses
Variable (9,000 units $6)
Fixed
Net Income

$1,350,000
720,000
630,000
$54,000
400,000

454,000
$176,000

(b) (1) Manufacturing Cost Per UnitVariable Costing


Variable manufacturing costs ($40 + $16 + $4) = $60
(2)

BLUE MOUNTAIN PRODUCTS


Variable Costing Income Statement
For the Month Ended June 30, 2012

Sales (9,000 units $150)


Less: variable costs
Variable COGS (9,000 units $60)
Variable S&A (9,000 units $6)
Contribution margin
Less: fixed costs ($200,000 + $400,000)
Net Income before tax

$1,350,000
$540,000
54,000

594,000
756,000
600,000
$156,000

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PROBLEM 8-26A (Continued)


(c)

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
difference in net income is $20,000 ($176,000 $156,000) which equals
the 1,000 tents in ending inventory times the $20 fixed overhead rate.

(d) (1) The throughput manufacturing cost consists of direct material only,
so the per unit rate would be $40.
(2)

BLUE MOUNTAIN PRODUCTS


Throughput Costing Income Statement
For the Month Ended June 30, 2012

Sales (9,000 units $150)


$1,350,000
Less: COGS (9,000 units $40)
360,000
Throughput contribution margin
990,000
Less: Operating expenses
Variable COGS (10,000 units ($16 + $4)) $200,000
Variable S&A (9,000 units $6)
54,000
Fixed ($200,000 + $400,000)
600,000
$854,000
Net Income before tax
$136,000
(e) The difference is $20,000 which is the per unit deferred variable
conversion costs times the number of tents in ending inventory, or
1,000 tents (direct labour, $16 + variable MOH, $4).

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PROBLEM 8-27A
(a)

Required calculations for variable costing, 2012:


Sales ($2,500 6,000 units)
Per unit variable manufacturing costs: ($2,500 0.15)
Variable manufacturing costs (8,000 $375)
Ending inventory (8,000 manufactured 6,000 sold)
Variable selling expenses (6,000 ($2,500 0.20))

$15,000,000
$375
$3,000,000
2,000 units
$3,000,000

Required calculations for variable costing, 2013


Variable manufacturing costs (6,000 $375)
Beginning inventory (2,000 units $375 per unit)
Ending inventory (2,000 + 6,000 8,000)
Variable selling expenses (8,000 ($2,500 0.20))

$2,250,000
$750,000

$4,000,000

AFN COMPANY
Income StatementVariable Costing
For the Years Ended December 31
____________________________________________________________
Sales (6,000; 8,000)
Less: Variable costs
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Variable cost of goods sold
Variable selling and administrative
Total variable costs
Contribution margin
Less: fixed costs
Net income

2012
$15,000,000

2013
$20,000,000

3,000,000
3,000,000
750,000
2,250,000
3,000,000
$5,250,000

750,000
2,250,000
3,000,000

3,000,000
4,000,000
7,000,000

9,750,000
3,800,000
$5,950,000

13,000,000
3,800,000
$9,200,000

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PROBLEM 8-27A (Continued)


(b)

Required calculations for absorption costing, 2012:


Sales ($2,500 6,000 units)
Variable manufacturing costs per unit: ($2,500 0.15)]
Fixed manufacturing costs per unit: ($3,200,000 8,000)
Ending inventory (8,000 manufactured 6,000 sold)
Variable selling expenses (6,000 ($2,500 0.20))

$15,000,000
$375
$400
2,000 units
$3,000,000

Required calculations for absorption costing, 2013


Variable manufacturing costs (6,000 $375)
Fixed manufacturing costs per unit: ($3,200,000 6,000)
Beginning inventory (2,000 units $775 per unit)
Ending inventory (2,000 + 6,000 8,000)
Variable selling expenses (8,000 ($2,500 0.20))

$2,250,000
$533.33
$1,550,000

$4,000,000

AFN COMPANY
Income StatementAbsorption Costing
For the Years Ended December 31
____________________________________________________________
Sales (6,000; 8,000)
Less: Cost of goods sold
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Cost of goods sold
Gross margin
Less: Selling and admin costs
Net income

2012
$15,000,000

2013
$20,000,000

6,200,000
6,200,000
1,550,000
$4,650,000

1,550,000
5,450,000
7,000,000

7,000,000

10,350,000
3,600,000
$6,750,000

13,000,000
4,600,000
$8,400,000

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PROBLEM 8-27A (Continued)


(c) Reconciliation, 2012
Variable costing net income
Plus: Fixed MOH deferred in ending inventory
(2,000 units $400 per unit)
Absorption costing net income
Reconciliation, 2013
Variable costing net income
Less: Fixed MOH released from beginning
Inventory (2,000 $400)
Absorption costing net income

$5,950,000
800,000
$6,750,000

$9,200,000
800,000
$8,400,000

In 2012, with variable costing, fixed manufacturing overhead of $3.2


million is expensed. Under absorption costing, only $2.4 million is
expensed through cost of goods sold, and the balance ($800,000)
becomes part of the ending inventory. Therefore, absorption costing
net income is $800,000 more than variable costing net income.
In the following year, all the units that were in inventory at the end of
2012 are sold. The result is an additional $800,000 cost of goods sold
under the absorption costing method, and absorption costing net
income is $800,000 less than variable costing net income.
Over the two years, when sales were equal to production, the two
cumulative net incomes are equal.
($5,950,000 + $9,200,000 = $6,750,000 + $8,400,000)
(d) Income parallels sales under variable costing as seen in the increase
in net income in 2012 when 1,000 additional units were sold. In
contrast, under absorption costing, income parallels production as
seen in the higher net income in 2013 when production exceeded sales
by 2,000 units.

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PROBLEM 8-28A
(a)

BASIC ELECTRIC MOTORS DIVISION


Income Statement
For the Year Ended 2012
Absorption Costing
_______________________________________________________________
Units produced
Units sold

250,000
200,000

Sales ($8)
Less: Cost of goods sold ($5.00; $5.50)
Gross profit
Less: Selling and Administration
(200,000 $0.50) + $12,000
Net Income

200,000
200,000

$1,600,000 $1,600,000
1,000,000 1,100,000
600,000
500,000
112,000
$488,000

112,000
$388,000

(b)

BASIC ELECTRIC MOTORS DIVISION


Income Statement
For the Year Ended 2012
Variable Costing
_______________________________________________________________
Units produced
Units sold

250,000
200,000

200,000
200,000

Sales ($8)
$1,600,000 $1,600,000
Less: Variable cost of goods sold ($3.00)
600,000
600,000
Variable selling and admin ($0.50)
100,000
100,000
Contribution margin
900,000
900,000
Less: Fixed manufacturing
500,000
500,000
Fixed selling and admin
12,000
12,000
Net Income
$388,000
$388,000

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PROBLEM 8-28A (Continued)


(c) If the company produces 250,000 units, but only sells 200,000 units,
then 50,000 units will remain in ending inventory. Under absorption
costing these 50,000 units will each include $2 of fixed manufacturing
overheada total of $100,000. However, under variable costing, fixed
manufacturing overhead is expensed when incurred. This accounts for
the $100,000 difference ($488,000 $388,000) in net income. This is
summarized as:
Net income under variable costing
Plus: Fixed manufacturing overhead included
in ending inventory (50,000 units $2)
Net income under absorption costing

$388,000
100,000
$488,000

When production equals sales, there is no increase in ending


inventory, so there is no opportunity to defer fixed overhead income
is the same under both methods.
(d) Variable costing has a number of advantages over absorption costing
for decision making and evaluation purposes.
The use of variable costing is consistent with cost-volume-profit and
incremental analysis.
Net income computed under variable costing is unaffected by
changes in production levels. Note that in our example, under variable
costing the companys net income is $388,000 no matter the level of
production.
Net income computed under variable costing is closely tied to
changes in sales levels (not production levels), and therefore
provides a more realistic assessment of the companys success or
failure during a period.
The presentation of fixed and variable cost components on the face of
the variable costing income statement makes it easier to identify
these costs and understand their effect on the business. Under
absorption costing the allocation of fixed costs makes it difficult to
evaluate the impact of fixed costs on the companys results.

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PROBLEM 8-29A
(a)
$115

Per unit product cost: $30 + $40 + $10 + ($70,000 2,000) =

ALTA PRODUCTS LTD.


Income StatementAbsorption Costing
Month ended August 31, 2012
______________________________________________________________
Sales (1,700 $175)
$297,500
Less: COGS
Inventory, beginning
$

Plus: Cost of goods manufactured 230,000


Cost of goods available for sale
230,000
Less: Inventory, ending
34,500 195,500
Gross profit
102,000
Less: Selling and Administration
[(6% $297,500) + $50,000]
67,850
Net income
$34,150
(b)

ALTA PRODUCTS LTD.


Income StatementVariable Costing
Month ended August 31, 2012
_____________________________________________________________
Sales
Less: Variable COGS
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Variable cost of goods sold
Variable selling and administrative
Contribution margin
Less: fixed costs ($70,000 + $50,000)

$297,500
$
160,000
160,000
24,000
136,000
17,850

153,850
143,650
120,000

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Net income

$23,650

PROBLEM 8-29A (Continued)


(c) Fixed overhead cost per unit = $70,000 2,000 = $35 per unit
Reconciliation
Income under variable costing
Plus: Fixed costs deferred in inventory (300 $35)
Income under absorption costing

$23,650
10,500
$34,150

(d)

ALTA PRODUCTS LTD.


Income StatementThroughput Costing
Month ended August 31, 2012
______________________________________________________________
Sales (1,700 units $175)
$297,500
Less: COGS (1,700 units $30)
51,000
Throughput contribution margin
246,500
Less: Operating expenses
Variable COGS (2,000 ($40 + $10))
$100,000
Variable S&A (6% Sales)
17,850
Fixed ($70,000 + $50,000)
120,000
237,850
Net Income before tax
$8,650

(e)

Reconciliation, 2012
Variable costing net income
Less: costs deferred in ending inventory
[($40 + $10 ) 300 units]
Throughput costing net income

$23,650
15,000
$8,650

(f) The proponents of variable costing appeal to the cost avoidance


criterion as a necessary condition for asset recognition. The
incurrence of fixed manufacturing costs this period will not allow the
firm to avoid or eliminate them next period, so fixed manufacturing
costs should not be recognized as assets. It is also pointed out that

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use of absorption costing can lead to manipulation of the net income


figure by managing levels of production and inventory.
PROBLEM 8-29A (Continued)
The proponents of absorption costing argue that the finished goods
should bear a fair share of all the costs that were incurred to bring the
goods to saleable condition, and that all costs should be properly
included in inventory. Absorption costing is the only method allowed
in Canada for externally reporting, and it is argued that in the long
run, variable costing can be misleading for purposes of long-run
costing and pricing.

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*PROBLEM 8-30A
(a)(1) Manufacturing cost per unit using normal costing:
Direct material
Direct labour
Variable overhead
Fixed overhead ($70,000 2,500 units)

$30
40
10
28
$108

(a)(2)
ALTA PRODUCTS LTD.
Income StatementNormal Costing
Month ended August 31, 2012
______________________________________________________________
Sales (1,700 $175)
Less: COGS
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Unadjusted cost of goods sold
Plus: volume variance*
Gross profit
Less: Selling and Administration
[(6% $297,500) + $50,000]
Net income
*(2,500 2,000) $28

$297,500
$

216,000
216,000
32,400
183,600
14,000

197,600
99,900
67,850
$32,050

(b) Reconciliation
Normal costing net income
Plus: Additional fixed MOH deferred in ending inventory
[300 units ($35 $28)]

$32,050
2,100

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Absorption costing net income (from P8-29A)

Weygandt, Kimmel, Kieso, Aly

$34,150

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PROBLEM 8-31A
Variable Costing Income Statement

(a)

Year 1
4,000
$2,000,000
1,280,000
720,000
280,0001
$440,000

Sales in units
Sales ($500)
Less: Variable costs ($320)
Contribution margin
Less: fixed costs
Net income
1

$180,000 + $100,000

Year 2
5,000
$2,500,000
1,600,000
900,000
350,0002
$550,000

$210,000 + $140,000

(b)
Ending inventory, Year 1: (6,000 4,000)
2,000 units
Fixed MOH per unit: ($180,000 6,000)
$30
Reconciliation

Year 1

Variable costing net income

$440,000

Plus: Fixed MOH deferred in ending inventory


(2,000 units $30)
Less: Fixed MOH released from beginning
inventory (2,000 units $30)
Absorption costing net income

Year 2
$550,00
0

60,000
60,000
$500,000

$490,00
0

(c) Amanjeet lost her bonus because the company uses absorption
costing. Since production was lower than sales in Year 2 and there was
no inventory at year end, under absorption costing, all of Year 2's fixed
overhead costs are expensed as well as the fixed overhead costs that
were deferred into inventory as a result of production being greater than
sales in Year 1.

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PROBLEM 8-31A (Continued)


Variable costing more accurately measures performance. Income for a
period is not affected by changes in absorption of fixed overhead costs
resulting from building or reducing inventory. Other things remaining equal,
profits move in the same direction as sales when variable costing is in use. It
follows management's thinking more closely than does absorption costing,
and subsequently, management finds it easier to understand and to use
variable cost reports.
Another reason for Amanjeet not receiving a bonus is the higher fixed
manufacturing costs of production over the prior year. For the 6,000 units
produced in Year 1 the fixed manufacturing costs were $180,000 whereas
for the 3,000 units produced in Year 2 the fixed manufacturing costs
(before factoring in the fixed manufacturing OH released from the units of
beginning inventory) were $210,000 an increase of $30,000 (which would
account for more than 1/5 of the shortfall of the 25% targeted increase in
net income).

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*PROBLEM 8-32A
Unit product costs:
Direct materials ($50)
Direct labour ($37.50)
Variable MOH ($22.50)
Fixed manufacturing overhead
Cost per unit (20,000 units)

Absorption
$1,000,000
750,000
450,000
800,000
$3,000,000
$150.00

Variable
TPC
$1,000,000 $1,000,000
750,000
450,000
$2,200,000 $1,000,000
$110.00
$50.00

Fixed manufacturing overhead product cost under


absorption costing:
$800,000 20,000 units = $40 per unit
Marketing cost per unit: $180,000 18,000 units = $10 per unit
XANTRA Corp.
Income Statement
Year ended December 31, 2012
Absorption Costing
______________________________________________________________
Production in units
20,000
Sales in units
18,000

(a)

Sales (18,000 $200)


Less: COGS
Inventory, beginning
Plus: Cost of goods manufactured ($150)
Cost of goods available for sale
Less: Inventory, ending ($150)
Cost of goods sold
Gross profit
Less: Marketing costs
Variable
Fixed
Net income

$3,600,000
$

3,000,000
3,000,000
300,000
2,700,000
900,000
180,000
200,000

380,000
$520,000

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PROBLEM 8-32A (Continued)


XANTRA Corp.
Variable Costing Income Statement
Year ended December 31, 2012
______________________________________________________________
Production in units
20,000
Sales in units
18,000

(b)

Sales ($200)
Less: Variable COGS
Inventory, beginning
Plus Cost of goods manufactured ($110)
Cost of goods available for sale
Less: Inventory, ending ($110)
Variable cost of goods sold
Variable marketing
Contribution Margin
Less: fixed costs ($800,000 + $200,000)
Net income

$3,600,000
$
2,200,000
2,200,000
220,000
1,980,000
180,000

2,160,000
1,440,000
1,000,000
$440,000

(c)
Reconciliation
Variable costing net income
Plus: Fixed MOH deferred in ending inventory
(2,000 units $40)
Absorption costing net income
(d)

$440,000
80,000
$520,000

Break-even (BE) point: SP (X) VC (X) = FC


Where
SP is the selling price
X is the number of units
VC is the variable cost
$200(X) ($110X + $10X) = $800,000 + $200,000
$80X = $1,000,000
X = 12,500 units

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PROBLEM 8-32A (Continued)


XANTRA Corp.
Income Statement
Year ended December 31, 2012
Throughput Costing
______________________________________________________________
Production in units
20,000
Sales in units
18,000

(e)

Sales ($200)
Less: COGS ($50)
Throughput contribution margin
Less: Operating expenses
Variable COGS ($750,000 + $450,000)
Variable Marketing
Fixed ($800,000 + $200,000)
Net income

(f)

Reconciliation
Throughput costing net income
Plus: costs deferred in ending inventory
[2,000 ($37.50 + $22.50)]
Variable costing net income

$3,600,000
900,000
2,700,000
$1,200,000
180,000
1,000,000

2,380,000
$320,000

$320,000
120,000
$440,000

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*PROBLEM 8-33A
(a)(1) Unit product cost:
Direct materials ($1,000,000 20,000 units)
Direct labour ($750,000 20,000 units)
Variable MOH ($450,000 20,000 units)
Fixed MOH ($800,000 25,000 units)
Cost per unit

Normal
$50.00
37.50
22.50
32.00
$142.00

XANTRA Corp.
Income StatementNormal Costing
Year ended December 31, 2012
______________________________________________________________
Production in units
20,000
Sales in units
18,000

(a)(2)

Sales (18,000 $200)


Less: COGS
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Cost of goods sold
Volume Variance ($800,000 (20,000 $32))
Gross profit
Less: Marketing costs
Variable
Fixed
Net income

$3,600,000
$

2,840,000
2,840,000
284,000
2,556,000
160,000
180,000
200,000

2,716,000
884,000
380,000
$504,000

(b) Reconciliation
Normal costing net income
Plus: Additional fixed MOH deferred in ending inventory
[2,000 units ($40 $32)]
Absorption costing net income

$504,000
16,000
$520,000

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PROBLEM 8-34A
(a) Due to the shutdown arising from the material shortage, the firm has
had to reduce inventory. In effect, fixed costs from beginning
inventory are being expensed in the current period, and the firm has
been unable to defer current period fixed costs because it has been
unable to restore inventory levels.
(b) If the firm can restore inventory levels in the last month, they will be
able to defer some of the current period's fixed costs and can
eliminate the fixed overhead adjustment. Some may raise the issue of
whether manipulating earnings in this way is ethical. Most managers
feel it is ethical provided there is a real action takenactually
increasing inventory, and the action is within the boundaries of normal
operations. However, it is still manipulation.
(c) A variable cost statement would not be affected by the changing
inventory. First determine variable costs for both statements.
Variable cost, Jan 1 = Total cost less fixed costs
= $212,000 $30,000 = $182,000
As a percentage of sales = $182,000 $268,000 = 68%
Because sales and variable costs have remained constant, the
November statement will also reflect 68% variable costs.
Variable cost, Nov = 68% $294,800 = $200,464
SUN COMPANY
Variable Costing Income Statement
Forecast of Operating Results
______________________________________________________________
Year 1
Year 2
Sales
$268,000
$294,800
Less: Variable costs
182,000
200,464
Contribution margin
86,000
94,336
Less: Fixed costs
70,200
71,540
Net income
$15,800
$22,796

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PROBLEM 8-35A
(a) In order to apply variable costing to the Daniels Tool & Die operations,
it is necessary to first remove fixed manufacturing costs from the
inventory values and the cost of goods sold.
Fixed MOH per unit = $25,000 25,000 DLH = $1.00 per DLH
Beginning finished goods inventory:
Using absorption costing
$18,000
Less: Fixed MOH included
1,050 hours $1.00
1,050
Using variable costing
$16,950
Ending finished goods inventory
Using absorption costing
Less: Fixed MOH included
820 hours $1.00
Using variable costing
Beginning work in process inventory:
Using absorption costing
Less: Fixed MOH included
1,600 hours $1.00
Using variable costing
Ending work in process inventory
Using absorption costing
Less: Fixed MOH included
2,100 hours $1.00
Using variable costing

$14,000
820
$13,180

$48,000
1,600
$46,400

$64,000
2,100
$61,900

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PROBLEM 8-35A (Continued)


Variable cost of goods manufactured:
Raw materials put into production
Direct labour [23,000 ($150,000 25,000)]
Variable overhead [23,000 ($155,000 25,000)]
Total variable manufacturing costs
Plus: Variable beginning work in process
Less: Variable ending work in process
Variable cost of goods manufactured

$370,000
138,000
142,600
650,600
46,400
697,000
61,900
$635,100

Variable cost of goods sold:


Variable beginning finished goods inventory
Plus: Variable cost of goods manufactured
Variable cost of goods available for sale
Less: Variable ending finished goods inventory
Variable cost of goods sold

$16,950
635,100
$652,050
13,180
$638,870

Daniels Tools & Die Corporation


Variable Costing Income Statement
For the year ended December 31, 2012
Sales
Less: Variable costs
Cost of goods sold
$638,870
Sales commissions (5% Sales)
50,750
Contribution margin
Less: Fixed manufacturing overhead
37,400
Selling & Admin ($95,000 $50,750 + $75,000) 119,250
Operating income

$1,015,000

689,620
325,380
156,650
$168,730

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PROBLEM 8-35A (Continued)


(b) The difference in the operating income of $270 is caused by the
different treatment of fixed manufacturing overhead. Under absorption
costing, fixed overhead costs are assigned to inventory and are not
expensed until the goods are sold. Under variable costing, these costs
are treated as expenses in the period incurred. Since the direct labour
hours in the work in process and finished goods inventories had a net
increase of 270 hours, the absorption costing operating profit is higher
because the fixed factory overhead associated with the increased
labour hours in inventory is not expensed when absorption costing is
used.
Variable costing operating income
Plus: FMOH deferred in work in process
Inventory [$1.00 (2,100 1,600)]
Less: FMOH released from finished goods
inventory [$1.00 (1,050 820)]
Absorption costing operating income

$168,730
500
169,230
230
$169,000

(c) The advantages of using variable costing follow.


The fixed manufacturing costs are reported at incurred values, not
at absorbed values, which increases the likelihood of better control
over fixed costs.
Profits are directly influenced by changes in sales volume and not
by changes in inventory levels.
Contribution margin by product line, territory, department, or
division is emphasized and more readily ascertainable.
The disadvantages of using variable costing follow.
PROBLEM 8-35A (Continued)
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Variable costing is not recommended for tax reporting, for external


financial reporting; therefore, companies need to adjust variable
costing amounts for these purposes.
Costs other than variable costs (i.e., fixed costs and total production
costs) may be ignored when making decisions, especially long-term
decisions.
With the advancement of factory technology and the movement
toward a fully automated factory, the fixed factory overhead may be a
significant portion of the production costs. To ignore these significant
costs in inventory valuation may not be acceptable.

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SOLUTIONS TO PROBLEMSSet B
*PROBLEM 8-36B
(a)(1)

Direct material
Direct labour
Variable manufacturing overhead
Fixed Manufacturing overhead ($150,000 50,000)
Manufacturing cost per unit

$10
10
5
3
$28

(2)

SPONGEFUN PRODUCTS
Absorption Costing Income Statement
For the year ended December 31, 2012
_________________________________________________________
Sales (46,000 units $60)
$2,760,000
Less: COGS (46,000 units $28)
1,288,000
Gross profit
1,472,000
Less: Variable S&A (46,000 $8)
$368,000
Fixed S&A
300,000
668,000
Net Income before tax
$804,000
(b) (1)

Direct materials
Direct labour
Variable manufacturing overhead
Manufacturing cost per unit

$10
10
5
$25

(2)

SPONGEFUN PRODUCTS
Variable Costing Income Statement
For the year ended December 31, 2012
____________________________________________________________
Sales (46,000 units $60)
$2,760,000
Less: variable costs
Variable COGS (46,000 units $25)
$1,150,000
Variable S&A (46,000 units $8)
368,000 1,518,000
Contribution margin
1,242,000
Less: fixed costs ($150,000 + $300,000)
450,000

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Net Income before tax


PROBLEM 8-36B (Continued)
(c)

Weygandt, Kimmel, Kieso, Aly

$792,000

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
difference in net income is $12,000 ($804,000 $792,000) which equals
the 4,000 units in ending inventory times the $3 fixed overhead rate.

(d) (1) Throughput manufacturing cost consists of direct material only, so


the rate would be $10 per unit.

(2)

SPONGEFUN PRODUCTS
Throughput Costing Income Statement
For the year ended December 31, 2012
____________________________________________________________
Sales (46,000 units $60)
$2,760,000
Less: COGS (46,000 units $10)
460,000
Throughput contribution margin
2,300,000
Less: Operating expenses
Variable COGS (50,000 units ($10 + $5)) $750,000
Variable S&A (46,000 units $8)
368,000
Fixed ($150,000 + $300,000)
450,000 1,568,000
Net Income before tax
$732,000
(e) The difference is $60,000 which is the per unit deferred variable
conversion costs times the number of units in ending inventory, or
4,000 (direct labour, $10 + variable MOH, $5).

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PROBLEM 8-37B
(a)(1)

Direct material
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead ($150,000 60,000)
Manufacturing cost per unit

$10.00
10.00
5.00
2.50
$27.50

(2)

SPONGEFUN PRODUCTS
Normal Costing Income Statement
For the year ended December 31, 2012
_______________________________________________________
Sales (46,000 units $60)
$2,760,000
Less: COGS (46,000 units $27.50)
$1,265,000
Volume variance (10,000 $2.50)
25,000
1,290,000
Gross profit
1,470,000
Less: Variable S&A (46,000 $8)
$368,000
Fixed S&A
300,000
668,000
Net income
$802,000

(b) Reconciliation
Normal costing net income
Plus: Additional fixed MOH deferred in ending inventory
[4,000 units ($28.00 $27.50)]
Absorption costing net income

$802,000
2,000
$804,000

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PROBLEM 8-38B
ZAKI METAL COMPANY
Variable Costing Income Statement
For the Year Ended December 31, 2012

(a)

Required calculations for variable costing 2012:


Sales ($120 50,000 km)
Per unit variable manufacturing costs: ($120 0.25)
Variable manufacturing costs (60,000 $30)
Ending inventory (60,000 manufactured 50,000 sold)
Variable selling expenses (50,000 $9)

$6,000,000
$30
$1,800,000
10,000 km
$450,000

ZAKI METAL COMPANY


Variable Costing Income Statement
For the Year Ended December 31, 2012

Sales
Less: Variable COGS
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Variable cost of goods sold
Variable selling
Contribution margin
Less: fixed costs
Fixed manufacturing costs
Fixed administrative costs
Net income

$6,000,000
$
1,800,000
1,800,000
300,000
1,500,000
450,000
1,500,000
300,000

1,950,000
4,050,000
1,800,000
$2,250,000

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ROBLEM 8-38B (Continued)


Required calculations for variable costing, 2013:
Sales ($120 60,000 units)
Per unit variable manufacturing costs: ($120 0.25)
Variable manufacturing costs (50,000 $30)
Beginning inventory (10,000 units $30 per unit)
Ending inventory (10,000 + 50,000 60,000)
Variable selling expenses (60,000 $9)

$7,200,000
$30
$1,500,000
$300,000

$540,000

ZAKI METAL COMPANY


Variable Costing Income Statement
For the Year Ended December 31, 2013

Sales
Less: Variable COGS
Inventory, beginning
Plus: Cost of goods manufactured
Cost of goods available for sale
Less: Inventory, ending
Variable cost of goods sold
Variable selling and administrative
Contribution margin
Less: Fixed costs
Fixed manufacturing costs
Fixed administrative costs
Net income
(b)

$7,200,000
$300,000
1,500,000
1,800,000

1,800,000
540,000
1,500,000
300,000

2,340,000
4,860,000
1,800,000
$3,060,000

Required calculations for absorption costing 2012:


Sales ($120 50,000 units)
Per unit variable manufacturing costs: ($120 0.25)
Per unit fixed manufacturing costs: ($1,500,000 60,000)
Absorption manufacturing costs (60,000 $55)
Ending inventory (60,000 50,000) $55
Selling expenses (50,000 $9)

$6,000,000
$30
$25
$3,300,000
$550,000
$450,000

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PROBLEM 8-38B (Continued)


ZAKI METAL COMPANY
Absorption Costing Income Statement
For the Year Ended December 31, 2012

Sales
$6,000,000
Less: COGS
Inventory, beginning
$
Plus: Cost of goods manufactured 3,300,000
Cost of goods available for sale
3,300,000
Less: Inventory, ending
550,000 2,750,000
Gross profit
3,250,000
Less: Selling and Administration
Selling costs
450,000
Administrative costs
300,000
750,000
Net income
$2,500,000
Required calculations for absorption costing for 2013:
Sales ($120 60,000 units)
Per unit variable manufacturing costs: ($120 0.25)
Per unit fixed manufacturing costs: ($1,500,000 50,000)
Absorption manufacturing costs (50,000 $60)
Beginning inventory (10,000 $55)
Variable selling expenses (60,000 $9)

$7,200,000
$30
$30
$3,000,000
$550,000
$540,000

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ROBLEM 8-38B (Continued)

ZAKI METAL COMPANY


Absorption Costing Income Statement
For the Year Ended December 31, 2013

Sales
$7,200,000
Less: COGS
Inventory, beginning
$550,000
Plus: Cost of goods manufactured 3,000,000
Cost of goods available for sale
3,550,000
Less: Inventory, ending

3,550,000
Gross profit
3,650,000
Less: Selling and Administration
Selling costs
540,000
Administrative costs
300,000
840,000
Net income
$2,810,000

(c)Fixed manufacturing overhead in ending


$250,000

inventory, 2012: (10,000 $25)


Reconciliation, 2012
Variable costing net income
Plus: Fixed MOH deferred in ending inventory
Absorption costing net income

$2,250,000
250,000
$2,500,000

Reconciliation, 2013
$3,060,000
Variable costing net income
250,000
Less: Fixed MOH released from beginning inventory
$2,810,000
Absorption costing net income

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PROBLEM 8-38B (Continued)


(d) Income parallels sales under variable costing as seen in the increase
in net income in 2013 when 10,000 additional units were sold. In
contrast, under absorption costing, income parallels production as
seen in the higher net income in 2012 when production exceeded sales
by 10,000 units.

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PROBLEM 8-39B
(a)

HARRISON PUMPS

DIVISION
Absorption Costing Income Statement
For the Year Ended 2012
_______________________________________________________________
Units produced
60,000
100,000
Sales ($20.00)
Less: Cost of Goods Sold ($13.00; $11.40)
Gross profit
Less: Selling and Administration
Variable ($1.00)
Fixed
Total fixed costs
Operating income

$1,200,000
780,000
420,000

$1,200,000
684,000
516,000

60,000
30,000
90,000
$330,000

60,000
30,000
90,000
$426,000

(b)

HARRISON PUMPS DIVISION


Variable Costing Income Statement
For the Year Ended 2012
_____________________________________________________________
Units produced

60,000

100,000

Sales ($20.00)
$1,200,000 $1,200,000
Less: Variable cost of goods sold ($9.00)
540,000
540,000
Variable selling and admin ($1.00)
60,000
60,000
600,000
600,000
Contribution margin
600,000
600,000
Less: Fixed manufacturing
Fixed selling and admin

240,000
30,000
270,000

240,000
30,000
270,000

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Net income

Weygandt, Kimmel, Kieso, Aly

$330,000

$330,000

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PROBLEM 8-39B (Continued)


(c) If the company produces 100,000 units, but only sells 60,000 units,
then 40,000 units will remain in ending inventory. Under absorption
costing these 40,000 units will each include $2.40 of fixed
manufacturing overheada total of $96,000. However, under variable
costing fixed manufacturing overhead is expensed when incurred. This
accounts for the $96,000 difference ($426,000 $330,000) in net
income. This is summarized as shown below.
Net income under absorption costing
$426,000
Less: Fixed manufacturing overhead included in
ending inventory (40,000 units $2.40 per unit)
Net income under variable costing

96,000
$330,000

(d) Variable costing has a number of advantages over absorption costing


for decision making and evaluation purposes.
The use of variable costing is consistent with cost-volume-profit
and incremental analysis.
Net income computed under variable costing is unaffected by
changes in production levels. Note that in our example, under
variable costing the companys net income is $330,000 no matter
what the level of production is.
Net income computed under variable costing is closely tied to
changes in sales levels (not production levels), and therefore
provides a more realistic assessment of the companys success
or failure during a period.
The presentation of fixed and variable cost components
separately on the variable costing income statement makes it
easier to identify these costs and understand their effect on the
business. Under absorption costing the allocation of fixed costs
makes it difficult to evaluate the impact of fixed costs on the
companys results.

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PROBLEM 8-40B
(a)

Variable production costs


Fixed MOH ($120,000 30,000)
Cost per unitabsorption costing

$20.00
4.00
$ 24.00

ALLERDYCE CORPORATION LTD.


Absorption Costing Income Statement
For the Years Ended December 31
_______________________________________________________________
Total
2011
2012
60,000
Units Sold
25,000
35,000
Sales ($35.00)
Less: Cost of Goods Sold ($24)
Gross profit
Less: Marketing costs
Operating income

$875,000 $1,225,000 $2,100,000


600,000
840,000 1,440,000
275,000
385,000
660,000
50,000
50,000
100,000
$225,000
$335,000
$560,000

(b)

ALLERDYCE CORPORATION LTD.


Variable Costing Income Statement
For the Years Ended December 31
_______________________________________________________________
Total
2011
2012
Units Sold
25,000
35,000
60,000
Sales ($35.00)
Less: Variable COGS ($20)
Contribution margin
Less: fixed costs ($120,000 + $50,000)
Operating income

$875,000 $1,225,000 $2,100,000


500,000
700,000 1,200,000
375,000
525,000
900,000
170,000
170,000
340,000
$205,000 $355,000
$560,000

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PROBLEM 8-40B (Continued)

(c)

Ending inventory2011: 30,000 produced 25,000 sold


Ending inventory2012: 5,000 + 30,000 35,000
FMOH per unit: $120,000 30,000 units

5,000 units
nil units
$4.00 /unit

Reconciliation of net income


Variable costing net income
Plus: FMOH stored in ending
inventory (5,000 $4)
Less: FMOH released in
beginning inventory
(5,000 $4)
Absorption costing net income

2011
$205,000
20,000

$225,000

2012
355,000

(20,000)
335,000

Total
$560,000
20,000

(20,000)
$560,000

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(a)

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PROBLEM 8-41B
Contribution margin per unit:
Sales
Less: Variable costs
Manufacturing
$9.00
Selling and Administration
6.00
Contribution margin per unit
Fixed costs:
Fixed manufacturing overhead
Adjust for under (over) applied fixed
overhead
Fixed manufacturing costs

July
$595,000

Total selling and administrative


Less: variable selling and
administrative (70,000 $6)
Fixed selling and admin costs
Total fixed costs (same each month)

620,000

$25.00

15.00
$10.00

(35,000)
560,000

420,000
200,000
$760,000

Break-even = $760,000 $10 = 76,000 units or


76,000 $25 = $1,900,000 Sales.

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PROBLEM 8-41B (Continued)


(b)(1)

Sales in units

ABSCORP LTD.
Variable Costing Income Statements
July
Aug
70,000
75,000

Sales ($25)
$1,750,000
Variable production costs ($15) 1,050,000
Contribution margin
700,000
Less: Fixed costs
760,000
Operating income
$(60,000)
(2)Inventory values
Beginning inventory
Plus: units manufactured
Units available for sale
Less: units sold
Ending inventory
Fixed MOH per unit
Total fixed MOH costs
Budgeted production
Per unit cost

July
5,000
85,000
90,000
70,000
20,000

July
$560,000
80,000
$7.00

Sep
80,000

$1,875,000 $2,000,000
1,125,000 1,200,000
750,000
800,000
760,000
760,000
$(10,000)
$40,000

Aug
20,000
80,000
100,000
75,000
25,000

Sep
25,000
60,000
85,000
80,000
5,000

Total
Aug
Sep
$560,000 $560,000 $1,680,000
80,000
80,000
240,000
$7.00

$7.00

$7.00

Reconciliation of net income


Variable costing net income
Plus: FMOH deferredend. inv.
Less: FMOH released in beg. inv.
Absorption costing net income

July
Aug
$(60,000) $(10,000)
140,000
175,000
(35,000)
$45,000

Sep
$40,000
35,000

(140,000) (175,000)
$25,000 $(100,000)

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PROBLEM 8-41B (Continued)


(3) In July, production exceeded sales by 15,000 units and, as a
result, $105,000 ($7 15,000 units) of fixed manufacturing
overhead cost was converted to inventory assets on the balance
sheet under absorption costing.
In August, production exceeded sales by 5,000 units and, as a
result, $35,000 ($7 5,000 units) of fixed manufacturing
overhead cost was converted to inventory assets on the balance
sheet under absorption costing.
In September, sales exceeded production by 20,000 units and, as
a result, $140,000 ($7 20,000 units) of inventory assets were
converted to expenses on the income statement under
absorption costing.

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PROBLEM 8-42B
(a)

Fixed MOH per unit = $600,000 2,000 units = $300.


Absorption costing net income
Variable costing net income
Difference

$400,000
310,000
$90,000

Since absorption costing net income exceeds variable costing net


income, this means sales must have been less than production, and
$90,000 fixed manufacturing overhead was deferred in the ending
inventory at $300 per unit. $90,000 $300 = 300 units
If 300 units are left in finished goods ending inventory, and there was
no beginning inventory, then sales must have been 1,700 units
(2,000 300 = 1,700).
(b) Contribution margin = net income + fixed costs
Contribution margin = $310,000 + $1,000,000 = $1,310,000
(c) Gross margin = net income + selling and administrative expenses
Gross margin = $400,000 + $400,000 = $800,000
(d) Variable costs = Sales - contribution margin
Variable costs = $3,400,000 $1,310,000 = $2,090,000
Cost per unit = $2,090,000 1,700 = $1,229.41
(e) Absorption costs = Sales gross profit
Absorption costs = $3,400,000 $800,000 = $2,600,000
Cost per unit = $2,600,000 1,700 = $1,529.41

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PROBLEM 8-43B

Variable cost per unit:


Direct material (2 kg. $10 per kg.)
Direct labour (1 hr $8 per hr)
Variable MOH [($15,000 $6,000) 18,000 units]
Variable manufacturing cost per unit
Variable selling and admin [($40,000 $4,000) 10,000]

$20.00
8.00
0.50
28.50
3.60
$32.10

WINGFOOT CO.
Variable Costing Income Statement
For the Year Ended June 30, 2012

Sales in units

10,000

Sales ($100)
$1,000,000
Less:
Variable COGS ($28.50)
$285,000
Variable selling and administrative ($3.60)
36,000
321,000
Contribution Margin
679,000
Less:
Fixed manufacturing overhead
6,000
Fixed administrative costs
4,000
10,000
Operating income before tax
$669,000
Income tax (40%)
267,600
Net income
$401,400

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PROBLEM 8-44B
(a) In order to apply variable costing to the Portland Optics operations, it
is necessary to first remove fixed manufacturing costs from the
inventory values and the cost of goods sold.
Beginning finished goods inventory:
Using absorption costing
Less: Fixed MOH included
1,080 hours ($130,000 32,500)
Using variable costing
Ending finished goods inventory
Using absorption costing
Less: Fixed MOH included
550 hours ($176,000 44,000)
Using variable costing
Beginning work in process inventory:
Using absorption costing
Less: Fixed MOH included
1,400 hours $4.00
Using variable costing
Ending work in process inventory
Using absorption costing
Less: Fixed MOH included
2,500 hours $4.00
Using variable costing

$25,000
4,320
$20,680

$14,000
2,200
$11,800

$34,000
5,600
$28,400

$60,000
10,000
$50,000

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PROBLEM 8-44B (Continued)


Variable cost of goods manufactured:
Raw materials put into production
Direct labour
Variable overhead [42,000 ($198,000 44,000)]
Total variable manufacturing costs
Plus: Variable beginning work in process
Less: Variable ending work in process
Variable cost of goods manufactured

$210,000
435,000
189,000
834,000
28,400
862,400
50,000
$812,400

Variable cost of goods sold:


Variable beginning finished goods inventory
Plus: Variable cost of goods manufactured
Variable cost of goods available for sale
Less: Variable ending finished goods inventory
Variable cost of goods sold

$ 20,680
812,400
830,080
11,800
$821,280

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PROBLEM 8-44B (Continued)


PORTLAND OPTICS INC.
Variable Costing Income Statement
For the year ended December 31, 2012
Sales
Less: Variable costs
Cost of goods sold
Sales commissions
Contribution margin
Less: Manufacturing overhead
Selling ($190,000 $121,600)
Administrative
Operating income

$1,520,000
$821,280
121,600
175,000
68,400
187,000

942,880
577,120

430,400
$146,720

(b) Two of the several advantages of using variable costing


rather than absorption costing are as follows.
Financial statements using variable costing are more easily
understood because they show that profits move in the same
direction as sales. This effect is more logical than that shown
with absorption costing, where profit is affected by changes
in inventory.
Variable costing facilitates the analysis of cost-volume-profit
relationships by separating fixed and variable costs on the
income statement.

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SOLUTIONS TO CASES
CASE 8-45
(a)
Sales (20,000 seats $680)
Variable costs (20,000 seats $340)
Contribution margin
Fixed costs
Net income

$13,600,000
6,800,000
6,800,000
4,420,000
$2,380,000

(b) Contribution margin ratio = $6,800,000 $13,600,000 = 50%


Break-even point in dollars = $4,420,000 0.50 = $8,840,000
Margin of safety ratio =
($13,600,000 $8,840,000) $13,600,000 = 35%
Degree of operating leverage = $6,800,000 $2,830,000 = 2.857
(c)
Sales (20,000 seats $680)
Variable costs (20,000 seats $280)
Contribution margin
Fixed costs
Net income

$13,600,000
5,600,000
8,000,000
5,000,000
$3,000,000

(d) Contribution margin ratio = $8,000,000 $13,600,000 = 58.82%


Break-even point = $5,000,000 0.5882 = $8,500,000 (rounded)
Margin of safety = ($13,600,000 $8,500,000) $13,600,000 = 37.5%
Degree of operating leverage = $8,000,000 $3,000,000 = 2.6667

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CASE 8-45 (Continued)


(e)

By automating its manufacturing process the company will replace some


of its variable costs with fixed costs. This shift toward more fixed costs will
decrease its break-even point from $8,840,000 to $8,500,000 and increase
its margin of safety from 35% to 37.5%. This means that under the old
system sales could fall by 35% percent before the company would operate
at a loss, whereas under the automated system they could only fall by
37.5%.
Both of these findings suggest that the operations would be less risky with
the automated system. However, the companys degree of operating
leverage would decrease from 2.857 to 2.667. This would be bad if the
company expects sales to increase, but would be good if the companys
sales fall.

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CASE 8-46
(a)

Manufacturing cost per unit:


Direct materialsrubber
Direct labourball makers
Variable manufacturing overhead
Other materialsindirect
Electricity usagefactory
Water usagefactory
Other labourindirect
Manufacturing cost per unit

$2.75
5.60
$1.40
0.50
0.15
0.27

2.32
$10.67

(b)
BIG SPORTS MANUFACTURING
Variable Costing Income Statement
For the Year Ended December 31, 2012

Sales in units

72,500

Sales ($18)
$1,305,000
Less: Variable COGS
Beginning inventory (85,000 $9.67) $821,950
Units produced (35,000 $10.67)
373,450
Total available for sale
1,195,400
1
Ending inventory
494,325
Variable cost of goods sold
701,075
Variable sell & admin ($0.40)
29,000
730,075
Contribution margin
574,925
Less: Fixed costs
Fixed manufacturing overhead
210,000
Fixed administrative costs
83,000
293,000
Operating income before tax
$281,925

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Ending inventory = (12,500 x $9.67) + (35,000 x $10.67)

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CASE 8-46 (Continued)


(c)

(d)

Throughput costing per unit:


Direct materialrubber

$2.75

This solution is prepared based on the assumption that the inventory


system in use is first-in, first-out; and the $1.00 increase in variable
manufacturing costs from 2011 to 2012 was not caused by any
increase in the cost of the direct material. That is, the direct material
rate remained the same for both years.
BIG SPORTS MANUFACTURING
Throughput Costing Income Statement
For the Year Ended December 31, 2012
Sales in units

72,500

Sales ($18)
Less: Throughput COGS ($2.75)
Throughput contribution margin
Less: Operating expenses
Variable COGS ($5.60 + $2.32)
Variable S&A ($0.40)
Fixed
Net Income before tax

$1,305,000
199,375
1,105,625
$574,200
29,000
293,000

896,200
$209,425

(e) Unit product costs: Absorption costing


Total variable production costs-from (a)
Fixed MOH ($210,000 35,000)
Cost per unit for 2012

$10.67
6.00
$16.67

Total variable production costs for 2011


Fixed MOH
Cost per unit for 2011

$9.67
4.00
$13.67

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CASE 8-46 (Continued)


(f)
BIG SPORTS MANUFACTURING
Absorption Costing Income Statement
For the Year Ended December 31, 2012
Sales in units

72,500

Sales ($18)
$1,305,000
Less: COGS
Beginning inventory (85,000 $13.67) $1,161,950
Units produced (35,000 $16.67)
583,450
Total available for sale
1,745,400
Ending inventory
754,325
991,075
Gross margin
313,925
Less: selling and administrative costs
Variable ($0.40)
29,000
Fixed
83,000
112,000
Operating income
$201,925
Ending inventory = (12,500 $13.67) + (35,000 $16.67)
(g) (1) Reconciliation of net income
Variable costing net income
Plus: FMOH deferred in ending inventory
(12,500 $4) + (35,000 $6)
Less: FMOH released in beginning inventory
(85,000 $4)
Absorption costing net income

$281,925
260,000
(340,000)
$201,925

(2) Break-even point = fixed costs CM ratio*


$293,000 (574,925 $1,305,000) = $666,000 (rounded)
$666,000 $18 = 37,000 units
*Cannot use CM per unit because variable costs are two different
amounts.

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CASE 8-46 (Continued)


(3) Mr. Swetkowski is right in his thinking that variable costing has
many advantages over the more traditional absorption costing
technique. However, his conclusion that absorption costing
should be stopped at Big Sports Manufacturing is incorrect. The
company can learn many things about their operations by
preparing the variable costing income statement, however they
cannot simply discard absorption costing altogether. Absorption
costing is recommended for external financial statements
produced under generally accepted accounting principles (GAAP).
With these standards in place, it would be better for Big Sports
Manufacturing to produce both sets of financial statements.

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CASE 8-47

(a)

Per unit manufacturing costs:


Direct material
Direct labour
Variable manufacturing overhead
Total variable unit cost
Plus: fixed manufacturing overhead
($2,500,000 60,000 units)
Plus: fixed manufacturing overhead
($2,500,000 50,000 units)

2011
$80.00
40.00
35.00
155.00
41.67

$196.67
Cost of goods sold: 2011
Beginning finished goods inventory
Plus: cost of goods manufactured
(60,000 $196.67)rounded
Cost of goods available for sale
Less: ending inventory
[(60,000 54,000) 196.67]
Cost of goods sold
Cost of goods sold: 2012
Beginning finished goods inventory
Plus: cost of goods manufactured
(50,000 $205.00)
Cost of goods available for sale
Less: ending inventory
[(110,000 108,000) $205.00]
Cost of goods sold

2012
$80.00
40.00
35.00
155.00

50.00
$205.00

11,800,000
11,800,000
1,180,000
$10,620,000

$1,180,000
10,250,000
11,430,000
410,000
$11,020,000

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CASE 8-47 (Continued)


WEI NAN COMPANY
Absorption Costing Income Statement
For the Years Ended December 31
2011
54,000

Sales in units
Sales ($250 per unit)
Cost of goods sold:
Gross Profit
Less: selling and administrative costs
[(54,000 $30) + $300,000]
Net income
(b)

2012
54,000

$13,500,000
10,620,000
2,880,000

$13,500,000
11,020,000
2,480,000

1,920,000
$ 960,000

1,920,000
$ 560,000

WEI NAN COMPANY


Variable Costing Income Statement
For the Years Ended December 31

Sales in units
Sales ($250 per unit)
Variable costs:
Cost of goods sold ($155)
Selling ($30)
Total variable costs
Contribution margin
Less: Fixed costs
Manufacturing overhead
Selling
Total fixed costs
Net income

2011
54,000

2012
54,000

$13,500,000

$13,500,000

8,370,000
1,620,000
9,990,000
3,510,000

8,370,000
1,620,000
9,990,000
3,510,000

2,500,000
300,000
2,800,000
$ 710,000

2,500,000
300,000
2,800,000
$ 710,000

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CASE 8-47 (Continued)


(c) Reconciliation of net income:
2011
2012
Variable costing net income
$710,000 $710,000
Plus: FMOH deferred in ending inventory
(6,000 $41.67); (2,000 $50.00)
250,000
100,000
Less: FMOH released in beginning inventory
(6,000 $41.67)
(250,000)
Absorption costing net income
$960,000 $560,000
(d)

WEI NAN COMPANY


Throughput Costing Income Statement
For the Years Ended December 31
2011
54,000

Sales in units
Sales ($250); ($250)
Less: Throughput COGS ($80); ($80)
Throughput contribution margin
Less: Operating expenses
Variable COGS ($75 60,000; 50,000)
Variable S&A ($30); ($30)
Fixed ($2,500,000 + $300,000)
Net income

2012
54,000

$13,500,000
4,320,000
9,180,000

$13,500,000
4,320,000
9,180,000

4,500,000
1,620,000
2,800,000
8,920,000
$260,000

3,750,000
1,620,000
2,800,000
8,170,000
$1,010,000

(e) Reconciliation of net income:


2011
$260,000

Throughput costing net income


Plus: Costs deferred in ending inventory
(6,000 $75); (2,000 $75)
450,000
Less: costs released in beginning inventory
(6,000 $75)
Variable costing net income
$710,000

2012
$1,010,000
150,000
(450,000)
$710,000

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CASE 8-48

(a)

Per unit manufacturing costs:


Direct material
Direct labour (0.25 $24)
Variable manufacturing overhead
Plus: fixed manufacturing overhead
($132,000 30,000 units)

(b)

Abs.
$2.00
6.00
4.00

Var.
$2.00
6.00
4.00

4.40
$16.40 $12.00

DDD GOLF LTD.


Absorption Costing Income Statement
For the Month Ended May 31, 2012
Sales in units

28,000

Sales ($20 per unit)


Less: cost of goods sold ($16.40)
Gross profit
Less: Selling ($40,000 + ($2 28,000))
Net income

$560,000
459,200
100,800
96,000
$4,800

DDD GOLF LTD.


Variable Costing Income Statement
For the Month Ended May 31, 2012
Sales in units

28,000

Sales ($20 per unit)


Variable costs:
Cost of goods sold ($12)
Selling ($2)
Contribution margin
Less: Fixed costs ($132,000 + $40,000)
Net income

$560,000
$336,000
56,000

392,000
168,000
172,000
$(4,000)

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CASE 8-48 (Continued)


(c)

Reconciliation of net income


Variable costing net income
Plus: FMOH deferred in ending inventory
(7,000 $4.40)
Less: FMOH released in beginning inventory*
(5,000 $4.40)
Absorption costing net income

$(4,000)
30,800
(22,000)
$4,800

*assuming costs in April were exactly the same as in May

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CASE 8-49
(a)

(1) Determination of beginning inventory:


Sales = $2,400,000 $24 per unit =
Plus ending inventory
Goods available for sale
Goods manufactured (100,000 + 45,000)
Finished goods, beginning inventory

100,000
80,000
180,000
145,000
35,000

HUBER CORPORATION
Absorption Costing Income Statement
For the Month Ended November 30, 2012
______________________________________________________________
Sales in units
100,000
Sales ($24 per unit)
Less: cost of goods sold ($16)
Gross profit
Less: Selling and administrative
Net income before overhead adjustment
Less: overhead adjustment ((150,000 145,000) $4)
Net income
(2) Reconciliation of net income:
Variable costing net income
Plus: FMOH deferred in ending inventory
(80,000 $4)
Less: FMOH released in beginning
inventory (35,000 $4)
Absorption costing net income

$2,400,000
1,600,000
800,000
400,000
400,000
20,000
$380,000

$200,000
320,000
(140,000)
$380,000

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CASE 8-49 (Continued)


(b) Variable cost statements are consistent with cost-volume-profit
analysis, making it easier to compare planned and actual results. In
addition, variable cost income becomes a function of sales only; it is
not affected by changes in inventory levels.

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CASE 8-50
(a) CM per unit = Sales per unit variable costs
CM = $8.00 ($2.00 + $3.00) = $3.00
Total fixed costs = (100,000 $0.50) + (100,000 $0.80)
Total fixed costs = $130,000
Break-even in units = Fixed costs CM per unit
Break-even in units = $130,000 $3.00 = 43,333 units
(b)

RICKUSE LIMITED
Variable Costing Income Statement
______________________________________________________________
Sales (130,000 $8)
Variable cost (130,000 $5.00)
Contribution margin
Less: Fixed costs
Manufacturing overhead
Selling and Administrative
Net income

$1,040,000
650,000
390,000
$50,000
80,000

130,000
$260,000

(c)

RICKUSE LIMITED
Absorption Costing Income Statement
______________________________________________________________
Sales (130,000 $8)
Less: cost of goods sold (130,000 $5.50)
$715,000
Volume variance ((130,000 100,000) $0.50)
15,000
Gross profit
Less: Selling (130,000 $.80)
Net income

$1,040,000
700,000
340,000
104,000
$236,000

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CASE 8-51
(a) Beginning inventories are carried at a full cost of $8 per unit. The 2012
cost of goods sold is made up of 600,000 $8 = $4,800,000 of
beginning inventory costs and $8,320,000 $4,800,000 = $3,520,000 of
current period costs (400,000 units at $8.80).
The fixed overhead rate per unit is given as $3.30; thus the $495,000
under-applied fixed overhead implies the firm produced $495,000
$3.30 = 150,000 units below their target level. The target level must be
$3,300,000 $3.30 = 1,000,000 units, so they produced 850,000 units.
With these observations, we can determine that the level of inventory
dropped by 150,000 units (sales of 1,000,000 less production of
850,000).
Two factors contributed to the decreased income in 2012 despite
increased sales.
First, in 2011, the firm was able to defer considerable fixed costs into
inventory by producing 600,000 300,000 = 300,000 more units than
were sold. In the current period, more units were sold than produced,
so "extra" fixed costs were incurred. Second, the firm treats the
volume variance as a period cost. In 2011, production exceeded the
planned level by $600,000 $3.00 = 200,000 units, yielding the overapplied fixed overhead, but in 2012 production fell below the planned
level, yielding the $495,000 under-applied fixed overhead.

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CASE 8-51 (Continued)


(b)

BBG CORPORATION
Variable Costing Income Statement
______________________________________________________________
Sales (1,000,000 units)
Variable cost: 600,000 $5.00 from 2011
400,000 $5.50 from 2012
Contribution margin
Less: Fixed costs
Manufacturing overhead
Selling and Administrative
Net income

(c) Reconciliation of net income:


Variable costing net income
Plus: FMOH deferred in ending inventory
(450,000 $3.30)
Less: FMOH released in beginning
inventory (600,000 $3)
Absorption costing net income

$11,200,000
$3,000,000
2,200,000

$3,300,000
1,500,000

5,200,000
6,000,000

4,800,000
$1,200,000

$1,200,000
1,485,000
(1,800,000)
$885,000

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CASE 8-52
(a)

The divisions net income increased by $200,000 ($600,000


$400,000). This represents a 50% increase over the previous year
($200,000 $400,000). Thus Scotts bonus would be 50 $5,000 =
$250,000.

(b) In 2011 the number of units produced and sold were equal. When this
occurs variable costing and absorption costing provide the same
results. Thus, in 2011 net income under variable costing would have
been $400,000. In 2012 units produced exceeded units sold by 5,000
units. However, net income under variable costing is not impacted by
the number of units produced. Since the number of units sold did not
change from 2011 to 2012, and the selling price, variable cost per unit,
and total fixed costs didnt change, the divisions net income in 2012
would equal its 2011 income of $400,000.
(c) In part (b) it was determined that the divisions net income would have
been $400,000 in 2012 under variable costing. Since this is the same as
2011 net income, Scott would not receive a bonus.
(d) If Scott intentionally overproduced inventory in order to increase his
bonus, then his actions were unethical. Based on the information
provided, we cant actually determine Scotts motives. He may have
believed that just-in-time inventory was causing the company to lose
sales due to stock-outs. If that was the case, there would be options
available to the company other than totally giving up on just-in-time
practices.
In order to eliminate any potential conflicts of interest between Scott
and the company, and to ensure that his actions are in the best interest
of the company, the company could begin preparing variable costing
income statements to supplement its absorption costing statements
for the purpose of calculating bonuses. This would eliminate any
incentive Scott might have to over-produce, as well as providing useful
information for other internal management decision making.

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CASE 8-53: All About You Activity


(a)Three months inventory is 30,000 units of the component (120,000 / 4)
The value of the three month inventory will be:

Variable
costing
300,000
180,000
00000
0

Absorption
costing
300,000
180,000
500,000

Annual inventory cost

480,000

980,000

Three month inventory cost

120,000

245,000

Direct labour and materials


Variable manufacturing costs
Fixed manufacturing costs

(b) There is no one correct solution to this question. Suggestions


include:
Moving to a Just in Time system, which would reduce the
volume of inventory required to be on hand and thereby reduce
the required financing
Outsourcing production to another business. Shorttress would
then only pay for inventory actually sold
Negotiating with suppliers to improve credit terms
Negotiating with customers to obtain faster payment of
Receivables

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SOLUTION TO WATERWAYS CONTINUING PROBLEM


WCP-8
(a)

Determine absorption per unit cost

Direct Material
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead*

2010
2011
2012
$3.00 $3.00 $4.00
2.00
2.00
3.00
4.00
4.00
4.00
7.65
7.20 10.20
$16.65 $16.20 $21.20

*Fixed manufacturing overhead annual production


WATERWAYS CORPORATION
Absorption Costing Income Statement
For the years ending December 31
______________________________________________________________

Sales
Cost of goods sold:
Beginning inventory
Plus: cost of goods manufactured
Cost of goods available for sale
Less: ending inventory

Gross margin
Selling & Admin expenses
Operating income

2010
2011
2012
$1,750,000 $1,875,000 $2,160,000

1,332,000
1,332,000
166,500
1,165,500

166,500
1,377,000
1,543,500
324,000
1,219,500

324,000
1,272,000
1,596,000

1,596,000

584,500
500,000
$84,500

655,500
525,000
$130,500

564,000
550,000
$14,000

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WCP-8 (Continued)
In 2010, production exceeded sales by 10,000 units and, as a result,
$76,500 ($7.65 10,000 units) of fixed manufacturing overhead costs
were converted to inventory assets on the balance sheet under
absorption costing.
By the end of 2011, inventory had increased to 20,000 units as
production again exceeded sales by 10,000 units. Manufacturing costs
deferred for the period totalled $144,000 ($7.20 20,000 units).
However, in 2012, conversion to lean manufacturing called for low
inventory levels, so sales exceeded production by 20,000 units. The
costs that had been deferred from the previous year, $144,000 ($7.20
20,000 units) were converted to expenses on the income statement as
cost of goods sold. At the same time this was not offset by deferred
costs as Waterways had no inventory at the end of the year.
(b) Determine variable per unit cost

Direct material
Direct labour
Variable manufacturing overhead

2010
$3.00
2.00
4.00
$9.00

2011
2012
$3.00 $4.00
2.00
3.00
4.00
4.00
$9.00 $11.00

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WCP-8 (Continued)
WATERWAYS CORPORATION
Absorption Costing Income Statement
For the years ending December 31
______________________________________________________________

2010
Sales
$1,750,000
Variable costs:
Cost of goods sold
Beginning inventory

Plus: cost of goods manufactured


720,000
Cost of goods available for sale
720,000
Less: ending inventory
90,000
630,000
Selling & Admin
350,000
980,000
Contribution margin
Less: Fixed costs

770,000
762,000

Operating income

$8,000

2011
$1,875,00
0

2012
$2,160,000

90,000
765,000
855,000
180,000
675,000
375,000
1,050,000

180,000
660,000
840,000

840,000
400,000
1,240,000

825,000
762,000
$63,00
0

920,000
762,000
$158,0
00

Reconciliation of variable costing and absorption costing income:


2010
$8,0
00
76,500

84,500

Variable costing income


Plus: deferred FMOH
Less: released FMOH
Absorption costing income

2011
$63,0
00
144,000
76,500
130,500

2012
$158,00
0

144,000
14,000

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WCP-8 (Continued)
Variable cost statements are consistent with cost-volume-profit
analysis, making it easier to perform CVP analysis. In addition, variable
cost income becomes a function of sales only; it is not affected by
changes in inventory levels. Further, using variable cost statements
eliminates the impression that fixed overhead costs are variable,
especially when per unit rates change from year to year depending on
production levels. Finally, variable cost statements more closely follow
actual cash flow patterns, which is easier for many managers to
understand.
(c) If Waterways had budgeted production of 80,000 units per year, and
annual fixed overhead costs were $612,000, then their pre-determined
overhead rate would have been $7.65 per unit ($612,000 80,000 units).
Volume variances would be 2010nil (actual rate = applied rate)
2011$38,250 favourable
2012$153,000 unfavourable
2010
Production in units
Pre-determined overhead rate
Overhead applied during the year

2012

80,000

85,000

60,000

$ 7.65
$612,000

$7.65
$650,250

$7.65
$459,000

612,000

612,000
$ 38,250

612,000
($153,000)

Actual overhead
Volume variance
(d)

2011

A company should probably meet two criteria before it chooses


throughput costing. The first criterion relates to the nature of the
manufacturing process. Throughput costing is suitable only for
companies engaged in a manufacturing process in which conversion
costs such as direct labour and manufacturing overhead are fixed
costs and do not vary proportionately with the units of production.
Assembly line and continuous processes that are highly automated are
most likely to meet this criterion.

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WCP-8 (Continued)
The second criterion is that management favour cost accounting
information that is helpful for short term, incremental analysis, such as
whether the company should accept or reject a special offer at a
reduced sales price.
Waterways Corporation appears to be highly automated as fixed
manufacturing overhead costs account for 46% of all production costs.
And their adoption of lean manufacturing techniques seems to be
working as they have reduced their inventory to zero. However, they
would have to look closely at labour and overhead to make certain they
are predominantly fixed.
Whether or not they decide to use throughput costing would depend on
their focus on long term planning and decision-making.

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LEGAL NOTICE
Copyright 2011 by John Wiley & Sons Canada, Ltd. or related companies. All rights
reserved.

The data contained in these files are protected by copyright. This manual is furnished under
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The material provided herein may not be downloaded, reproduced, stored in a retrieval
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in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or
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