CH-2 Product Costing Systems Concepts And Design Issues – Cost Management: Strategies for Business Decisions : Book Guide

CHAPTER 2 PRODUCT COSTING SYSTEMS: CONCEPTS AND DESIGN ISSUES ANSWERS TO REVIEW QUESTIONS 2.1 Cost is a more general term that refers to a sacrifice of resources and may be either an opportunity cost or an outlay cost. An expense is the write-off of an outlay cost against revenues in a particular accounting period and usually pertains only to external financial reports. 2.2 Product costs are those costs that can be more easily attributed to products, while period costs are those costs that are more easily attributed to time periods. The determination of product costs varies depending on the approach used: full absorption, variable, or throughput costing. 2.3 Yes. The costs associated with goods sold in a period are not expected to result in future benefits. They provided revenues for the period in which the goods were sold; therefore, they are expensed for financial accounting purposes. 2.4 Direct material: Material in its raw or unconverted form which become an integral part of the finished product is considered direct material. Direct labor: Costs associated with labor engaged in manufacturing activities. Sometimes this is considered as the labor which is actually responsible for converting the materials into finished product. Assembly workers, cutters, finishers and similar “hands on” personnel are classified as direct labor. Manufacturing overhead: All other costs directly related to product manufacture. These costs include the indirect labor and materials, costs related to the facilities and equipment required to carry out manufacturing operations, supervisory costs, and all other direct support activities. 2.5 Total variable costs change in proportion to a change in activity level (within the relevant range of activity). Unit variable costs remain constant, within the relevant range of activity. 2.6 Total fixed costs do not change as volume changes (within the relevant range of activity). Unit fixed costs decline as the activity level increases, within the relevant range of activity. 2.7 Material, conversion, and operating resources are names given to different types of resources based on how they are used to provide products and services to customers. Material resources are tangible, physical resources that are added or converted into products. Conversion resources are the resources used in processes to convert materials (or ideas) into products and services. Operating resources provide the infrastructure necessary to provide logistical support and support for the conversion process. 2.8 Conceptually, all resources are obtained to facilitate the provision of products and services. However, for convenience and by convention, we sometimes split resources into production and non-production resources based on the proximity and involvement with the production process. Production resources are used in an observable way to provide products and services. Examples include assembly labor, bank-loan supervision, and buildings that house production processes. Non-production resources are used to provide the logistical, administrative, and marketing infrastructure necessary to manage the flow of resources and finished products. Examples include top management salaries, distribution costs, and legal services. 2.9 Traceability refers to the ease or difficulty with which one can associate the acquisition (or use) of a resource with a particular cost object or decision. Ideally, the association can be extended to causation; that is, determining whether a decision causes acquisition or use of a resource. This concept is important for several reasons. First, assessing the cost/benefit impact of a decision requires that we understand which resources are and are not affected by the decision. Second, most accounting systems treat costs of direct (traceable) resources differently than indirect (non-traceable) resources. Costs of traceable resources are counted as costs of products and services, but non-traceable costs may not be. 2.10 Given this book’s cost management stance, we believe that all the resources of an organization are the direct result of some decision(s); that is, they are traceable to decisions. Though all resources, therefore, are direct with respect to some decision, a resource may be classified as indirect to other decisions. For example, the materials necessary to build a table are a direct resource needed to support the decision to build the table. However, the shop in which the table is built was obtained for the purpose of building tables, chairs, and other furniture – not just the table in question. The shop is a necessary resource for building tables, but it is indirect to the decision to build a particular table. So, the shop is a direct resource to support the decision to be in the furniture business, but it is an indirect resource of the task of building a specific table. 2.11 A unit-level cost is the direct cost of resources acquired to support the decision to make or provide another unit of product or service. Examples include parts and materials purchased and assembled into each unit of product. Making another unit requires purchasing another set of materials. An average cost is the total costs of resources used to provide products and services divided by the number of units of product or service provided. The average cost of materials may be the same as the unit-level cost of materials, if every unit of product is made with identical materials. Average cost may differ from unit-level cost if products and services use different amounts of unit-level resources or if average costs include costs of both direct, unit-level and indirect resources. Variable costs are measures of the use of resources directly to make or provide products and services, which may not be the same as the acquisition of those resources. For example, variable costs could include unit-level materials and direct labor, even if labor is salaried and the amount of labor obtained is invariant to how many units of product are made. Because the use of labor can be traced to specific products or services, its use would be counted as a variable cost. Some non-production cost usage, such as sales and distribution, also may be traced directly to specific units of product and would be classified as variable costs of those units. 2.12 a. Opportunity cost: The forgone value of an alternative that is precluded by choosing another alternative. Example: Rather than studying, you could be working and earning an hourly wage. The opportunity cost of every hour that you decide to study is the forgone hourly wage. b. Outlay cost: The value of actual resources that you give up in order to obtain other resources or consumption. For example, the price you pay for a theater ticket is the outlay cost of attending the theater. c. Product cost: The costs of all resources used to produce a product. These include direct and indirect production costs. Examples include the cost of parts and materials (direct), costs of factory building occupancy expressed per unit of product (indirect). d. Period cost: The cost of resources used in a period that cannot be traced easily to either products or production processes. Example: corporate office costs that are expensed each period. e. Direct cost: The cost of resources used that can be traced directly to decisions. Example: costs of consulting labor traced directly to jobs performed for specific clients. f. Indirect cost: The cost of resources used that are necessary for logistics or infrastructure but that cannot be traced directly to specific products or services provided. g. Controllable cost: A cost that a manager can control or heavily influence. h. Uncontrollable cost: A cost that a manager cannot significantly influence. 2.13 Fixed or sunk costs are immutable; that is, they cannot be changed. Historical purchase prices of resources are examples of sunk costs that cannot be changed. At the time decisions are made, all costs are discretionary, but when a decision is made those costs become committed costs, at least for a time. Unlike fixed or sunk costs, committed costs can be changed, but in some cases penalties for changing them may prevent changes. For example, the decision to lease an apartment for a year results in a committed cost in the amount of the periodic lease payments. You may break the lease, but depending on the lease contract you may be responsible for making payments for the duration of the lease. Discretionary costs refer to costs of decisions that may be changed quickly with little or no penalty. 2.14 Throughput costing counts only unit-level costs as the cost of a product or service. All other costs of resources used are counted as operating costs (or expenses). Variable costing adds all traceable costs of resources used to unit-level costs. Absorption costing accumulates only product costs, direct and indirect, to measure product cost. 2.15 The throughput (under throughput costing) is sales revenue minus all unit-level spending for direct costs. The contribution margin (under variable costing) is sales revenue minus all variable cost. The gross margin (under absorption costing) is sales revenue minus all product costs, including applied fixed manufacturing overhead. 2.16 Absorption costing averages all product costs across units produced. When there are large amounts of committed or fixed costs, making more units reduces the average cost per unit, which may be a visible number. Also, placing some units in inventory defers all the costs of those units from being recognized as expense, which could increase currently reported income. 2.17 Timing is the key in distinguishing between absorption, variable, and throughput costing. All manufacturing costs will ultimately be expensed under all three methods. Under throughput costing, only the unit-level spending for direct costs are included in the product cost. All other committed costs are expensed as period costs during the period in which they are incurred. Under variable costing, the fixed manufacturing-overhead costs are expensed during the period in which they are incurred. Under absorption costing, fixed manufacturing-overhead costs are held in inventory as product costs until the period during which the units are sold. Then those costs flow into cost-of-goods-sold expense. 2.18 When inventory increases, the income reported under absorption costing will be greater than the income reported under variable costing. This difference results from the fact that under absorption costing, some of the fixed manufacturing costs incurred during the period will not be expensed. In contrast, under variable costing all of the fixed manufacturing costs incurred during the period will be expensed during that period. 2.19 Throughput, variable and absorption costing will not result in significantly different income measures in a JIT setting. Under JIT inventory and production management, inventories are minimal and as a result inventory changes are also minimal. The three methods result in significantly different income measures only when inventory changes significantly from period to period. ANSWERS TO CRITICAL ANALYSIS 2.20 In terms of measuring overall, periodic income, this statement is true. However, the statement ignores the value of throughput-based information for managing service organizations. For example, clearly identifying the unit-level costs of services may give more accurate information to managers seeking to identify the most profitable uses of the organization’s resources. Variable or absorption costs of services may obscure actual cost behavior. 2.21 Product costs for virtual organizations that outsource all production are similar to purchase costs of merchandise for retail organizations. Both types of organization are interested in the cost to them, not to the producers. If that is the extent of the virtual organization’s involvement with production, different product-costing methods probably are irrelevant. If, however, virtual organizations add processing to purchased products, they may allocate costs of that processing to unit-level costs, obscuring, perhaps, actual unit-level costs. 2.22 The following table shows how various resources can be considered either direct or indirect, depending on the organizational subunit in question. Resources Entire organization Divisions Services Headquarters Direct to overall organization Probably indirect to individual divisions; e.g. necessary, but adding or dropping a division may not change headquarters resources Indirect to individual services provided Facilities Direct to subunit with the facilities Direct to individual divisions Indirect to individual services provided Division managers Direct to decisions to have individual divisions Indirect to individual services provided Information systems personnel Direct to overall organization Probably indirect to individual divisions; e.g. necessary, but adding or dropping a division may not change IS resources Indirect to individual services provided 2.23 There may be some truth to this jibe, but it also ignores the practical difficulties of measuring opportunity costs. Ideally, managers would weigh the benefits of every decision against its opportunity cost, and other measures of costs are irrelevant. It is very difficult to know, at all times, what the opportunity costs of resources are. Cost managers seek to find accurate proxy measures for opportunity costs that reflect decision-making needs and realities. 2.24 Tracing costs does imply knowledge of cause and effect, whereas allocating costs may reflect vague perceptions or guesses about cause and effect. Though measuring use of resources accurately may be a primary goal of costing, it is not the only goal. For example, organizations may allocate costs to maximize allowable reimbursement under contractual arrangements or to influence evaluations and behavior (see chapter 9). Under some idealized, general economic equilibrium conditions this may be done best by accurate measures of resource use, but these conditions may or may not exist. Undoubtedly, cost allocations may be used to exploit real opportunities, and they may not have to be accurately traced costs to do so. 2.25 Our preference for “committed cost” is more than semantic. Cost managers should be challenging the existence of any cost or use of resources in an organization. Unfortunately, labeling some costs as “fixed” may deflect scrutiny. In some organizations, so-called fixed costs are growing faster than sales. How does one account for that if these are fixed costs? Most costs in organizations lie somewhere between committed and discretionary, and these costs can be changed. Whether they should be changed is a matter of applying cost-benefit analysis tools. Note: changing methods or estimates of lives and salvage values can change even depreciation, a so-called fixed cost. 2.26 This proposal is one possible defensive response to the challenge of throughput costing, which would require a new set of books. If the interest rate is set at the company’s opportunity rate, divisions should reduce inventory levels to optimal levels. Of course, there are many adjustments that could be made to absorption-cost based income to measure economic performance and create desired incentives. This is the intent of residual income and economic value added (EVA). But as most firms who adopt these approaches find out, they are not cheap or uncontroversial, either. 2.27 If an organization uses absorption costing to cost its products, it allocates some committed product costs to each unit of product made. If it makes more than it sells, by applying the matching principle, it defers recognition of the costs of unsold products. This cannot be a sustainable practice (without fraud) because it would have to be repeated each period. Product inventories cannot continue to build without consequences. Eventually the inventoried products will be either sold or written off, and all the cost that had been hidden will be expensed. Services, by definition, are not complete until they are provided to the customer, so services cannot be inventoried as can products. 2.28 This comment ignores the value of having the different forms of information available. All three types of information – throughput, variable, and absorption – convey valuable information, but each may be appropriate for different decisions. 2.29 This comment points out a very important problem in managing competitive businesses. Managers feel pressures from many constituents, and the greatest pressure may be from external parties, such as creditors, stockholders, and financial analysts. Many believe that it is possible to influence credit terms and stock prices by reporting favorable, short-term earnings, even though theory and empirical evidence indicates that markets “see through” cosmetic manipulations. Therefore, current earnings (and earnings “surprises”) are important to managers. 2.30 Under absorption costing, both inventory and retained earnings will be greater than or equal to the balances in those accounts under variable costing. This will be true at any balance sheet date. 2.31 The term direct costing is a misnomer. Variable costing is a better term for this product-costing method. Under variable costing, the variable costs of direct material, direct labor, and variable overhead are treated as product costs. Fixed manufacturing-overhead costs are not treated as product costs. Thus, the important characteristic of a cost that determines whether it is treated as a product cost under variable costing is its cost behavior. Direct costing is a misnomer because variable-overhead costs are not direct costs, but they are treated as product costs under the variable-costing method. 2.32 Prime costs are direct. Direct materials and direct labor are by their very nature directly related to the product. Some overhead costs are treated as indirect for practical reasons—while they might be directly associated with the product (e.g., incidental materials), they are too small in value to be separately measured. Other overhead costs, such as the occupancy costs of the manufacturing plant, are clearly indirect. SOLUTIONS TO EXERCISES 2.33 (30 min) Income statement; schedule of cost of goods manufactured and sold a. The income statement and schedule of cost of goods manufactured and sold are as follows: ZODIAC CORPORATION Income Statement For the Year Ended December 31 Sales revenue $2,036,000 Cost of goods sold (see following schedule) 1,239,000 Gross margin $ 797,000 Less Marketing costs 272,000 Administrative costs 304,000 Operating profit $ 221,000 Schedule of Cost of Goods Manufactured and Sold For the Year Ended December 31 Beginning work in process inventory, January 1 $135,000 Manufacturing costs during the year Direct material: Raw-material inventory, 1/1 $102,000 Add purchases 313,000 Raw material available for use $415,000 Less inventory, 12/31 81,000 Direct material put into production $334,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.33 (continued) Direct labor 482,000 Manufacturing overhead Supervisory and indirect labor 127,000 Supplies and indirect material 14,000 Heat, light and powerplant 87,000 Plant maintenance and repairs 74,000 Depreciation manufacturing 103,000 Miscellaneous manufacturing costs 12,000 Total manufacturing overhead $417,000 Total manufacturing costs incurred during the year 1,233,000 Total cost of work in process during the year $1,368,000 Less ending work in process inventory, December 31 142,000 Costs of goods manufactured during the year $1,226,000 Beginning finished goods inventory, January 1 160,000 Finished goods inventory available for sale $1,386,000 Less ending finished goods inventory, December 31 147,000 Cost of goods sold $1,239,000 2.34 (45 min) Cost behavior; current issues in cost management Direct labor is a variable cost if management is both able and willing to continually adjust the workforce to meet short-term needs. Many observers would argue that it is ethical to “tap and zap” employees provided that those employees are appropriately notified about and compensated for the added risks and uncertainties surrounding their employment. For example, hourly rates for temporary employees may be set somewhat higher than for permanent employees to account for temps not having paid vacation, health benefits, and other standard compensation features of the modern workforce. For many cyclical industries (e.g., recreational resorts) such labor flexibility is essential. For industries with more stable labor levels, there are legal limitations, which seek to prevent classifying labor incorrectly as “temporary.” The deliberate misclassification of employees to avoid appropriate compensation is unethical, and in certain circumstances may be illegal. 2.35 (15 min) Basic cost concepts Cost Item Fixed (F) Variable (V) Period (P) Product (R) a. Sales commissions V P b. Sales personnel office rent F P c. Sales supervisory salaries F P d. Cost-management staff office rental F P e. Administrative office heat and air conditioning F* P f. Transportation-in costs on material purchased………………….. V R g. Assembly line workers’ wages V R h. Property taxes on office buildings for administrative staff F P i. Salaries of top executives in the company F P j. Overtime pay for assembly workers V R *Fixed with respect to activity. Utility costs vary, however, with respect to the weather. 2.36 (10 min) Basic Cost concepts a. Assembly line worker’s salary. B b. Raw materials used in production process. P c. Indirect materials. C d. Factory heating and air conditioning. C e. Production supervisor’s salary. C f. Transportation-in costs on materials purchased. P 2.37 (15 min) Basic cost concepts Cost Item Fixed (F) Variable (V) Period (P) Product (R) a. Utilities in cost-management analyst’s office F* P b. Factory security personnel………………………………… F R c. Factory heat and air conditioning F* R d. Power to operate factory equipment V R e. Depreciation on furniture for company executives F P *Fixed with respect to activity. Utility costs vary, however, with respect to the weather. 2.38 (15 min) Prepare statements for a merchandising company a. The income statement and schedule of cost of goods sold follow. DIGITECH INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, THIS YEAR Revenue $5,000,000 Cost of goods sold (see statement below) 3,060,000 Gross margin 1,940,000 Marketing and administrative costs 1,600,000 Operating profit $ 340,000 DIGITECH SCHEDULE OF COST OF GOODS SOLD FOR THE YEAR ENDED DECEMBER 31, THIS YEAR Beginning inventory $ 500,000 Purchases $2,600,000 Transportation-in 260,000 Total cost of goods purchased 2,860,000 Cost of goods available for sale 3,360,000 Ending inventory 300,000 Cost of goods sold $3,060,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.39 (30 min) Prepare cost schedules for a manufacturing company It helps to set up T-accounts or equations to solve for the missing data. The numbers in the T-accounts and equations are expressed in terms of yen, the Japanese national currency. a. Raw-Material Inventory Beginning raw- material + Raw material = Direct material + Ending raw- material 328,000 x 1,732,000 inventory purchases used inventory 366,000 328,000 + X = 1,732,000 + 366,000 X = 1,732,000 + 366,000 – 328,000 X = 1,770,000 b. Finished-Goods Inventory Beginning finished-goods + Cost of goods = Cost of goods + Ending finished-goods 146,000 x 6,000,000 inventory manufactured sold inventory 150,000 146,000 + X = 6,000,000 + 150,000 X = 6,000,000 + 150,000 – 146,000 X = 6,004,000 c. Work-in-Process Inventory Beginning work –in-process + Total manufacturing = Cost of goods + Ending work -in-process 362,000 x 6,004,000 * inventory costs manufactured inventory 354,000 362,000 + X = 6,004,000 + 354,000 X = 6,004,000 + 354,000 – 362,000 X = 5,996,000 *From part b. 2.39 (continued) In the following statement, y denotes yen, the Japanese national currency. OSAKA MACHINE TOOLS COMPANY SCHEDULE OF COST OF GOODS MANUFACTURED AND SOLD FOR THE YEAR ENDED DECEMBER 31 Beginning work in process inventory 362,000 yManufacturing costs:Direct material:Beginning inventory 328,000 yPurchases 1,770,000 y (a)Raw material available 2,098,000 yLess ending inventory 366,000 yDirect material used 1,732,000 yOther manufacturing costs 4,264,000 y *Total manufacturing costs 5,996,000 y (c)Total costs of work in process 6,358,000 yLess ending work in process 354,000 y Cost of goods manufactured 6,004,000 y (b) Beginning finished goods inventory 146,000 y Finished goods available for sale 6,150,000 y Ending finished goods inventory 150,000y Cost of goods sold 6,000,000y Letters (a), (b), and (c) refer to amounts found in solutions to requirements a, b, and c. *Difference between total manufacturing costs and direct material used. 2.40 (30 min) Prepare statements for a manufacturing company COLUMBUS CABLE COMPANY SCHEDULE OF COST OF GOODS MANUFACTURED AND SOLD FOR THE YEAR ENDED DECEMBER 31 Work in process, Jan. 1 $30,800 Manufacturing costs:Direct material:Beginning inventory, Jan. 1 $36,800Add material purchases 44,600Raw material available $81,400Less ending inventory, Dec. 31 38,000Direct material used $43,400Direct labor 71,200Manufacturing overhead:Supervisory and indirect labor $28,800Indirect material and supplies 12,600Plant utilities and power 47,000Manufacturing building depreciation 54,000Property taxes, manufacturing plant 16,800Total manufacturing overhead 159,200 Total manufacturing costs 273,800 Total cost of work in process during the year $304,600Less work in process, Dec. 31 26,200Costs of goods manufactured during the year $278,400 Beginning finished goods, Jan. 1 21,800 Finished goods inventory available for sale $300,200 Less ending finished goods inventory, Dec. 31 17,000 Cost of goods sold $283,200 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.40 (continued) COLUMBUS CABLE COMPANY INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31 Sales revenue $418,000 Less: Cost of goods sold 283,200 Gross margin $134,800 Administrative costs $87,500 Marketing costs (sales commissions) 29,000 Total marketing and administrative costs 116,500 Operating profit $ 18,300 2.41 (30 min) Prepare statements for a manufacturing company TOLEDO TOY COMPANY SCHEDULE OF COST OF GOODS MANUFACTURED AND SOLD FOR THE YEAR ENDED DECEMBER 31 Beginning work in process, Jan. 1 $6,600 Manufacturing costs:Direct material:Beginning inventory, January 1 $8,200Add purchases 10,150Raw material available $18,350Less ending inventory, December 31 9,000Direct material put into process $9,350Direct labor 16,300Manufacturing overhead:Supervisory and indirect labor $ 6,200Indirect material and supplies 2,150Plant utilities and power 11,500Manufacturing building depreciation 11,750Property taxes, manufacturing plant 3,700Total manufacturing overhead 35,300Total manufacturing costs 60,950 Total cost of work in process during the year $67,550Less work in process, December 31 5,550Costs of goods manufactured during the year $62,000 Beginning finished goods, January 1 4,450 Finished goods inventory available for sale $66,450 Less ending finished goods inventory, December 31 3,900 Cost of goods sold $62,550 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.41 (continued) TOLEDO TOY COMPANY INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31 Sales revenue……………………………………………………. $99,300 Less: Cost of goods sold (per statement) 62,550 Gross margin $36,750 Administrative costs $19,700 Sales commissions 6,800 Total marketing and administrative costs 26,500 Operating profit $10,250 2.42 (20 min) Cost behavior for decision making Variable costs:Direct material used ($69,000 x 1.4) $ 96,600Direct labor ($134,400 x 1.4) 188,160Indirect material and supplies ($15,500 x 1.4) 21,700Power to run plant equipment ($14,700 x 1.4) 20,580Total variable costs $327,040 Fixed costs:Supervisory salaries 61,200Plant utilities (other than power to run plant equipment) 19,200Depreciation on plant and equipment 9,600Property taxes on building 14,000Total fixed costs $104,000 Total costs for 1,400 units $431,040 Unit cost = $431,040/1,400 units = $307.88 Unit variable cost = $327,040/1,400 units = $233.60 Check to see if variable cost per unit is the same at 1,400 units as at 1,000 units: Unit variable cost = $69,000 + $134,400 + $15,500 + $14,700 = $233,600 = $233.60 at 1,000 units 1,000 1,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.43 (20 min) Cost behavior Fixed costs = $104,000 = $61,200 + $19,200 + $9,600 + $14,000 Variable costs = $233.60 per unit = ($327,040  1,400 units) or ($233,600  1,000 units) 2.44 (30 min)Variable costing vs. absorption costing; comparison of operating profit Unit Cost a. Direct material $6.50 a Direct labor 3.75 b Variable manufacturing overhead 1.50 c Total variable unit cost $11.75 b. Sales revenue $2,288,000 d Less: Variable cost of goods sold 1,222,000 e Variable selling and administrative 140,000 Contribution margin $ 926,000 Less: Fixed manufacturing costs 180,000 Fixed selling and administrative 120,000 Operating profit $ 626,000 c. Sales revenue $2,288,000 d Less: Cost of goods sold 1,378,000 f Gross margin 910,000 Less: Selling and administrative costs 260,000 Operating profit $ 650,000 a$6.50 = $780,000/120,000 units b$3.75 = $450,000/120,000 units c$1.50 = $180,000/120,000 units d$2,288,000 = $22.00 x 104,000 units e$1,222,000 = $11.75 x 104,000 units fCost of goods sold = 104,000 units sold x [($780,000 + $450,000 + $180,000 + $180,000) / 120,000 units made] = $1,378,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.45 (45 min) Absorption versus variable costing a. Since there were no variances in 20x0, actual production and budgeted production must have been the same. Predetermined fixed overhead rate = = = $2 per unit Standard Cost per Unit Direct material $5 Direct labor 2 Variable overhead 3 Standard cost per unit under variable costing $10 Fixed overhead per unit under absorption costing 2 Standard cost per unit under absorption costing $12 b. (1) CAROLINA CATSUP COMPANY ABSORPTION-COSTING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X0 Sales revenue (125,000 units sold at $16 per unit) $2,000,000 Less: Cost of goods sold (at standard absorption cost of $12 per unit) 1,500,000 Gross margin $ 500,000 Less: Selling and administrative expenses: Variable (at $1 per unit) 125,000 Fixed50,000 Net income $ 325,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.45 (continued) (2) CAROLINA CATSUP COMPANY VARIABLE-COSTING INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X0 Sales revenue (125,000 units sold at $16 per unit) $2,000,000 Less: Variable expenses: Variable manufacturing costs (at standard variable cost of $10 per unit) 1,250,000 Variable selling and administrative costs (at $1 per unit)125,000 Contribution margin $ 625,000 Less: Fixed expenses: Fixed manufacturing overhead 300,000 Fixed selling and administrative expenses 50,000 Net income $ 275,000 c. Cost of goods sold under absorption costing $1,500,000 Less: Variable manufacturing costs under variable costing 1,250,000 Difference $ 250,000 Less: Fixed manufacturing overhead as period expense under variable costing300,000 Total $(50,000 ) Net income under variable costing $ 275,000 Less: Net income under absorption costing325,000 Difference in net income $(50,000 ) d. Difference inreported income = difference in fixed overhead expensed under absorption and variable costing =  = (25,000 units)  ($2 per unit) = $50,000 As shown in requirement b, reported income is $50,000 lower under variable costing. 2.46 (25 min) Comparison of variable and full-absorption costing Unit cost under absorption costing: Direct material $2.20 Direct labor 1.70 Variable overhead .90 Fixed overhead 2.40 * Total $7.20 *$2.40 = $240,000 ÷ 100,000 units produced Unit costing under variable costing: Under variable costing, fixed factory overhead is not included in inventory, only variable costs are: Direct material $2.20 Direct labor 1.70 Variable overhead .90 Total $4.80 c. Operating profit under variable costing: Revenue (80,000 units x $12.00) $960,000 Variable costs:Cost of goods sold (80,000 units x $4.80) 384,000Selling and admin. (80,000 units x $1.00) 80,000 Contribution margin $496,000 Fixed costs:Manufacturing $240,000Selling and admin. 128,000 368,000 Operating profit $128,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.46 (continued) d. Operating profit under absorption costing: Revenue (80,000 x $12.00) $960,000Cost of goods sold (80,000 x $7.20) 576,000 Gross margin $384,000 Selling and admin:Variable $80,000Fixed 128,000 208,000 Operating profit $176,000 e. Unit cost under full-absorption costing is $7.20. There are 20,000 units in ending inventory. The value of ending inventory is $144,000 ($7.20 x 20,000 units). f. Unit cost under variable costing is $4.80. There are 20,000 units in ending inventory. The value of ending inventory is $96,000 ($4.80 x 20,000 units). 2.47 (15 min) Difference in income under absorption and variable costing 1. (a) Inventory increases by 2,000 units, so income is greater under absorption costing. (b) = = $200 = $200  2,000 = $400,000 2. (a) Inventory remains unchanged, so there is no difference in reported income under the two methods of product costing. (b) No difference. 2.47 (continued) 3. (a) Inventory decreases by 3,000 units, so income is greater under variable costing. (b) = = $110 = $110  3,000 = $330,000 2.48 (30 min) Throughput costing A B C D 1 Throughput costing Month 1 Month 2 Month 3 2 Beginning inventory units - - 100 3 Units produced 500 600 400 4 Units sold 500 500 500 5 Sales $50,000 $50,000 $50,000 6 Material cost 10,000 12,000 8,000 7 Direct conversion cost useda 12,000 14,400 9,600 8 Indirect conversion costs 8,000 5,600 10,400 9 Indirect operating costs 16,000 16,000 16,000 10 Sales (B5)b $50,000 $50,000 $50,000 11 Cost of goods sold [(B6/B3)*B4] b 10,000 10,000 10,000 12 Throughput (B10 – B11) b 40,000 40,000 40,000 13 Operating expense (sum(B7:B9) b 36,000 36,000 36,000 14 Operating income (B12 – B13) b $ 4,000 $ 4,000 $ 4,000 aNote that this is also a variable cost, because the total cost changes in proportion to changes in the production quantity (i.e., $12,000/500 = $14,400/600 = $9,600/400). bFormulas for cells in column B. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.49 (35 min) Variable costing A B C D 1 Variable costing Month 1 Month 2 Month 3 2 Beginning inventory units - - 100 3 Units produced 500 600 400 4 Units sold 500 500 500 5 Sales $50,000 $50,000 $50,000 6 Material cost 10,000 12,000 8,000 7 Direct conversion cost useda 12,000 14,400 9,600 8 Indirect conversion costs 8,000 5,600 10,400 9 Indirect operating costs 16,000 16,000 16,000 10 Sales 50,000 50,000 50,000 11 Cost of goods sold 12 Material cost [(B6/B3)*B4]b 10,000 10,000 10,000 13 Direct conv. (B7/B3)*B4 b 12,000 12,000 12,000 14 Total cost of goods sold (B12+B13) b 22,000 22,000 22,000 15 Contribution margin (B10-B14) b 28,000 28,000 28,000 16 Operating expense (B8+B9) b 24,000 21,600 26,400 17 Operating income (B15-B16)b $ 4,000 $ 6,400 $ 1,600 aNote that this is also a variable cost, because the total cost changes in proportion to changes in the production quantity (i.e., $12,000/500 = $14,400/600 = $9,600/400). bFormulas for cells in column B. __________________________________________________________________ Operating income in month 2 is higher even though sales are the same as in month 1. The reason is that 100 units have been added to inventory. They each carry $24 in direct conversion cost ($14,400/600, the same per unit cost each month), but the total conversion cost does not vary from month to month. Thus, ($24 x 100) $2,400 of conversion cost remains in inventory, but in month 1 the total conversion cost was expensed. This is the source of the $2,400 greater income in month 2. In contrast, in month 3 the additional 100 units are sold, which increases the amount of conversion cost recognized as expense by $2,400 and accounts for the lower operating income in month 3. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.50 (35 min) Absorption costing A B C D 1 Absorption costing Month 1 Month 2 Month 3 2 Beginning inventory units - - 100 3 Units produced 500 600 400 4 Units sold 500 500 500 5 Sales $50,000 $50,000 $50,000 6 Material cost 10,000 12,000 8,000 7 Variable conversion cost used 12,000 14,400 9,600 8 Indirect conversion costs 8,000 5,600 10,400 9 Indirect operating costs 16,000 16,000 16,000 10 Sales $50,000 $50,000 $50,000 11 Cost of goods sold 12 Material cost [(B6/B3)*B4] a 10,000 10,000 10,000 13 Direct conv. (B7/B3)*B4a 12,000 12,000 12,000 14 Indirect conv. (B8/B3)*B4a 8,000 4,667 11,333 15 Total CGS (sum(B12:B14) a 30,000 26,667 33,333 16 Gross margin (B10-B15) a 20,000 23,333 16,667 17 Operating expense (B9) a 16,000 16,000 16,000 18 Operating income (B16-B17) a $ 4,000 $ 7,333 $ 667 a Formulas for cells in column B. __________________________________________________________________ Operating income in month 2 is higher even though sales are the same as in month 1. The reason is that 100 units have been added to inventory. They each carry $33.33 in conversion cost ($20,000/600), but the total conversion cost does not vary from month to month. Thus, $33.33 x 100 = $3,333 of conversion cost remains in inventory, but in month 1 the total conversion cost was expensed. This is the source of the $3,333 greater income in month 2. In contrast, in month 3 the additional 100 units are sold, which increases the amount of conversion cost recognized as expense by $3,333 and accounts for the lower operating income in month 3. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.51 (40 min) Compare income under variable and absorption costing a. Sales revenue $2,600,000 Less: Variable cost of goods sold 1,729,000 a Variable selling and admin. 135,200 b Contribution margin 735,800 Less: Fixed manufacturing overhead 140,000 c Fixed selling and admin. 91,000 d Operating profit $ 504,800 b. Since sales exceed production, profit reported under variable costing will be greater, as shown by comparing the variable costing results in a with the following absorption-costing results. Sales revenue $2,600,000 Less: Cost of goods sold 1,911,000 e Gross margin 689,000 Less: Variable selling and admin. 135,200 b Fixed selling and admin. 91,000 d Operating profit $ 462,800 Note: Absorption costing expenses $42,000 (1,500 units x $28) in this period from the prior period’s production that variable costing already expensed in the prior period. a$1,729,000 = 6,500 units x $266 = 6,500 units x ($164 + $70.80 + $31.20), including 1,500 units from beginning inventory b$135,200 = 6,500 units x $20.80 c$140,000 = 5,000 units x $28 d$91,000 = 6,500 units x $14 e$1,911,000 = 6,500 units x $294 = 6,500 units x ($164 + $70.80 + $31.20 + $28), including 1,500 units from beginning inventory 2.52 (10 min) Absorption, variable, and throughput costing Note that sales revenue is not needed to solve this exercise. a. Inventoriable costs under variable costing: Direct material used $290,000 Direct labor 100,000 Variable manufacturing overhead 50,000 Total $440,000 b. Inventoriable costs under absorption costing: Direct material used $290,000 Direct labor 100,000 Variable manufacturing overhead 50,000 Fixed manufacturing overhead 80,000 Total $520,000 c. Inventoriable costs under throughput costing: Direct material used* $290,000 Total $290,000 *Under this scenario, direct material cost is the only throughput cost. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.53 (25 min) Absorption, variable, and throughput costing Note that sales revenue is not needed to solve this exercise. Inventory calculations (units): Finished-goods inventory, January 1 0 units Add: Units produced 10,000 units Less: Units sold 9,000 units Finished-goods inventory, December 31 1,000 units a. Variable costing: Inventoriable costs under variable costing: Direct material used $40,000 Direct labor incurred 20,000 Variable manufacturing overhead 12,000 Total $72,000 Cost per unit produced = $72,000/10,000 units = $7.20 per unitEnding inventory: 1,000 units  $7.20 per unit $7,200 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE b. Absorption costing: Predetermined fixed-overhead rate = = = $2.50 per unit Difference in fixed overhead expensed under absorption and variable costing = = (1,000 units)  ($2.50 per unit) = $2,500 Difference in reported income: Since inventory increased during the year, income reported under absorption costing will be $2,500 higher than income reported under variable costing. 2.53 (continued) c. Throughput costing: Inventoriable costs under throughput costing: Direct material used $40,000 Total $40,000 Cost per unit produced = $40,000/10,000 units = $4.00 per unitEnding inventory: 1,000 units  $4.00 per unit $4,000 2.54 (45 min) Internet search; throughput and variable costing Internet search. Answers will vary. SOLUTIONS TO PROBLEMS 2.55 (40 min) Find unknown account balances a. Material beginning inventory + Purchases – Material used = Material ending inventory $8,000 + Purchases – $15,000 = $12,400 Purchases = $19,400 (= $12,400 – $8,000 + $15,000) b. Finished goods beginning inventory + Cost of goods manufactured – Cost of goods sold = Finished goods ending inventory $254,200 + $679,200 – $760,000 = Finished goods ending inventory $173,400 = Finished goods ending inventory c. Direct material used + Direct labor + Manufacturing overhead = Total manufacturing costs Direct material used + $173,000 + $240,000 = $679,600 Direct material used = $266,600* (= $679,600 – $173,000 – $240,000) *Also can be found from the Raw-Material Inventory account: $24,600 + $262,000 = $20,000 + direct material used. Direct material used = $266,600 d. Material beginning inventory + Purchases – Material used = Material ending inventory $45,000 + $248,400 – $234,200 = Material ending inventory $59,200 = Material ending inventory 2.55 (continued) e. Work in process beginning inventory + Total manufacturing costs – Cost of goods manufactured = Work in process ending inventory Work in process beginning inventory + $1,526,800 – $1,518,220 = $85,200 Work in process beginning inventory = $76,620 (= $85,200 – $1,526,800 + $1,518,220) f. Revenue – Cost of goods sold = Gross margin $3,359,900 – Cost of goods sold = $1,874,600 Cost of goods sold = $1,485,300 (= $3,359,900 – $1,874,600) g. Direct material used + Direct labor + Manufacturing overhead = Total manufacturing costs $234,200 + Direct labor + $430,600 = $1,526,800 Direct labor = $862,000 (= $1,526,800 – $234,200 – $430,600) 2.55 (continued) Although not required in the problem, some instructors require the companies’ Statements of Cost of Goods Sold, which we include here. (Note: Superscript letters cross-reference to missing amounts in the problem.) Company 1 Work in process, January 1 $12,560 Manufacturing costs:Direct material:Raw material inventory, January 1 $8,000Raw material purchased 19,400 (a)Raw material available for use $27,400Less material inventory, December 31 12,400Direct material used $15,000Direct labor 23,200Manufacturing overhead 19,800 Total manufacturing costs 58,000 Total costs of work in process for the year $70,560Less work in process, December 31 12,560Cost of goods manufactured this year $58,000 Add finished goods, January 1 2,800 Cost of goods available for sale $60,800 Less finished goods, December 31 4,600 Cost of goods sold $56,200 Company 2 Work in process, January 1 $11,600 Manufacturing costs:Direct material:Raw material inventory, January 1 $24,600Raw material purchased 262,000Raw material available for use $286,600Less material inventory, December 31 20,000Direct material used $266,600 (c)Direct labor 173,000Manufacturing overhead 240,000 Total manufacturing costs 679,600 Total costs of work in process for the year $691,200Less work in process, December 31 12,000Cost of goods manufactured this year $679,200 Add finished goods, January 1 254,200 Cost of goods available for sale $933,400 Less finished goods, December 31 173,400 (b) Cost of goods sold $760,000 2.55 (continued) Company 3 Work in process, January 1 $76,620 (e) Manufacturing costs:Direct material:Raw-material inventory, January 1 $45,000Raw material purchased 248,400Raw material available for use $293,400Less raw-material inventory, December 31 59,200 (d)Direct material used $234,200Direct labor 862,000 (g)Manufacturing overhead 430,600 Total manufacturing costs 1,526,800 Total costs of work in process during the year $1,603,420Less work in process, December 31 85,200Cost of goods manufactured this year $1,518,220 Add finished goods, January 1 334,480 Cost of goods available for sale $1,852,700 Less finished goods, December 31 367,400 Cost of goods sold $1,485,300 (f) 2.56 (30 min)Analyze the impact of a decision on income statements a. This year’s income statement: Baseline (Status Quo) Rent Equipment Difference Revenue $1,590,000 $1,590,000 0 Operating costs:Variable (190,000 ) (190,000) 0Fixed (cash expenditures) (750,000 ) (750,000) 0Equipment depreciation (150,000 ) (150,000) 0Other depreciation (125,000 ) (125,000) 0Loss from equipment write-off 0 (850,000) * $850,000 lower Operating profit (before taxes) $ 375,000 $(475,000) $850,000 lower *Equipment write-off = $1 million cost – $150,000 accumulated depreciation for one year (equipment was purchased on January 1 of the year). b. Next year’s income statement: Baseline (Status Quo) Rent Equipment Difference Revenue $1,590,000 $1,749,000 $159,000 higher Operating costs:Equipment rental 0 (230,000) 230,000 higherVariable (190,000) (190,000) 0Fixed cash expenditures (750,000) (712,500) 37,500 lowerEquipment depreciation (150,000) 0 150,000 lowerOther depreciation (125,000) (125,000) 0 Operating profit $375,000 $491,500 116,500 higher Despite the effect on next year’s income statement, the company should not rent the new machine because net cash inflow as a result of installing the new machine ($159,000 + $37,500) does not cover cash outflow for equipment rental. 2.57 (35 min) Schedule of cost of goods manufactured and sold; income statement a. FRESNO FASHIONS COMPANY SCHEDULE OF COST OF GOODS MANUFACTURED FOR THE YEAR ENDED DECEMBER 31, 20X2 Direct material: Raw-material inventory, January 1 $ 40,000 Add: Purchases of raw material 180,000 Raw material available for use $220,000 Deduct: Raw-material inventory, December 31 25,000 Raw material used $195,000 Direct labor 200,000 Manufacturing overhead: Indirect material $ 11,000 Indirect labor 16,000 Utilities: plant 40,000 Depreciation: plant and equipment 60,000 Other 78,000 Total manufacturing overhead 205,000 Total manufacturing costs $600,000 Add: Work-in-process inventory, January 1 40,000 Subtotal $640,000 Deduct: Work-in-process inventory, December 31 30,000 Cost of goods manufactured $610,000 b. FRESNO FASHIONS COMPANY SCHEDULE OF COST OF GOODS SOLD FOR THE YEAR ENDED DECEMBER 31, 20X2 Finished goods inventory, January 1 $ 20,000 Add: Cost of goods manufactured 610,000 Cost of goods available for sale $630,000 Deduct: Finished-goods inventory, December 31 50,000 Cost of goods sold $580,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.57 (continued) c. FRESNO FASHIONS COMPANY INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X2 Sales revenue $945,000 Less: Cost of goods sold 580,000 Gross margin $365,000 Selling and administrative expenses 145,000 Income before taxes $220,000 Income tax expense 80,000 Net income $140,000 2.58 (15 min) Fixed and variable costs; forecasting Variable or Fixed 20x2 Forecast Explanation Direct material V $3,480,000 $2,900,000  1.20 Direct labor V 2,340,000 $1,950,000  1.20 Manufacturing overhead Utilities (primarily electricity) V 168,000$140,000  1.20 Depreciation on plant and equipment F 230,000 same Insurance F 150,000 same Supervisory salaries F 300,000 same Property taxes F 220,000 same Selling costs Advertising F 195,000 same Sales commissions V 108,000 $90,000  1.20 Administrative costs Salaries of top management and staff F 369,000 same Office supplies F 40,000 same Depreciation on building and equipment F 75,000 same EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.59 (15 min) Characteristics of cost a. 3, sunk cost e. 3, sunk cost b. 1, opportunity cost f. 5, conversion cost c. 4, prime cost g. 2, out-of-pocket cost; 6, average cost d. 2, out-of-pocket cost; 6, average cost 2.60 (15 min) Variable costs; graphical and tabular analysis a. Graph of raw-material cost: b. Production Level in Pounds Unit Cost Total Cost 1 $40 per pound $40 10 $40 per pound $400 1,000 $40 per pound $40,000 2.61 (25 min) Fixed cost; graphical and tabular analysis Graph of fixed production cost: b. Production Level in Yards Unit Fixed Cost Total Fixed Cost 1 $100,000 per yard $100,000 10 $10,000 per yard $100,000 10,000 $10 per yard $100,000 40,000 $2.50 per yard $100,000 2.61 (continued) c. Graph of unit fixed production cost: 2.62 (30 min) Reconstruct financial statements TICONDEROGA TILE COMPANY STATEMENT OF COST OF GOODS SOLD FOR THE YEAR ENDED DECEMBER 31 Work in process, January 1 $12,950 Manufacturing costs:Direct material:Raw-material inventory, January 1 $53,550 aRaw material purchased 180,000Raw material available for use $233,550Less raw-material inventory, December 31 42,500Direct material used $191,050Direct labor 195,000Manufacturing overhead:Indirect labor $16,000Plant heat, light and power 22,600Building depreciation 31,500 bMiscellaneous factory costs 16,950Maintenance on factory machines 6,050Insurance on factory equipment 9,500Taxes on manufacturing property 6,550Total overhead 109,150 Total manufacturing costs 495,200 Total cost of work in process during the year $508,150Less work in process, December 31 12,300Cost of goods manufactured this year $495,850 Add finished goods, January 1 40,000 Cost of goods available for sale $535,850 Less finished goods, December 31 45,000 Cost of goods sold (to income statement) $490,850 aMaterials used is given, but this number is not. To obtain it, Beg. Bal. + Purchases = Mat. Used + End. Bal. Beg. Bal. = Mat. Used + End. Bal. – Purchases $53,550 = $191,050 + 42,500 – $180,000 b$31,500 = 7/9 times $40,500 2.62 (continued) TICONDEROGA TILE COMPANY INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31 Sales revenue $812,500 Less: Cost of goods sold (per statement) 490,850 Gross margin $321,650Building depreciation $9,000 aAdministrative salaries 24,900Selling costs 19,300Distribution costs 800Legal fees 4,100Total operating costs 58,100 Operating profit $263,550 a2/9 times $40,500 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.63 (40 min) Find unknown account balances a. Material beginning inventory + Purchases – Material used = Material ending inventory Material beginning inventory + $16,100 – $15,300 = $3,600 Material beginning inventory = $2,800 (= $3,600 – $16,100 + $15,300) b. Work in process beginning inventory + Total manufacturing costs – Cost of goods manufactured = Work in process ending inventory $2,700 + $55,550 – Cost of goods manufactured = $ 3,800 Cost of goods manufactured = $54,450* *$2,700 + $55,550 – $3,800 c. Sales revenues – Cost of goods sold = Gross margin $103,300 – $56,050 = Gross margin $47,250 = Gross margin d. Finished goods beginning inventory + Cost of goods manufactured – Cost of goods sold = Finished goods ending inventory Finished goods beginning inventory + $27,220 – $27,200 = $4,400 Finished goods beginning inventory = $ 4,380 (= $4,400 – $27,220 + $27,200) 2.63 (continued) e. Direct material used + Direct labor + Manufacturing overhead = Total manufacturing costs Direct material used + $ 3,800a + $7,200 = $23,600 Direct material used = $12,600a (= $23,600 – $3,800 – $7,200) f. Sales revenue – Cost of goods sold = Gross margin Sales revenue – $27,200 = $16,400 Sales revenue = $43,600 (= $16,400 + $27,200) g. Direct material used + Direct labor + Manufacturing overhead = Total manufacturing costs $66,100 + $124,700 + Manufacturing overhead = $308,100 Manufacturing overhead = $117,300 aAlso found from Material Inventory account: Beg. Balance + Purchases = Material Used + End. Balance $3,500 + $12,000 = Material Used + $2,900 Material Used = $12,600 2.63 (continued) Although not required in the problem, some instructors assign the companies’ Statements of Cost of Goods Sold, which are as follows: Company 1 Company 2 Work in process, January 1 $ 2,700 $ 6,720 Manufacturing costs:Direct material:Raw-material inventory,1/ 1 $ 2,800 (a) $ 3,500Raw material purchased 16,100 12,000Raw material available for use $18,900 $15,500Less raw-material inv, 12/31 3,600 2,900Direct material used $15,300 $12,600 (e)Direct labor 26,450 3,800Manufacturing overhead 13,800 7,200 Total manufacturing costs 55,550 23,600 Total cost of work in process for the year $58,250 $30,320Less work in process, 12/31……… 3,800 3,100Cost of goods manufactured $54,450 (b) $27,220 Add finished–goods inv, 1/1 1,900 4,380 (d) Cost of goods available for sale $56,350 $31,600 Less finished-goods inv, 12/31 300 4,400 Cost of goods sold $56,050 $27,200 2.63 (continued) Company 3 Work in process, January 1 $82,400 Manufacturing costs:Direct material:Raw-material inventory, January 1 $16,000Raw material purchased 64,200Raw material available for use $80,200Less raw-material inventory, December 31 14,100Direct material used $66,100Direct labor 124,700Manufacturing overhead 117,300 (g) Total manufacturing costs 308,100 Total costs of work in process during the year $390,500Less work in process, December 31 76,730Cost of goods manufactured this year $313,770 Add finished goods, January 1 17,200 Cost of goods available for sale $330,970 Less finished goods, December 31 28,400 Cost of goods sold $302,570 2.64 (30 min) Cost Concepts a. Unit variable manufacturing cost = manufacturing overhead + direct labor + direct material = $30 + $10 + $40 = $80 b. Unit variable cost = all variable unit costs = $5 + $30 + $10 + $40 = $85 c. Full absorption cost per unit = fixed and variable manufacturing overhead + direct labor + direct material = $15 + $30 + $10 + $40 = $95 2.64 (continued) d. Prime cost per unit = direct labor + direct material = $10 + $40 = $50 e. Conversion cost per unit = direct labor + manufacturing overhead = $10 + ($30 + $15) = $55 f. Profit margin per unit = sales price – full cost = $175 – $120 = $55 g. Unit contribution margin = sales price – variable costs = $175 – $85 = $90 h. Gross margin per unit = sales price – full absorption cost = $175 – $95 = $80 i. As the number of units increases (reflected in the denominator), the fixed manufacturing cost per unit decreases. 2.65 (30 min) Cost concepts Note that sales revenue and selling and administrative expenses are not needed to solve this problem. a. Prime cost = direct material + direct labor Direct material = beginning inventory + purchases – ending inventory = $9,000 + $22,000 – $8,500 = $22,500 Direct labor is given as $14,000 Prime cost = $22,500 + $14,000 = $36,500 b. Conversion cost = direct labor + manufacturing overhead Conversion cost = $14,000 + $20,000 = $34,000 c. Total manufacturing cost = direct material + direct labor + manufacturing overhead = $22,500 (from req. a above) + $14,000 + $20,000 = $56,500 d. Cost of goods manufactured = beginning WIP* + total manufacturing costs – ending WIP = beginning WIP + direct material + direct labor + manufacturing overhead – ending WIP = $4,500 + $22,500 + $14,000 + $20,000 – $3,000 = $4,500 + $56,500 (from req. c above) – $3,000 = $58,000 *WIP denotes work in process e. Cost of goods sold = cost of goods manufactured + beginning finished-goods inventory – Ending finished -goods inventory = $58,000 (from d above) + $13,500 – $18,000 = $53,500 2.66 (30 min) Cost data for managerial purposes This problem demonstrates the ambiguity of cost-based contracting and, indeed, the measurement of “cost.” Recommended prices may range from the $42.90 suggested by NASA to the $53.35 charged by Florida Fruits, Inc. The key is to negotiate the cost-based price prior to the signing of the contract. Considerations which affect the base cost are reflected in the following options: Option (1) Only the differential costs could be considered as the cost basis. Option (2) The total cost per case for normal production of 80,000 cases could be used as the cost basis. Option (3) The total cost per case for production of 120,000 cases, excluding marketing costs, could be used as the cost basis. Option (4) The total cost per case for production of 120,000 cases, including marketing costs, could be used as the cost basis. Costs Unit Cost Options (one unit is one case of Fang) (1) (2) (3) (4) Materials (variable) $12 $12 $12 $12 $12 Labor (variable) 19 19 19 19 19 Supplies (variable) 8 8 8 8 8 Indirect costs (fixed) 440,000 N/A 5.50 3.67 3.67 Marketing (variable) 2 N/A 2 N/A 2 Administrative (fixed) 160,000 N/A 2 1.33 1.33 Per case cost basis $39 $48.50 $44 $46 Per case price (cost + 10%) $42.90 $53.35 $48.40 $50.60 We believe the most justifiable options exclude marketing costs and reflect the actual production level of 120,000 cases. These are Options (1) and (3). 2.67 (40 min)Absorption versus variable costing a. Absorption-costing operating profit: Year 1 Year 2 Two-year Total Sales revenue (10,000 x $51) $510,000 $510,000 $1,020,000 Less: Cost of goods sold:Beginning inventory –0– $100,000 –0–Current manufacturing costs: Variable costs: Year 1, (15,000 x $5)…………….. 75,000 Year 2, (5,000 x $5)……………… 25,000 100,000 Fixed costs 225,000 225,000 450,000Less: Ending inventory (100,000 )* –0– –0–Cost of goods sold $200,000 $350,000 $550,000 Gross margin $310,000 $160,000 $470,000 Less: Marketing and admin. costs 140,000 140,000 280,000 Operating profit $170,000 $ 20,000 $190,000 *(Total manufacturing costs/units produced) x units sold = [ ($75,000 + $225,000) / 15,000] x 5,000 = $100,000 b. Variable-costing operating profit: Year 1 Year 2 Two-year Total Sales revenue (10,000 x $51) $510,000 $510,000 $1,020,000 Less: Cost of goods sold:Beginning inventory –0– $ 25,000 –0–Current manufacturing costs: Variable costs: Year 1, (15,000 x $5)…………….. 75,000 Year 2, (5,000 x $5)……………… 25,000 100,000Less: Ending inventory (25,000 )* –0– –0–Cost of goods sold $ 50,000 $ 50,000 $ 100,000 Contribution margin $460,000 $460,000 $ 920,000 Less: Fixed manufacturing costs $225,000 $225,000 $ 450,000 Less: Marketing and admin. costs 140,000 140,000 280,000 Operating profit $ 95,000 $ 95,000 $ 190,000 *5,000 units in ending inventory x $5.00 per unit variable cost = $25,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.67 (continued) Reconciliation to appear in report to management: Inventory increased during year 1, because production exceeded sales by 5,000 units. Therefore, under absorption costing $75,000 of the year’s fixed manufacturing overhead cost remained in ending inventory as a product cost: $75,000 = [($225,000 / 15,000 units produced) x 5,000 units remaining in inventory] However, under variable costing, all of the year’s fixed manufacturing overhead cost is expensed during the period (as a period cost). As a result, income under absorption costing exceeds income under variable costing by $75,000 in year 1. In year 2, inventory declined by 5,000 units, because sales exceeded production. So in year 2, the opposite results occur. The following table shows these effects and reconciles reported income under the two product-costing methods. Year 1 Year 2 Operating profit: absorption costing $170,000 $ 20,000 Add: Fixed costs in beginning inventory –0– 75,000 Less: Fixed costs in ending inventory (75,000 ) –0– Operating profit: variable costing $95,000 $95,000 2.68 (40 min) Variable costing operating profit; reconciliation with absorption costing a. Revenue $465,000 Cost of goods sold:Beginning inventory ($22,000 x 45%) $9,900 *Cost of goods manufactured ($315,000 x 70%) 220,500Ending inventory ($86,000 x 70%) (60,200 )* 170,200 Variable selling costs ($83,000 x 80%) 66,400 Variable admin. costs ($49,800 x 40%) 19,920 Contribution margin 208,480 Fixed manufacturing costs ($315,000 x 30%) 94,500 Fixed selling costs ($83,000 x 20%) 16,600 Fixed administrative costs ($49,800 x 60%) 29,880Operating profit before tax (variable costing) $ 67,500 *Amounts given in footnote to annual income statement. They can also be derived from knowing what percent of manufacturing costs are variable last year and this year. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE b. Points to include in report to management: (1) Reconciliation of full-absorption operating profit to variable costing operating profit. Operating profit before tax: absorption costing $81,200 Add: fixed costs in beginning inventory ($22,000 x 55%) 12,100 Deduct: fixed costs in ending inventory ($86,000 x 30%) (25,800 ) Operating profit before tax: variable costing $67,500 (2) Operating profit using full-absorption costing is high (relative to variable costing) because fixed manufacturing costs are assigned both to goods sold and goods in inventory at the end of the period. Although some of the fixed manufacturing costs are deferred on the income statement, they are likely paid for with cash in the current period. 2.69 (50 min) Variable and absorption costing; incomplete records a. Comparative income statements. Variable Costing Sales $540,000 Less: Variable cost of goods sold 270,000 a Less: Variable selling and administrative costs –0– Contribution margin $270,000 Less: Fixed manufacturing costs 66,000 Less: Fixed selling and administrative costs 21,000 Operating profit $183,000 Absorption Costing Sales $540,000 Cost of goods sold 369,000 b Gross margin 171,000 Fixed selling and administrative costs 21,000 Operating profit $150,000 Calculations: aSales – contribution margin = $540,000 – $270,000 = $270,000 bSales – gross margin = $540,000 – $171,000 = $369,000 2.69 (continued) b. (1) Units sold = Variable cost of goods sold Variable manufacturing cost = $270,000 $3/unit = 90,000 units (2) Absorption cost per unit = $4.10 = $369,000 90,000 units Fixed cost per unit = $1.10 (= $4.10 – $3.00 variable costs) Difference in income = $33,000. Since variable costing operating profit is $33,000 higher than full-absorption costing, sales must have exceeded production by 30,000 units (where 30,000 = $33,000 / $1.10). Therefore, production was 60,000 units (90,000 – 30,000). Also, fixed manufacturing cost per unit = Fixed mfg. costs Units produced $1.10 = $66,000 Units produced Units produced = 60,000 units (3) The cost per unit for last year for variable costs is $3.00 per unit, and $4.10 per unit for full-absorption. c. See part (2) of requirement (b) above. We also reconcile by asking students what fixed manufacturing costs are expensed under each method: Variable: Fixed manufacturing costs expensed = $66,000 Absorption: From current period's production 60,000 units x $1.10 = 66,000 From beginning inventory 30,000 units x $1.10 = 33,000 Total = $99,000 Difference (excess of absorption costingexpenses over variable costing) $33,000 2.70 (25 min) Comparison of variable and absorption costing Tennessee Tool Corporation’s (TTC) reported 20x0 income will be higher under absorption costing because actual production exceeded actual sales. Therefore, inventory increased and some fixed costs will remain in inventory under absorption costing which would be expensed under variable costing. a. Beginning inventory (in units) 35,000 Actual production (in units) 130,000 Available for sale (in units) 165,000 Sales (in units) 125,000 Ending inventory (in units) 40,000 Budgeted manufacturing costs: Direct material $1,680,000 Direct labor 1,260,000 Variable manufacturing overhead 560,000 Fixed manufacturing overhead 700,000Total$4,200,000 == $30 per unit Value of ending inventory = quantity  cost per unit = 40,000 units  $30 per unit = $1,200,000 b. Budgeted variable manufacturing costs: Direct material $1,680,000 Direct labor 1,260,000 Variable manufacturing overhead560,000 Total $3,500,000 ==$25 per unit 2.70 (continued) Value of ending inventory = quantity  cost per unit = 40,000 units  $25 per unit = $1,000,000 c. Increase in inventory (in units) = production – sales = 130,000 units – 125,000 units = 5,000 units Budgeted fixed manufacturing overhead per unit ==$5 per unit Difference in reported income =budgeted fixed overhead per unit  change in inventory (in units) =$5  5,000 units = $25,000 d. If TTC had adopted a JIT program at the beginning of 20x0: (1) It is unlikely that TTC would have manufactured 5,000 more units than it sold. Under JIT, production and sales would be nearly equal. (2) Reported income under variable and absorption costing would most likely be nearly the same. Differences in reported income are caused by changes in inventory levels. Under JIT, inventory levels would be minimal. Therefore, the change in these levels would be minimal. 2.71 (45 min) Comparison of absorption and variable costing Absorption-costing income statements: Year 1 Year 2 Sales revenue $150,000 a $150,000 d Less: Cost of goods sold: Beginning finished-goods inventory $ 0 $10,500 e Cost of goods manufactured 63,000 b 56,000 f Cost of goods available for sale $63,000 $66,500 Ending finished-goods inventory 10,500 c0 Cost of goods sold $52,500 $66,500 Gross margin $97,500 $83,500 Selling and administrative expenses 45,000 45,000 Operating income $52,500 $38,500 a2,500 units  $60 per unit b$21,000 + $42,000 (i.e., both variable and fixed costs) c500 units  ($63,000/3,000 units) d2,500 units  $60 per unit eSame as year 1 ending inventory f$14,000 + $42,000 (i.e., both variable and fixed costs) EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.71 (continued) Variable-costing income statements: Year 1 Year 2 Sales revenue $150,000 a $150,000 d Less: Cost of goods sold: Beginning finished-goods inventory $ 0 $3,500 e Cost of goods manufactured 21,000 b 14,000 f Cost of goods available for sale $21,000 $17,500 Ending finished-goods inventory 3,500 c0 Cost of goods sold $17,500 $17,500 Less: Variable selling and administrative costs $25,000 $25,000 Total variable costs: $42,500 $42,500 Contribution margin $107,500 $107,500 Less: Fixed costs: Manufacturing $42,000 $42,000 Selling and administrative 20,000 20,000 Total fixed costs $62,000 $62,000 Operating income $45,500 $45,500 a2,500 units  $60 per unit bThe variable manufacturing cost only, $21,000 c500 units  ($21,000/3,000 units) d2,500 units  $60 per unit eSame as year 1 ending inventory fThe variable manufacturing cost only, $14,000 2.71 (continued) Reconciliation of reported income under absorption and variable costing: Year Change in Inventory (in units) Actual Fixed- Overhead Rate Difference in Fixed Overhead Expensed Absorption- Costing Income Minus Variable- Costing Income 1 500 increase  $14 $ 7,000$7,000 2 500 decrease  $14* $(7,000) (7,000) *The 500 units which were sold in year 2, but which were manufactured in year 1, include an absorption-costing product cost of $14 per unit for fixed overhead. Since these 500 units were manufactured in year 1, it is the year 1 fixed-overhead rate that is relevant to this calculation, not the year 2 rate. Explanation: At the end of year 1, under absorption costing, $7,000 of fixed overhead remained stored in finished-goods inventory as a product cost (year 1 fixed-overhead rate of $14 per unit  500 units = $7,000). However, in year 1, under variable costing, that fixed overhead was expensed as a period cost. In year 2, under absorption costing, that same $7,000 of fixed overhead was expensed when the units were sold. However, under variable costing, that $7,000 of fixed overhead cost had already been expensed in year 1 as a period cost. 2.71 (continued) d. Reconciliation of income by comparison of cost of goods sold and fixed manufacturing overhead under absorption and variable costing. Year 1 Absorption Variable Difference Cost of goods sold $52,500 $17,500 Fixed manufacturing overhead (period cost) 0 42,000 Total $52,500 59,500 $7,000 Expenses greater under variable costing Operating income $52,500 $45,500 $7,000 Operating income greater under absorption costing Year 2 Absorption Variable Difference Cost of goods sold $66,500 $17,500 Fixed manufacturing overhead (period cost) 0 42,000 Total $66,500 $59,500 $7,000 Expenses greater under absorption costing Operating income $38,500 $45,500 $7,000 Operating income greater under variable costing e. Total operating income across years 1 and 2 is $91,000 under both absorption and variable costing. This highlights the fact that the key difference between these two costing methods is the timing with which fixed manufacturing overhead costs are expensed. Since the company sold the same number of units that it produced, across the two years taken together, the same amount of fixed manufacturing overhead is expensed, across the two years taken together, under both absorption and variable costing. 2.72 (45 min) Comparison of costing methods A B C 1 Year 1 Year 2 2 Sales units 250,000 250,000 3 Production units 250,000 344,000 4 Selling price per unit $45 $45 5 Variable manufacturing cost per unit $24 $24 6 Annual committed manufacturing cost $860,000 $860,000 7 Variable selling and administrative costs per unit sold $2.40 $2.40 8 Committed selling and administrative costs $840,000 $840,000 9 Beginning inventory - - 10 Variable costing (formulas for column B) 11 Sales (B2*B4) $11,250,000 $11,250,000 12 Variable manufacturing cost (B2*B5) 6,000,000 6,000,000 13 Variable selling & admin cost (B2*B7) 600,000 600,000 14 Contribution margin (B11-SUM(B12:B13)) 4,650,000 4,650,000 15 Committed manufacturing (B6) 860,000 860,000 16 Committed selling & admin (B8) 840,000 840,000 17 Operating income (B14-SUM(B15:B16)) $ 2,950,000 $ 2,950,000 18 Absorption costing (formulas for column B) 19 Sales (B2*B4) $11,250,000 $11,250,000 20 Cost of goods sold 21 Variable manufacturing cost (B2*B5) 6,000,000 6,000,000 22 Committed manufacturing ((B6/B3)*B2) 860,000 625,000 23 Total cost of goods sold (B21+B22) 6,860,000 6,625,000 24 Gross margin (B19-B23) 4,390,000 4,625,000 25 Variable selling & admin (B2*B7) 600,000 600,000 26 Committed selling & admin (B8) 840,000 840,000 27 Operating income (B24 – SUM(B25:B26) $ 2,950,000 $ 3,185,000 28 Analysis of difference in income measures 29 Difference of absorption from variable costing (B27-B17) - $ 235,000 30 Units added to inventory (B3-B2) 0 94,000 31 Committed mfg. per unit (B6/B3) $3.44 $2.50 32 Committed mfg. added to inventory (B30*B31) $0 $ 235,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE Year 1 Year 2 Sales, units 2,50,000 2,50,000 Production, units 2,50,000 3,44,000 Sales price, per unit $ 45 $ 45 Annual committed manufacturing cost 8,60,000 8,60,000 Variable selling and administrative cost per unit 2.40 2.40 Annual committed selling and admin cost 8,40,000 8,40,000 Beginning inventory, units - - Ending inventory, units - 94,000 Variable manufacturing costs per unit $ 24.00 $ 24.00 Indirect manufacturing cost per unit 3.44 2.50 Absorption cost per unit $ 27.44 $ 26.50 a. Income statements, absorption cost Year 1 Year 2 Sales revenue $ 1,12,50,000 $ 1,12,50,000 Less: Cost of goods sold (at absorption cost) 68,60,000 66,25,000 Gross margin $ 43,90,000 $ 46,25,000 Less: Selling and administrative expenses Variable 6,00,000 6,00,000 Fixed 8,40,000 8,40,000 Operating income $ 29,50,000 $ 31,85,000 $ 61,35,000 b. Income statements, variable cost Year 1 Year 2 Sales revenue $ 1,12,50,000 $ 1,12,50,000 Less: Variable expenses: Variable manufacturing costs 60,00,000 60,00,000 Variable selling and administrative costs 6,00,000 6,00,000 Contribution margin $ 46,50,000 $ 46,50,000 Less: Fixed expenses: Fixed manufacturing overhead 8,60,000 8,60,000 Fixed selling and administrative expenses 8,40,000 8,40,000 Operating income $ 29,50,000 $ 29,50,000 $ 59,00,000 c. Reconciliatiion of Income Year 1 Year 2 Cost of goods sold under absorption costing $ 68,60,000 $ 66,25,000 Variable manufacturing costs under variable costing 60,00,000 60,00,000 Difference $ 8,60,000 $ 6,25,000 Fixed manufacturing overhead as a period expense under variable costing 8,60,000 8,60,000 Difference $ - $ (2,35,000) $ (2,35,000) Operating income under variable costing $ 29,50,000 $ 29,50,000 Operating income under absorption costing 29,50,000 31,85,000 Difference in operating income $ - $ (2,35,000) $ (2,35,000) 2.73 (45 min) Comparison of costing methods Sales price $15 Units sold 80,000 Units produced 100,000 Direct materials (unit-level cost) $240,000 Direct labor (unit-level cost) 160,000 Factory overhead (unit-level cost) 80,000 Factory overhead (capacity cost) 240,000 Selling and administrative (unit-level cost) 80,000 Selling and administrative (capacity cost) 128,000 a) Absorption cost per unit: Materials (unit-level) $ 2.40 = $240,000 / 100,000 Direct labor (unit-level) 1.60 = $160,000 / 100,000 Factory overhead (unit-level) 0.80 = $80,000 / 100,000 Factory overhead (capacity) 2.40 = $240,000 / 100,000 Total absorption cost $ 7.20 b) Variable product cost per unit: Materials (unit-level) $ 2.40 = $240,000 / 100,000 Direct labor (unit-level) 1.60 = $160,000 / 100,000 Factory overhead (unit-level) 0.80 = $80,000 / 100,000 Total variable product cost $ 4.80 c) Variable costing operating profit: Sales $1,200,000 = $15 x 80,000 Variable product cost 384,000 = $4.80 x 80,000 Variable selling cost 80,000 Contribution margin 736,000 Factory overhead 240,000 Selling & admin 128,000 Operating income $368,000 d) Absorption costing operating profit: Sales $1,200,000 = $15 x 80,000 Cost of goods sold 576,000 = $7.20 x 80,000 Gross margin 624,000 Selling & admin 208,000 Operating income $416,000 Difference from variable costing $ 48,000 e) Absorption cost ending inventory $ 144,000 = $7.20 x 20,000 f) Variable cost ending inventory 96,000 = $4.80 x 20,000 Difference $48,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 2.74 (35 min) Throughput costing, absorption costing, and variable costing a. Total cost: b. The cost of the year-end inventory of 400 units (10,000 units produced – 9,600 units sold) is computed as follows: c. The total costs would be allocated between the current period’s income statement and the year-end inventory on the balance sheet. Thus: (1) Absorption costing: $644,800 - $18,000 = $626,800 (2) Variable costing: $644,800 - $9,200 = $635,600 (3) Throughput costing: $644,800 - $4,800 = $640,000 2.74 (continued) Alternatively, these amounts can be derived as follows: d. Throughput-costing income statement: SOLUTIONS TO CASES 2.75 (40 min) Inventory turnover a. Department Cost of goods sold Average inventory Inventory turnover ratio Percent of warehouse space Average purchase days in advance of sale New textbooks……… $5,730,972 $840,475 6.82 25% 63 Used textbooks…….. 1,258,007 180,600 6.97 12% 37 Trade books…………. 563,686 370,500 1.52 10% 86 Supplies…………….. 662,560 251,700 2.63 8% 71 General merchandise 883,251 640,600 1.38 25% 94 Computers…………… 2,246,600 402,000 5.59 20% 28 Total store…………… $11,345,076 $2,685,875 4.22 100% 66.3 2.75 (continued) These ratios indicate that several departments (trade books, supplies, and general merchandise) are much less efficient in their use of inventory than others. There may be good reasons why the bookstore carries these slow moving items, but the manager should question why the store maintains so much of them when scarce space could be used for other items. Though the slow moving items perhaps appeal to a different market than textbooks and computers do, it does seem reasonable to compare ratios across departments and question why turnover is so different. b. By specializing in general merchandise, the private store can focus on being a narrow, but efficient operation. Perhaps the university bookstore is stretching its management effort too thin. Cost managers should urge their organizations to emulate best practices; in this case, the manager of the general merchandise department should study the more efficient private store to find ways to make his department more efficient. c. The bookstore has decentralized responsibility for managing inventories to department managers. Ordinarily this would be considered a good thing as long as the managers are motivated to work for the best interests of its constituents (students). Since students are not buying a number of items until or unless they are marked down to purchase cost, someone is making the implicit judgment that this way of managing the bookstore is better than stocking the store with items that students really want to buy. Since space is scarce, this seems at least potentially wasteful. Forty-three percent of the store’s warehouse space is devoted to items that sit for nearly a year. This space has an opportunity cost which may be forgone sales of more popular items or other uses of students’ space and rental fees. Buying items well in advance of sales also consumes cash (and or credit) that may be used for other purposes. The Student Council may wish to review the goals and objectives of the bookstore and ensure that they are being met. d. She would need to know alternative uses of the space and cash consumed by these slow moving items. Then she would have to estimate the net benefits of converting these resources to other uses. These net benefits include possibly lost sales of some fast-moving items that are bought because some students buy them on impulse when they came to buy general merchandise, etc. – this is probably a small effect. e. Wailua has a responsibility to take her concerns first to the general merchandise manager and then to the bookstore manager to seek an explanation. It would be unwise and improper to take her concerns first to the Student Council, but she may do so if she perceives an unwillingness to change unethical behavior (if indeed it is) or a desire to cover up these practices. It might be a good idea for her to look for another part-time job as well. Whistle-blowers may be right, but they often pay a price, too. 2.76 (40 min) Incentive for overproduction of inventory under absorption costing It is often asserted that absorption costing results in an incentive for managers to overproduce inventory, even during a period of slack demand, in order to boost profit. This scenario is just such an example. The year 1 and year 2 income statements presented in the text for Brassinni Company are prepared under absorption costing. While sales revenue, direct manufacturing costs, and selling and administrative costs are the same both years, income is dramatically higher in year 2. Why? The reason for the higher year 2 income is that Brassinni’s new president increased production from 10,000,000 units in year 1 to 30,000,000 units in year 2. Under absorption costing, 2/3 of the year 2 fixed manufacturing overhead of $48,000,000 will remain in the year 2 ending inventory rather than being expensed during year 2. In contrast, in year 1, the entire amount was expensed (even under absorption costing), because year 1 sales was equal to year 1 production. (We know that the entire $48,000,000 of manufacturing overhead is fixed, because it remained constant across the two years in spite of the significant change in production volume.) If the year 1 and year 2 income statements had been prepared under variable costing, the entire $48,000,000 of fixed manufacturing overhead would have been expensed as a period cost in both year 1 and year 2. Thus, under variable costing, the operating loss for each year would have been $(18,000,000), calculated as follows: What has happened in this company? Brassinni’s new president, taking advantage of the company’s absorption-costing system, increased production from 10,000,000 units to 30,000,000 units for the sole purpose of showing a large operating income and earning a large bonus in year 2. After year 2, the president left the company. During some future period(s), the remaining $32,000,000 (2/3 x $48,000,000) of year 2 fixed manufacturing overhead will eventually be expensed, and Brassinni will very likely once again be in a loss position. Meanwhile, the president has moved on, because he “enjoys challenges.” 2.77 (45 min) Absorption and variable costing; import decisions The key to this problem is to realize that the purchase and duty costs for the lot of 1,000 dresses are committed, even though one might normally think that these costs vary with the number of dresses. It is necessary to acquire the full 1,000 dresses even though only a fraction of the lot will be sold. In this situation, neither full-absorption nor variable costing gives a totally satisfactory answer. Part “d” of the case calls for development of a method that will relate costs and revenues better than either full-absorption or variable costing even though the method may not be suitable for external reporting purposes. 2.77 (continued) d. One alternative considers the inventoriable cost of the dresses to be zero and charges the full $30,000 to the first period since it is a direct, commited cost of the decision to import. This generates a loss in the first period as follows: This solution is not much better than the previous one. Another alternative would be to relate the $30,000 cost to the revenue expected from the dresses that are expected to be sold. The inventory value would not be a standard one, but it would tend to match the expected dollars revenue with the costs of the lot of dresses. Provision could also be made for the expected disposal costs. Thus, the company could consider that it incurred $30,900 in costs to obtain the following revenues: 2.77 (continued) For each dollar of revenue, 74.91 cents would be deducted to cover the cost of the dresses and the disposal costs. Each period’s operating profits would appear as follows: Solution Manual for Cost Management: Strategies for Business Decisions Ronald W. Hilton, Michael W. Maher, Frank H. Selto 9780073526805, 9780072430332, 9780072830088, 9780072299021, 9780072881820, 9780072882551, 9780070874664, 9780072388404, 9780072343533