SMCH 13

CHAPTER 13
STANDARD COSTING AND VARIABLE COSTING

13-1 JIT and Costing Methods
Throughput costing is most compatible because it penalizes production
in excess of sales. Variable costing does not penalize excess production,
while absorption costing actually rewards overproduction.
Throughput costing expenses everything except material cost as those
costs are incurred. It expenses material costs when material goes into
production. Thus, starting to make something gives rise to expense, which
encourages managers to produce only when they can sell the product.
Absorption costing rewards high production because it capitalizes fixed
production costs in inventory, thus postponing their appearance in the income
statement until products are sold.
13-2 Use of Costing Methods
The construction company is least likely to use standard costs because
it does not make standard products. Such a company could, and probably does,
budget costs for major projects, but these are not standards. An automaker
uses standard costs both for control and because it could not possibly use
actual or normal process costing because of product diversity. Job order
costing would be prohibitively costly. A processor of flour could use actual
or normal costing, but would benefit from the control uses of standards.
13-3 Product Cost--Period Cost
Classifying a cost as either product or period tells little about the
cost itself but rather describes how we treat it for reporting purposes.
Identifying a cost as a product cost results in its being reported as an
expense in the period in which the product is sold. Identifying a cost as a
period cost results in its being reported as an expense in the period in
which it is incurred. The distinction between period and product costs has
no relevance to decision making except, perhaps, in connection with capital
budgeting decisions where the period of expense reporting for tax purposes is
relevant to the determination of future cash flows.
13-4 Costing Methods and Zero Inventories
All three methods will give the same results. Total expenses will
equal total costs incurred, including purchases of materials and components.
13-5 Costing Methods and Cash Flows
Throughput costing will probably be the closest because the flow of
costs parallels their incurrence. Absorption costing will have the least
close relationship to cash flow.
13-1
13-6 Fundamentals of Absorption and Variable Costing (15 minutes)
1.
Sales, 18,000 x $50 $900,000
Standard cost of sales, 18,000 x $30 540,000
Standard gross margin 360,000
Selling and administrative expenses 300,000
Income $ 60,000
2.
Sales, $900,000
Standard variable cost of sales, 18,000 x $10 180,000
Standard gross margin, contribution margin 720,000
Fixed costs, $400,000 + $300,000 700,000
Income $ 20,000
The cost of sales sections of the income statement focus attention on
inventories.
Absorption Variable
Beginning inventory $ 0 $ 0
Variable production costs 200,000 200,000
Fixed production costs 400,000 0
Total available 600,000 200,000
Ending inventory, 2,000 units at $30, $10 60,000 20,000
Cost of sales $540,000 $180,000
Because actual production equalled the level used to set the standard, there
is no volume variance. You might ask how much income the company should earn
per month if it continues to sell 18,000 units. The answer is $20,000,
because the company cannot indefinitely make 2,000 units more than it sells.
13-7 Fundamentals of Absorption and Variable Costing (15 minutes)
1.
Sales, 22,000 x $50 $1,100,000
Income $ 140,000
2.
Sales, 22,000 x $50 $1,100,000
Standard gross margin, contribution margin 880,000
Fixed costs, $400,000 + $300,000 700,000
Income $ 180,000
The cost of sales sections of the income statement again focus attention on
inventories.
Absorption Variable
Beginning inventory, 13-5 $ 60,000 $ 20,000
Fixed production costs 400,000 0
Ending inventory 0 0
Cost of sales $660,000 $220,000
13-2
Because actual production again equalled the level used to set the standard,
there is no volume variance.
13-8 Basic Standard Costing--Absorption and Variable (25 minutes)
Income Statements--Variable Costing
March April
Sales at $7 per case $700,000 $700,000
Cost of sales:
Beginning inventory:
30,000 x $3 90,000
Production costs:
130,000 x $3 390,000
90,000 x $3 ____ ___ 270,000
Total 390,000 360,000
Ending inventory:
30,000 x $3 90,000
20,000 x $3 ________ 60,000
Variable cost of sales 300,000 300,000
Contribution margin 400,000 400,000
Fixed costs:
Production 300,000 300,000
Selling and administrative 60,000 60,000
Total fixed costs 360,000 360,000
Income $ 40,000 $ 40,000
Income Statements--Absorption Costing
March April
Sales, at $7 per case $700,000 $700,000
Cost of sales:
Beginning inventory:
30,000 x ($3 + $2)* 150,000
Production costs applied:
Variable--130,000 x $3 390,000
-- 90,000 x $3 270,000
Fixed costs applied:
130,000 x $2 260,000
90,000 x $2 ________ 180,000
Total 650,000 600,000
Ending inventory:
30,000 x $5 150,000
20,000 x $5 ________ 100,000
Standard cost of sales at $5 500,000 500,000
Volume variance:
$300,000 - $260,000 40,000 U
$300,000 - $180,000 ________ 120,000 U
Actual cost of sales 540,000 620,000
Gross margin 160,000 80,000
Income $100,000 $ 20,000
* Standard fixed overhead per unit is $2 ($300,000 total fixed manufacturing
cost divided by 150,000 units at practical capacity).
2. B&Y should earn about $40,000 per month, the variable costing income.
Absorption costing income depends on production, which over time must
13-3
approximate sales. As inventories stabilize, income will approach $40,000,
the variable costing equilibrium amount.
This answer does not rely on the company's using absorption costing or
variable costing. In the long run, any method will give the same result.
(You might want to point out that variable costing is not acceptable for tax
purposes, so income differences cannot rise from investing tax savings, as
can happen with LIFO.)
Note to the Instructor: You can do this exercise without the details of
the cost of sales section, as shown below. The cost of sales section can be
used to show how the costs flow and why incomes turn out the way they do, but
it is not necessary.
Income Statements--Variable Costing
March April
Sales, at $7 per case $700,000 $700,000
Variable cost of sales at $3 300,000 300,000
Fixed costs:
Production 300,000 300,000
Total fixed costs 360,000 360,000
Income $ 40,000 $ 40,000
Income Statements--Absorption Costing
March April
Sales, at $7 per case $700,000 $700,000
Volume variance:
$300,000 - $260,000 40,000 U
$300,000 - $180,000 _________ 120,000 U
Actual cost of sales 540,000 620,000
Gross margin 160,000 80,000
Income $100,000 $ 20,000
Note to the Instructor: Because this exercise is quite straightforward
and uncomplicated by variances for variable costs, it provides a basis for
drawing attention to the essential differences between variable and
absorption costing. You may, for example, wish to ask the students if they
can explain the differences between the incomes under the two methods. The
explanation might proceed as follows:
Explanation of the differences in income in the two months
March April
Differences to be explained:
Income under variable costing $ 40,000 $ 40,000
Income under absorption costing 100,000 20,000
Difference to be explained:
Variable costing income smaller $ 60,000
Variable costing income larger $ 20,000
Prior month's fixed costs deferred to
current month by inclusion in the
beginning inventory:
30,000 x $2 0 60,000
Current month's fixed costs deferred to
the next month by inclusion in the
ending inventory:
30,000 x $2 60,000
13-4
20,000 x $2 40,000
Difference in income due to fixed ________ ________
costs in inventory $ 60,000 $ 20,000
13-9 Actual Costing Income Statements (15-20 minutes)
1.
January February
Sales, 18,000 x $30, 22,000 x $30 $540,000 $660,000
Cost of sales:
Beginning inventory 0 40,000
Production costs:
Variable, 20,000 x $10 200,000 200,000
Fixed 200,000 200,000
Total available for sale 400,000 440,000
Less ending inventory* 40,000 0
Cost of sales 360,000 440,000
Gross margin 180,000 220,000
Selling and administrative expenses 40,000 40,000
Income $140,000 $180,000
Inventory, $400,000/20,000 = $20 per unit, times 2,000 units = $40,000.
There is no inventory at the end of February, so no calculation is needed.
2.
January February
Sales, 18,000 x $30, 22,000 x $30 $540,000 $660,000
Cost of sales, variable costs at $10/unit 180,000 220,000
Contribution margin at $20 360,000 440,000
Fixed costs, $200,000 + $40,000 240,000 240,000
Income $120,000 $200,000
The cost of goods sold sections under variable costing appear below.
January February
Beginning inventory $ 0 20,000
Variable production costs, 20,000 x $10 200,000 200,000
Total available for sale 200,000 220,000
Less ending inventory, 2,000 x $10 20,000 0
Cost of sales $180,000 $220,000
3.
January February
Sales, 18,000 x $30, 22,000 x $30 $540,000 $660,000
Cost of sales, material cost at $6 x production 120,000 120,000
Throughput 420,000 540,000
Other costs, $80,000 + $200,000 + $40,000 320,000 320,000
Income $100,000 $220,000

13-10 Standard Fixed Cost and Volume Variance (15 minutes)
1. (a) (b)
Normal Practical
Budgeted fixed manufacturing costs $900,000 $900,000
Divided by capacity measure 225,000 300,000
Equals standard fixed cost per unit $4 $3
13-5
2. (a) (b)
Standard fixed cost per unit $4 $3
Times number of units produced 240,000 240,000
Fixed overhead applied to production $960,000 $720,000
Less budgeted fixed overhead 900,000 900,000
Volume variance (unfavorable) $ 60,000 ($180,000)
Alternatively, the calculations could be made using the differences
between actual production and the volume used to set the standard fixed cost.
Volume Used to Actual Standard Volume
Set Standard Production Difference x Fixed Cost = Variance
(a) 225,000 240,000 (15,000) x $4 $ 60,000 F
(b) 300,000 240,000 60,000 x $3 180,000 U
13-11 Relationships (20-25 minutes)

1. (a) $10 per unit $10,000 favorable variance/1,000 units above normal
production
(b) $200,000 20,000 units x $10
2. (b) $60,000 20,000 units x $3
(c) 17,000 units $9,000 unfavorable variance/$3 per unit = 3,000 units
below normal of 20,000
3. (a) $2 per unit $40,000/20,000
(d) $4,000 unfavorable (20,000 - 18,000) x $2
4. (a) $7 per unit $140,000/20,000
(c) 22,000 units $14,000 favorable variance/$7 per unit = 2,000 units
more than normal of 20,000
13-12 Effects of Changes in Production--Standard Variable Costing (15
minutes)
Production
40,000 units 41,000 units
Sales (40,000 x $10) $400,000 $400,000
Variable cost of goods sold:
Variable production costs
40,000 x $3 $120,000
41,000 x $3 $123,000
Ending inventory
0 x $3 0
1,000 x $3 3,000
Variable cost of goods sold
40,000 x $3 120,000 120,000
Fixed production costs 200,000 200,000
Income $ 80,000 $ 80,000
13-6
Note to the Instructor: We asked for income statements for both levels
of production to allow you to highlight how increases in variable cost
occurring because of increases in production are deferred in inventory,
therefore having no effect on income. Most students should see that income
will be the same no matter what production is. You might therefore reiterate
that income can be computed as we did as early as Chapter 2.
Sales - variable costs - fixed costs = income
(40,000 x $10) - (40,000 x $3) - $200,000 = $80,000
13-13 Effects of Changes in Production--Standard Absorption Costing (15-20
minutes)
Production
40,000 units 41,000 units
Sales (40,000 x $10) $400,000 $400,000
Cost of goods sold:
Variable production costs $120,000 $123,000
Applied fixed production costs
40,000 x $5 200,000
41,000 x $5 ________ 205,000
Cost of goods available for sale 320,000 328,000
Ending inventory
0 x $8 0
1,000 x $8 ________ 8,000
Cost of goods sold (40,000 x $8) 320,000 320,000
Standard gross profit (40,000 x $2) 80,000 80,000
Volume variance, favorable (1,000 x $5) 0 5,000
Income $ 80,000 $ 85,000
Note to the Instructor: We asked for details of the cost of sales
section so that you can show how increases in production lead to increases in
applied fixed costs with a corresponding increase in ending inventory and a
more favorable (or less unfavorable) volume variance. The 1,000 unit
increase in production leads to an increase in the fixed costs in inventory
of $5,000, which is also the increase in income.
13-14 "Now Wait a Minute Here." (20 minutes)
This assignment shows the relationships of income to sales and
production.
Sales 10,000 Sales 10,000 Sales 10,001 Sales 9,999
Prod. 10,000 Prod. 10,001 Prod. 10,001 Prod. 10,001

Sales at $10 $100,000 $100,000 $100,010 $99,990
Cost of sales at $7 70,000 70,000 70,007 69,993
Standard gross margin 30,000 30,000 30,003 29,997
Volume variance 0 6F 6F 6F
Actual gross margin $ 30,000 $ 30,006 $ 30,009 $30,003
The highest profit is with sales and production at 10,001, but the
lowest is with sales and production at 10,000. Sales of 9,999 with
production of 10,001 gives a higher profit than sales of 10,000 with
production of 10,000. Sales of 10,000 with production of 10,001 gives the
second best profit. In other words, production increases income more than
does sales. The company increases its profit by $6 for each additional unit
it produces, while selling an additional unit gains $3 ($10 - $7), and
producing and selling another unit gains $9, the $6 for producing and the $3
for selling.
13-7
13-15 All Fixed Cost Company (25-30 minutes)
This problem shows the effects on both income and the balance sheet of
the two costing methods. The reconciling factor between incomes in both
years is the $80,000 absorption costing inventory, increase in 20X2, decrease
in 20X3.
1. 20X2 20X3
Sales, 120,000 x $6 $720,000 $720,000
Cost of sales:
Beginning inventory $ 0 $120,000
Costs applied at $4 600,000 360,000
Ending inventory at $4 120,000 0
Standard gross margin 240,000 240,000
Volume variance 100,000F
140,000U
Actual gross margin and profit $340,000 $100,000
Volume variances are $600,000 - $500,000 and $360,000 - $500,000.
2. Balance sheets
20X2 20X3
Cash = cumulative sales $ 720,000 $1,440,000
Inventory, 30,000 x $4 120,000 0
Plant, net 2,000,000 1,500,000
Total assets $2,840,000 $2,940,000
Stockholders' equity ($2,500,000 + $340,000) $2,840,000
($2,840,000 + $100,000) $2,940,000
3.
Sales $720,000 $720,000
Fixed costs 500,000 500,000
Profit $220,000 $220,000
Balance sheets
Cash = cumulative sales $ 720,000 $1,440,000
Plant, net 2,000,000 1,500,000
Total assets $2,720,000 $2,940,000
Stockholders' equity ($2,500,000 + $220,000) $2,720,000
($2,720,000 + $220,000) $2,940,000
13-16 Basic Absorption Costing (15-20 minutes)
April
Sales, 9,000 x $100 $900,000
Standard gross margin, 9,000 x $35 315,000
Volume variance* 80,000 F
Actual gross margin 395,000
Profit $ 115,000
*
13-8
Actual production 12,000
Normal activity 10,000
Difference 2,000
Standard fixed cost $40
Volume variance, favorable $80,000
An expanded cost of goods sold section appears as follows.
Beginning inventory $ 0
Variable production costs, 12,000 x $25 300,000
Fixed production costs, 12,000 x $40 480,000
Total, 12,000 x $65 780,000
Less ending inventory, 3,000 x $65 195,000
Standard cost of sales, 9,000 x $65 $ 585,000
Note that the volume variance is also the difference between applied
fixed overhead of $480,000 and budgeted fixed overhead of $400,000.
May
Sales, 11,000 x $100 $1,100,000
Volume variance* 40,000 U
Profit $ 65,000
*
Difference 1,000
Volume variance, unfavorable $40,000
Beginning inventory, 3,000 x $65 $ 195,000
Available for sale, 12,000 x $65 780,000
Note to the Instructor: You might wish to point out that profit dropped
by $50,000, while sales increased 22.1% (from 9,000 to 11,000 units). You
might remind students that Chapter 2 showed how income increases more rapidly
than sales when a company has fixed costs. A manager looking at these
statements must wonder why the increase in income lagged that of sales when
the cost structure remained the same. The next exercise in this series
allows you to show how variable costing alleviates this problem.
13-17 Basic Variable Costing (Continuation of 13-16) (15-20 minutes)
1.
April
Sales, 9,000 x $100 $ 900,000
Contribution margin, 9,000 x $75 675,000
Fixed costs:
Manufacturing $400,000
Selling and administrative 280,000
13-9
Total fixed costs 680,000
Loss ($ 5,000)
An expanded cost of goods sold section shows
Less ending inventory 3,000 x $25 75,000
Standard cost of sales 9,000 x $25 $ 225,000
May
Sales, 11,000 x $100 $1,100,000
Fixed costs:
Profit $ 145,000
An expanded cost of goods sold section shows
Total, 12,000 x $25 300,000
2. Jasper should earn about $145,000 per month, the variable costing income.
Absorption costing income does not reflect long-run earning power when
production and sales differ. Over the long-run, sales and production would
have to approximate one another, bringing total income to the variable
costing equilibrium amount.
Note to the Instructor: In connection with the previous exercise, you
might wish to show how income is affected under the two costing methods.
Using variable costing, we see the following.
Loss at 9,000 units ($ 5,000)
Contribution margin on 2,000 units at $75 150,000
Income at 11,000 units $145,000
Income under absorption costing is more complicated. Both sales and
production affect results. The following analysis might be useful.
Income at 9,000 units $115,000
Less inventory effect, (12,000 - 9,000) x $40 120,000
Loss at 9,000 units if production equals sales ($ 5,000)
Income at 11,000 units $ 65,000
Plus inventory effect, (11,000 - 9,000) x $40 80,000
Income if production equals sales $145,000
13-18 Throughput Costing (Continuation of 13-16) (15 minutes)
Cost of sales is now the cost of materials used in production, and all other
costs are expensed. Material cost is $15 per unit, so direct labor and
variable overhead are $10 ($25 - $15).
April
Sales, 9,000 x $100 $ 900,000
Cost of sales, 12,000 x $15 180,000
13-10
Margin 720,000
Operating expenses:
Direct labor and variable overhead, 12,000 x $10 $120,000
Fixed manufacturing 400,000
Loss ($ 80,000)
May
Sales, 11,000 x $100 $1,100,000
Margin 965,000
Operating expenses:
Direct labor and variable overhead, 9,000 x $10 $ 90,000
Manufacturing 400,000
Profit $ 195,000
The differences among the three methods are, as always, differences in
inventories. The table below summarizes the differences. Absorption and
variable costing treat only one element, fixed production costs, differently.
Throughput costing treats all elements differently from the other two methods
except that variable costing also expenses fixed production costs as
incurred.

Other Variable Fixed
Materials Production Costs Production Costs
Absorption costing X X X
Variable costing X X Y
Throughput costing Z Y Y
X = treat as product cost, Y = expense as incurred, Z = expense as used in
production
13-19 Effect of Measure of Activity (Continuation of 13-16) (15-20
minutes)
Standard fixed cost is $16 per unit, $400,000/25,000, and total standard
cost is $41.
April
Sales, 9,000 x $100 $ 900,000
Profit $ 123,000
* Actual production 12,000
Practical capacity 20,000
Difference ( 8,000)
Volume variance, unfavorable ($128,000)
13-11
Total, 12,000 x $41 492,000
May
Sales, 11,000 x $100 $1,100,000
Volume variance* ( 176,000)U
Profit $ 193,000
*
Practical capacity 20,000
Difference (11,000)
Volume variance, unfavorable ($176,000)
Available for sale, 12,000 x $41 492,000

The differences are in the standard costs, affecting both inventory and
cost of goods sold. Using practical capacity gives a lower standard cost of
sales because the standard cost is lower, but it gives higher (more
unfavorable) volume variances because the basis for setting the standard is
higher. Income was higher in April, and lower in May, than when the company
used normal capacity. If production exceeds sales, income will be higher for
the method that has the higher unit cost, and vice versa. This relationship
works the same as that between variable costing and absorption costing, and
for the same reason.
13-20 Absorption Costing (15-20 minutes)
Note to the Instructor: This problem and its sequel include variable
cost variances, a fixed overhead budget variance, and a volume variance.
1.
Sales, 90,000 x $400 $36,000,000
Standard cost of sales, 90,000 x $250 22,500,000
Standard gross margin, 90,000 x $150 13,500,000
Volume variance* $600,000 U
Fixed overhead spending variance* 130,000 F
Variable cost variances** 50,000 F 420,000 U
Actual gross margin 13,080,000
Selling and administrative expenses 10,550,000
Profit $ 2,530,000
*
Actual Fixed Overhead Budgeted Fixed Overhead Applied Fixed
Overhead 96,000 x
$150
$14,870,000 $15,000,000 $14,400,000
$130,000 F $600,000 U
Budget variance Volume variance
13-12
**
Actual Variable Cost Standard Variable Cost
96,000 x $100
$9,550,000 $9,600,000
$50,000 F
Variable overhead variances
We cannot determine how much of the variable cost variance relates to
spending and how much to efficiency.
Variable production costs, 96,000 x $100 9,600,000
Fixed production costs, 96,000 x $150 14,400,000
Total, 96,000 x $250 24,000,000
Less ending inventory, 6,000 x $250 1,500,000
Standard cost of sales, 90,000 x $250 $22,500,000
13-21 Variable Costing (15-20 minutes)
Note to the Instructor: You might wish to ignore the fixed overhead
budget variance. We showed it because it is an economic variance. Moreover,
students tend to forget that companies using variable costing still plan and
control fixed costs.
1.
Sales, 90,000 x $400 $36,000,000
Standard variable manufacturing margin, 90,000 x $300 27,000,000
Variable cost variances 50,000 F
Variable manufacturing margin 27,050,000
Fixed costs:
Budgeted manufacturing costs $15,000,000
Budget variance 130,000 F
Selling and administrative 10,550,000
Total fixed costs 25,420,000
Profit $ 1,630,000
Variable production costs, 96,000 x $100 9,600,000
The difference in incomes between this and the previous exercise is the
$900,000 fixed costs in the ending inventory (6,000 x $150).
13-22 Interpreting Results (15 minutes)
1. February, 35,000 units; March, 16,000 units
February March
Volume variance = $6 x difference between actual $60,000 F $54,000 U
production and 25,000 units
Divided by $6 equals difference between actual
production and 25,000 units (under) 10,000 (9,000)
13-13
Normal capacity 25,000 25,000
Production 35,000 16,000
2. The results that the president believes strange occur because absorption
costing defers fixed production costs in inventory, so that in periods of
high production, profit will be higher than in periods of low production,
sales being the same (or even, as here, with higher sales in the low
production period).
It is not the volume variance per se that causes the results, as
students often think. Rather, it is the deferral of fixed costs in
inventory.
3. Income statements using variable costing
February March
Sales $480,000 $680,000
Variable cost of sales 48,000 68,000
Fixed costs 270,000 270,000
Income $162,000 $342,000
Variable cost of sales: Unit volumes = 24,000 and 34,000, from revenue/$20
selling price. We can use either month to find standard variable cost of
sales, in several ways. Perhaps the most obvious is
February standard cost of sales $192,000
Divided by February sales 24,000
Standard cost of sales $8
Less standard fixed cost of $6 = standard variable cost $2
Fixed costs = $120,000 selling and administrative plus $150,000 fixed
production costs (25,000 x $6).
The variable costing income statements present the picture much better.
Profits rose by $180,000 ($342,000 - $162,000), accompanying a 10,000 unit
sales increase. Contribution margin is $18 per unit, $20 - $2.

13-23 Income Determination--Absorption Costing (20-25 minutes)
Standard cost calculations:

Standard fixed cost per unit:
Fixed production costs $960,000
Production basis 80,000 = $12 per unit
Standard fixed cost per unit:
Production basis 120,000 = $8 per unit

With the $8 standard variable cost ($880,000/110,000), the total standard
costs are $20 and $16.
80,000-unit 120,000-unit
Basis Basis
Sales, 90,000 units $2,700,000 $2,700,000
Standard cost of sales 1,800,000 1,440,000
Volume variance:
$960,000 - $1,320,000 360,000 F
13-14
$960,000 - $880,000 __________ 80,000 U
Actual cost of goods sold 1,440,000 1,520,000
Gross profit 1,260,000 1,180,000
Selling and administrative costs 250,000 250,000
Income $1,010,000 $ 930,000
An expanded cost of sales section shows the following.
Production costs:
Variable (110,000 x $8) $ 880,000 $ 880,000
Fixed:
110,000 x $12 1,320,000
110,000 x $8 __________ 880,000
Total 2,200,000 1,760,000
Less ending inventory:
20,000 x $20 400,000
20,000 x $16 320,000
Standard cost of sales $1,800,000 $1,440,000
Note to the Instructor: You might wish to show that the $80,000
difference between the two incomes is the $4 difference in standard fixed
cost multiplied by the 20,000 unit change in inventory.
13-24 Income Determination--Variable Costing (Continuation of 13-23) (15-20
minutes)
Sales $2,700,000
Cost of goods sold:
Variable production costs (110,000 x $8) $880,000
Less ending inventory (20,000 x $8) 160,000
Standard cost of sales 720,000
Standard variable manufacturing margin 1,980,000
Fixed costs:
Production $960,000
Selling and administrative 250,000 1,210,000
Income $ 770,000
Note to the Instructor: You might wish to show that the difference
between income here and in the previous exercise is the fixed costs in
inventory.
80,000-unit basis 120,000-unit basis
Fixed costs in ending inventory:
20,000 x $12 $ 240,000
20,000 x $8 $160,000
Add variable costing income 770,000 770,000
Absorption costing income $1,010,000 $930,000
13-25 Relationships (15-20 minutes)
1. (c) $240,000
Sales (80,000 x $10) $800,000
Variable cost of goods sold (80,000 x $4) 320,000
Contribution margin, variable costing ($10 - $4) 480,000
Fixed costs 240,000
Income, variable costing $240,000
(b) 70,000 units
Income under variable costing (part c) $240,000
Income under absorption costing (given) 210,000
13-15
Difference in income, absorption costing lower $ 30,000
Divided by per-unit fixed cost used under
absorption costing ($240,000/80,000) $3
Equals change in inventory 10,000 units
Because absorption costing income is lower, the inventory change is negative
(inventory declines), so that production must have been 10,000 units lower
than sales.
2. (a) 50,000 units
Income under variable costing $ 60,000
Add fixed costs 240,000
Equals contribution margin $300,000
Divided by contribution margin per unit $6
Equals sales, in units 50,000
(b) 70,000 units
Income under absorption costing $120,000
Less income under variable costing 60,000
Equals income difference due to inventory change,
absorption costing higher $ 60,000
Divided by per-unit fixed cost, absorption $3
Equals inventory change 20,000 units
Because absorption costing income is higher, the inventory change is positive
(inventory increases), so that production must have been 20,000 units higher
than sales.
3. (c) $120,000
Total contribution margin [60,000 x ($10 - $4)] $360,000
Less fixed costs 240,000
Income, variable costing $120,000
(d) $105,000
Income under variable costing $120,000
Inventory change (60,000 - 55,000) 5,000
Times fixed cost per unit $3
Equals the difference between income under
variable and under absorption costing 15,000
Absorption costing income $105,000
(The difference is subtracted because absorption costing income is lower than
variable costing income when inventory decreases, which is the case here.)
Note to the Instructor: Some students have great difficulty with all or
parts of this assignment, but those who understand the two costing methods
and the relationships among sales, production, and income should be able to
complete the problem successfully with little difficulty. A critical step is
to recognize that the difference between incomes under the two costing
methods will relate to changes in inventory and, more specifically, to the
change in fixed costs in inventory. Hence, an important first calculation is
the $3 per-unit fixed cost.
We have found that students who attack the assignment methodically have
taken one of two approaches. One group expresses income under each method in
formula fashion, to see the relationships. Thus,
13-16
Income, variable = (unit sales x unit contribution margin) - fixed costs
costing
= (unit sales x ($10 - $4) - $240,000
Income, absorption = variable costing income +/- (inventory change x
costing per-unit fixed cost)
= variable costing income +/- (inventory change
x $3)
The second group, perhaps less inventive but with an understanding of the
calculation of the volume variance, will work toward the answers by filling
in the details of income statements reflecting each method.
13-26 All-Fixed Company (20 minutes)
1. Absorption costing
May June July
Unit sales 9,000 10,000 11,000
Unit production 11,000 10,000 9,000
Sales at $5 $45,000 $50,000 $55,000
Beginning inventory 0 4,000 4,000
Applied fixed costs at $2 22,000 20,000 18,000
Available for sale 22,000 24,000 22,000
Less ending inventory at $2 4,000 4,000 0
Standard cost of sales at $2 18,000 20,000 22,000
Standard gross margin at $3 27,000 30,000 33,000
Volume variance* 2,000 F 0 2,000 U
Profit $29,000 $30,000 $31,000
* $20,000 - applied fixed production costs or ([actual units - 10,000] x
$2).
Note to the Instructor: This exercise highlights the differences
between absorption costing and variable costing. In the required format,
with simple numbers, it is easy to see several important relationships.
Applied fixed production costs and the volume variance add up to $20,000,
budgeted fixed costs. That is, all fixed costs go through the calculation of
income, with the amounts deferred in inventory (beginning and ending) being
the difference between absorption costing and variable costing. Thus, the
difference in income in the first month will be $4,000 (absorption over
variable), zero in the second month because there is no change in
inventories, and $4,000 in the third month (variable over absorption). It is
also worth noting that total expenses on the income statement equal standard
cost of sales plus/minus the volume variance, $16,000 ($18,000 - $2,000) in
May, $20,000 in June, and $24,000 ($22,000 + $2,000) in July.
2. Variable costing
May June July
Sales at $5 $45,000 $50,000 $55,000
Fixed costs 20,000 20,000 20,000
Profit $25,000 $30,000 $35,000
Because there are no variable costs, profit is simply sales - $20,000.
13-27 Standard Costing--Absorption and Variable (20-30 minutes)
1. $32 $15 + $6 + $11 Variable overhead = $2 x 0.50 = $1. Fixed
overhead = $500,000/50,000 = $10, or ($500,000/25,000 DLH) x 0.50 DLH per
13-17
unit of product. Total standard variable production costs are $22.
2.
Sales (40,000 x $40) $1,600,000
Standard cost of sales:
Applied variable production costs (45,000 x $22) $ 990,000
Applied fixed production costs (45,000 x $10) 450,000
Available for sale (45,000 x $32) 1,440,000
Ending inventory (5,000 x $32) 160,000
Standard cost of sales (40,000 x $32) 1,280,000
Standard gross margin [40,000 x ($40 - $32)] 320,000
Volume variance [(45,000 - 50,000) x $10] 50,000U
Income $ 70,000
3.
Sales (40,000 x $40) $1,600,000
Standard variable cost of sales:
Applied variable production costs (45,000 x $22) $990,000
Standard variable cost of sales (40,000 x $22) 880,000
Standard variable gross margin [40,000 x ($40 - $22)] 720,000
Income $ 20,000
Alternatively, income is simply [40,000 x ($40 - $22)] - $700,000 = $720,000
- $700,000 = $20,000.
13-28 Absorption Costing and Variable Costing (20-25 minutes)
1. $40, $600,000/15,000
2. Income statement
Sales, 14,000 x $90 $1,260,000
Profit $ 230,000
*
Difference 1,000
Standard fixed cost (requirement 1) $40
An expanded cost of goods sold section follows.
13-18
Total available, 19,000 x $65 1,235,000
3. Income statement, variable costing
Sales, 14,000 x $90 $1,260,000
Fixed costs:
Profit $ 150,000
Total available, 19,000 x $25 475,000
Standard cost of sales, 14,000 x $25 $350,000
13-29 Absorption Costing and Variable Costing--Variances (15-20 minutes)
1. $3 per unit, $900,000/300,000; total standard cost is $9, $3 + $6
2.
Actual Fixed Overhead Budgeted Fixed Overhead Applied Fixed
Overhead
$3 x 290,000
$910,000 $900,000 $870,000
$10,000 U $30,000 U
Budget variance Volume variance
$40,000 U
Total fixed overhead variances
Total actual variable costs $1,715,000
Total standard variable costs (290,000 x $6) 1,740,000
Variable cost variances 25,000 F
Fixed overhead variances 40,000 U
Total variances $ 15,000 U
3.
Sales (270,000 x $20) $5,400,000
Standard cost of sales (270,000 x $9) $2,430,000
Variances 15,000 U
Cost of sales 2,445,000
Gross margin 2,955,000
Income $2,155,000
4.
Sales (270,000 x $20) $5,400,000
Standard cost of sales (270,000 x $6) $1,620,000
Variable cost variances 25,000 F 1,595,000
13-19
Gross margin and contribution margin 3,805,000
Fixed costs ($800,000 + $910,000) 1,710,000
Income $2,095,000
13-30 Budgeted Income Statements (20 minutes)
1. Absorption costing income statement
Sales, 37,000 x $70 $2,590,000
Selling and administrative expenses:
Variable, 37,000 x $8 $296,000
Fixed 600,000 896,000
Profit $ 189,000
* Budgeted production 39,000
Difference 1,000
Variable production costs, 39,000 x $15 $ 585,000
Sales, 37,000 x $70 $2,590,000
Variable manufacturing margin, 37,000 x $55 2,035,000
Variable selling and
administrative expenses, 37,000 x $8 296,000
Contribution margin, 37,000 x $47* 1,739,000
Fixed costs:
Manufacturing $1,000,000
Profit $ 139,000
* $70 - $15 - $8 = $47 contribution margin
Variable production costs, 39,000 x $15 $585,000
The $50,000 difference in income ($189,000 - $139,000) is explained by
the fixed overhead in the ending inventory ($25 x 2,000 pairs).
13-31 Analysis of Results (Continuation of 13-30) (30 minutes)
1. Absorption costing income statement
13-20
Sales, 40,000 x $70 $2,800,000
Selling and administrative expenses:
Variable 40,000 x $8 $320,000
Fixed 600,000 920,000
Profit $ 305,000
*
Difference 1,000
An expanded cost of sales section appears below.
Variable production costs, 41,000 x $15 $ 615,000
Fixed production costs, 41,000 x $25 1,025,000
Sales, 40,000 x $70 $2,800,000
Variable manufacturing margin, 40,000 x $55 2,200,000
Variable selling and
administrative expenses, 40,000 x $8 320,000
Contribution margin, 40,000 x $47 1,880,000
Fixed costs:
Profit $ 280,000
Variable production costs, 41,000 x $15 $615,000
3. The variable costing income statements provide a better basis for
analyzing results. Income changes purely as a function of the change in
sales. The higher income (actual versus budgeted) under absorption costing
is due in part to increased production, where under variable costing it is
due solely to increased sales. Because goods must be sold to increase profit
(at least at some point they must be sold), variable costing provides a
better basis for evaluating results.
13-32 Analysis of Income Statement--Standard Costs (25 minutes)
1. (a) 24,000 units, volume variance/application rate = $8,000/$2 = 4,000
units over normal activity of 20,000 units
(b) $7,000 favorable
Standard use of materials (24,000 x 16) 384,000
13-21
Materials used 370,000
Use below standard 14,000
Material use variance at $0.50 per pound $ 7,000
(c) $10,000 unfavorable, total unfavorable variance of $3,000 + the
favorable use variance calculated in part b.
(d) $12,000 favorable
Standard hours (24,000 x 2 hours/unit) 48,000
Actual hours 47,000
Hours above standard 1,000
Variance at $12 per hour $12,000
(e) $8,000 unfavorable, total favorable labor variance of $4,000 - the
$12,000 favorable efficiency variance from part d
(f) $1,000 favorable, 1,000 hours under standard from part d x $1
standard variable overhead rate per hour
(g) $3,000 unfavorable, total unfavorable variable overhead variance of
$2,000 + the favorable efficiency variance from part f
(h) $37,000
Total budgeted fixed overhead
$2 standard rate x 20,000 units $40,000
Fixed overhead spending variance, favorable 3,000
Actual fixed overhead $37,000
2. Variable costing income statement
Sales (20,000 x $50) $1,000,000
Standard variable cost of sales (20,000 x $34) 680,000
Variances:
Materials $3,000U
Labor 4,000F
Variable overhead 2,000U 1,000 U
Fixed costs:
Production $ 37,000
Income $ 52,000
Note that the incomes are easily reconciled:
Increase in inventory (24,000 - 20,000) 4,000
Multiplied by $2 standard fixed cost $2
Difference in incomes ($60,000 - $52,000) $8,000
13-33 Conversion of Absorption Costing Statement from Normal to Practical
Capacity (Continuation of 13-32) (15-20 minutes)
1. $1.60 ($40,000/25,000)
2.
Sales $1,000,000
Standard cost of sales (20,000 x $35.60)* 712,000
Standard gross profit 288,000
Variances:
Materials $3,000U
Labor 4,000F
Variable overhead 2,000U
13-22
Fixed overhead--budget 3,000F
--volume** 1,600U 400 F
Actual gross profit 288,400
Income $ 58,400
* $34 + $1.60
** $1.60 x (25,000 - 24,000) = $1,600 unfavorable
Note to the Instructor: You might ask students whether they can
reconcile income here with that in 13-31. The difference in incomes of
$1,600 ($60,000 - $58,400) is the difference in unit fixed costs ($2.00 -
$1.60) multiplied by the increase of 4,000 units.
Fixed costs in ending inventory at $2 ($2 x 4,000) $8,000
Fixed costs in ending inventory at $1.60 ($1.60 x 4,000) 6,400
Difference in incomes ($60,000 - $58,400) $1,600
13-34 Reconciling Incomes--Absorption Costing (20 minutes)
1.
Sales (214.0 x $20) $4,280.0
Standard cost of sales (214.0 x $9) 1,926.0
Standard gross margin 2,354.0
Volume variance* 50.0 U
Actual gross margin 2,304.0
Selling and administrative expenses 1,800.0
Income $ 504.0
* (220.0 - 210.0) x $5 = $50 U Alternatively,
Budgeted fixed manufacturing cost (220 x $5) $1,100
Applied fixed manufacturing cost (210 x $5) 1,050
Unfavorable volume variance $ 50
There was no fixed overhead budget variance, nor variable cost variances.
Budgeted variable costs for 210,000 units are $840,000, which equalled actual
variable costs.

2.
Memorandum

To: Lynn Maffett
From: Student
Subj: Operating results
Date: Today
The difficulty with interpreting our results is that we use absorption
costing. Under absorption costing, our income depends partly on production.
The original budget assumed that we would produce 220 thousand units, but we
actually produced only 210 thousand units. We therefore deferred $50
thousand less fixed cost than originally planned [(220 - 210) x $5].
The effect of the change in production is greater than that of the change
in sales. A reconciliation of the incomes is:
Standard gross margin, actual results (214.0 x $11) $2,354.0
Standard gross margin, budgeted results (211.5 x $11) 2,326.5
Difference (2.5 x $11) $ 27.5
Less difference in fixed overhead deferral 50.0
Difference in incomes $ 22.5
13-23
Note to the Instructor: The difference in volume variances (between
budgeted and actual) equals the actual volume variance because the budgeted
amount was zero. Note that had there been a budgeted volume variance, it
would be necessary to use the differences in volume variances, not the actual
amount.
It is worth pointing out that the budgeted income statement shows income
higher than the company can maintain at that level of sales, which reflects
production in excess of sales. The company cannot continue for long to
produce in excess of sales. The sequel to this assignment uses variable
costing and shows that production does not affect income using that method.

13-35 Reconciling Incomes--Variable Costing (Continuation of 13-34) (15
minutes)
1. Budgeted income statement
Sales (211.5 x $20) $4,230.0
Standard cost of sales (211.5 x $4) 846.0
Contribution margin 3,384.0
Fixed costs ($1,800 + $1,100)* 2,900.0
Income $ 484.0
* 220 x $5, from 13-33
Actual income statement
Sales (214.0 x $20) $4,280.0
Standard cost of sales (214.0 x $4) 856.0
Contribution margin 3,424.0
Fixed costs 2,900.0
Income $ 524.0
2. The difference in incomes of $40 thousand ($524 - $484) is simply the
additional contribution margin from selling 2,500 more units.
Additional volume 2,500
Times contribution margin ($20 - $4) $16
Additional contribution margin $40,000
The change in production is irrelevant, as is the level of production, so
that the variable costing income statements give a clearer picture of the
economic situation than do the absorption costing statements.
13-36 Analyzing Income Statements (15-20 minutes)
1. Statement A was prepared using variable costing, statement B using
absorption costing. We can determine this several ways: (1) production costs
are higher in statement B because fixed costs are included; (2) ending
inventory is higher in statement B because of the fixed costs included in
inventory; (3) "other costs" are higher in statement A because of the
inclusion of fixed costs as a direct charge-off in the income statement.
2. (a) $900,000, the difference between production costs in the two
statements
(b) $300,000, the amount shown as "other costs" in statement B
13-24
(c) 30,000 units. Since one-third of production costs are included in
ending inventory in both statements and 20,000 units were sold, 20,000 is
two- thirds of production. Also, the variable costing statement shows
$1,800,000 in production costs (must be only variable costs); since variable
cost per unit is $60, production must have been 30,000 units
($1,800,000/$60).
(d) Ending inventory is 10,000 units (production of 30,000 - 20,000
sold). Inventory cost is $60 per unit under variable costing, which is given.
Under absorption costing, $90 per unit is the cost ($900,000/10,000 units).
3. There is no correct answer to this question. If one accepts the view
that sales managers are most likely to prefer absorption costing because of
the need to "cover" all costs, then the sales manager would probably have
prepared the absorption costing statement, the controller the variable
costing statement. (It might also be argued that the controller would prefer
the simpler and more direct treatment that variable costing affords, though
this is only our opinion.) Others would assume that the absorption costing
statement was prepared by the controller, on the theory that the controller
would be influenced by the demands of financial accounting. Still others
might suggest that the emphasis on "covering all costs" is more likely to
come from the controller, or that the desire to show the best picture would
probably be consistent with the optimism of the sales force rather than the
conservatism of the accounting personnel. Perhaps this is a good place to
discuss (and maybe destroy) some stereotypes.

13-25
13-37 Conversion of Income Statement (15-20 minutes)
Income Statement, Morgan Division
Sales (33,100 x $40) $1,324,000
Variable cost of sales (33,100 x $15) 496,500
Contribution margin [33,100 x ($40 - $15)] 827,500
Fixed costs:
Income $ 71,200
Calculations
Sales 33,100 units, $1,324,000/$40 per unit
Variable cost per unit $15
Absorption cost of sales $893,700
Divided by sales, in units 33,100
Equals absorption cost per unit $27
Less fixed cost per unit 12
Equals variable cost per unit $15
Divided by fixed cost per unit $12
Equals volume of production less than
volume used to set fixed cost per unit 1,800
Add production 38,200
Equals volume used to set fixed cost per unit 40,000
Times fixed cost per unit $12
Equals budgeted fixed costs $480,000
Note to the Instructor: You might want to remind your students that
they can check their answers by determining the difference they should expect
to find between absorption costing income and variable costing income. After
calculating sales of 33,100 units, you know the difference between production
and sales.
Sales, calculated 33,100 units
Production, given 38,200
Difference, change in inventory (increase) 5,100 units
Times fixed cost per unit, given $12
Equals difference in income $ 61,200
Subtracted from absorption costing income, given 132,400
Equals variable costing income, as above $ 71,200
Variable costing income is lower than absorption costing income because some
fixed costs ($61,200) are carried forward into the next period through the
increase in inventory. You may also want to remind your students that they
do not need to know the number of units in inventory at either the beginning
or the end of the quarter; all they need to know is the change in inventory.
13-26
13-38 Effects of Costing Methods on Balance Sheet (30 minutes)
1. McPherson Company
Budgeted Income Statement for 20X2
Sales (100,000 units) $1,000,000
Cost of sales:
Beginning inventory $ 200,000
Production costs:
Fixed 300,000
Variable 750,000
Total $1,250,000
Ending inventory* 630,000
Cost of sales 620,000
Gross profit 380,000
Other expenses:
Variable $ 50,000
Fixed 50,000
Total 100,000
Income $ 280,000
* Fixed manufacturing costs $300,000
Divided by production of 150,000 units
Equals standard fixed cost per unit $2.00
Variable cost per unit 5.00
Total cost per unit $7.00
Times number of units in inventory:
Beginning inventory 40,000
Production 150,000
Available for sale 190,000
Sales 100,000
90,000
Equals ending inventory $630,000

McPherson Company
Pro Forma Balance Sheet
December 31, 20X2
Assets Equities
Cash and receivables Current liabilities $ 240,000
$400,000 - $250,000 $ 150,000 Long-term bank loan 460,000
Inventory 630,000 Stockholders' equity
Total current assets 780,000 ($760,000 + $280,000) 1,040,000
Fixed assets, net 960,000 __________
Total $1,740,000 Total $1,740,000
2. Current assets = $780,000 = 3.25
Current liabilities $240,000
Total debt = $700,000 = 67.3%
Owners' equity $1,040,000
3. Yes and no. Since the use of absorption costing does enable the company
to meet the requirements, it is de facto helpful. Most students will see
that the company is probably in a worse situation because its cash is
$250,000 lower and it has inventory equal to 90% of 20X2 sales. Such a large
amount might be hard to sell.

13-27
13-39 CVP Analysis and Absorption Costing (20 minutes)
1.
Sales, 82,000 units at $40 $3,280,000
Standard variable cost of sales at $24 1,968,000
Contribution margin 1,312,000
Fixed costs 800,000
Profit $ 512,000
2. The results in the income statement here do not depend on production,
only on sales. The manager is therefore better able to see whether she met
her objectives, and if not, why not. Here, the difference between the
original objective of a $480,000 profit and the actual $512,000 is 2,000
units at a contribution margin of $16, for $32,000.
You might wish to show the following reconciliation of incomes.
Variable costing $512,000
Absorption costing 440,000
Difference $ 72,000
Explained by:
Sales 82,000
Production 70,000
Difference 12,000
Times standard fixed cost per unit $6
Difference in incomes $72,000
You might also wish to show the following derivations for the income
statement, even though students need not analyze that statement to complete
the assignment.
Total fixed costs $800,000
Fixed manufacturing costs, 75% of total $600,000
Divided by 100,000 units = standard fixed cost per unit $ 6
Plus variable cost 24
Standard cost per unit $30
Production variances of $180,000 = (100,000 - 70,000) x $6, all volume
variance.
13-40 Standard Costing--Activity-Based Overhead Rates (25 minutes)
1. $0.15 per part and $64.80 per machine hour
Part-related Machine-related
Budgeted overhead $1,200,000 $6,480,000
Measure of activity 8,000,000 parts 100,000 MH
Rates $0.15 $64.80
2.
Parts (given) $27.50
Part-related overhead (11 x $0.15) 1.65
Machine-related overhead (0.15 x $64.80) 9.72
Total standard cost $38.87
3. We can calculate budget and volume variances for each overhead element.
13-28
Part-related Overhead
Actual Budget Applied
($1,200,000/12) 60,000 x $1.65
$105,300 $100,000 $99,000
$5,300 $1,000
Unfavorable budget variance Unfavorable volume variance
$6,300
Unfavorable total variance
Machine-related Overhead
Actual Budget Applied
($6,480,000/12) 60,000 x $9.72
$542,230 $540,000 $583,200
$2,230 $43,200
Unfavorable budget variance Favorable volume variance
$40,970
Unfavorable total variance
Note to the Instructor: This assignment illustrates standard cost
calculations with more than one basis for applying overhead, the underlying
principle of which we have developed since Chapter 3, most relevantly for
this purpose in Chapters 12 and 13.

13-41 Preparing Income Statements (30 minutes)
1. Income statements
March February
Sales $1,256.8 $1,452.4
Standard variable cost of sales 510.3 580.5
Variable cost variances* 18.5 U 17.2 U
Variable cost of sales 528.8 597.7
Contribution margin 728.0 854.7
Fixed costs:
Production 299.8 305.2
Selling and administrative expenses 406.4 412.6
Total fixed costs 706.2 717.8
Profit $ 21.8 $ 136.9

* February $7.1 + $6.9 + $3.2 = $17.2; March $8.4 + $7.8 + $2.3 = $18.5
2. $6.5 favorable in March, $11.9 unfavorable in February.
March February
Total overhead variance $ 8.9 F $15.8 U
Variable overhead variance 2.3 U 3.2 U
Fixed overhead variance $11.2 F $12.6 U
Actual fixed overhead $299.8 $305.2
Budgeted fixed overhead 304.5 304.5
Budget variance $ 4.7 F $ 0.7 U
13-29
Volume variance $11.2 - $4.7 $ 6.5 F
$12.6 - $0.7 $ 11.9 U
Note to the Instructor: This assignment is less straightforward than
others of the same type. It also offers the opportunity to pursue such
questions as:
1. Was production higher in February or in March? March because of the
favorable volume variance.
2. Was production above the amount used to set standard fixed costs in
February or in March? Yes in March, favorable volume variance. No in
February, unfavorable volume variance.

13-42 Incorporating Variances into Budgets (30 minutes)
1.
Materials Variances
Price variance:
Standard quantity required for planned production
24,000 units x 3 gallons per unit 72,000
Additional quantity expected to be used, 10% of standard 7,200
Total materials expected to be used 79,200
Expected price savings on materials:
Standard cost per gallon $3
Expected savings per gallon 5% $ 0.15
Expected favorable variance $11,880
Use variance:
Additional quantity expected to be used, from above 7,200 gals.
Standard cost per gallon $3
Expected unfavorable variance $21,600
Labor Variances
Rate variance:
Standard quantity of labor required (24,000 units
x 2 hrs. per unit) 48,000 hrs.
Expected savings in hours, 4% of standard 1,920
Expected actual hours 46,080
Expected excess labor rate:
Standard cost per hour $10
Expected increase 6% $ 0.60
Efficiency variance:
Expected savings in hours, from above 1,920 hrs.
Variable Overhead Variances
Spending variance:
Expected hours of labor, see computation of labor
variances, above 46,080 hrs.
Expected excess spending:
Expected increase 5% $ 0.60
13-30
Efficiency variance:
Expected savings in labor hours, see computation
of labor variance, above 1,920 hrs.
2.
Viner Company
Budgeted Income Statement
for the Year 20X1
Sales (20,000 units x $100) $2,000,000
Cost of sales, at standard (20,000 units x $53) 1,060,000
Gross profit, at standard 940,000
Less manufacturing variances: (favorable)
Material price ($11,880)
Material use 21,600
Labor rate 27,648
Labor efficiency (19,200)
Variable overhead spending 27,648
Variable overhead efficiency (23,040)
Total 22,776
Fixed costs:
Manufacturing 300,000
Income before taxes $ 217,224
Note to the Instructor: Several points about this problem are worth
special note.
1. Variances should be computed using production rather than sales figures.
Some students may not have seen this at first.
2. The anticipated wage increase should probably have been incorporated in
the standard since the increase is certain. To bring this point to light,
you might ask the students for recommendations. To the extent that the other
anticipated variances have been experienced, the question of the currentness
of standards is also relevant.
3. The students may want to (or you might prompt them to) bring up the
question whether variances should be allocated between the units sold and the
units remaining on hand. There are no beginning inventories so we can be
sure that the ending inventory is equal to at least the excess of production
over sales (4,000 units). Since we know that at least one standard (labor
rate) is clearly out of date, there is an argument for assigning some of the
variance from this standard to the ending inventory.
4. You could point out that the budgeted material price variance has been
computed under the assumption that materials purchases will equal material
used. If the company plans a change in its materials inventory, the variance
as computed would be in error. You might wish to discuss what effect a
planned change (increase or decrease) would have on the variance.
13-43 Costs and Decisions (20 minutes)
Memorandum

To: Mr. Beatty
From: Student
13-31
Subj: Special order
Date: Today
I have prepared the following analysis showing that we did increase
profits as a result of accepting the special order. Please examine the
comparative income statements that use variable costing.

Without Actual, With
Special Order Special
Order
Total sales $2,500,000 $2,620,000
Standard variable cost of goods sold at $10 1,000,000 1,100,000
Contribution margin 1,500,000 1,520,000
Fixed costs ($6 x 130,000) 780,000 780,000
Subtotal, manufacturing margin 720,000 740,000
Income $ 10,000 $ 30,000
The statements show that the sale provided positive contribution margin.
The income statements you showed me reflect no increase in production to meet
the order. Thus the effect of the sale on expenses recognized during the
period was $160,000, the 10,000 units at the standard cost of $16 each. Had
we increased production by 10,000 units, we would have deferred $60,000
(10,000 x $6) fixed overhead in inventory, which would have produced income
of $90,000 for the statement showing actual results.
With Special Order
and Increased Production
Sales $2,620,000
Standard cost of sales 1,760,000
Volume variance (10,000 x $6) 60,000U
Income $ 90,000
This statement shows that the additional revenue more than covered the
variable costs that would have been incurred had the additional units been
produced. However, producing them might not have been a wise decision; the
firm apparently thought it better to fill the order from inventory.
Depending on the prospects for selling the existing inventory, it might have
been wise to have sold the units at any price that could be gotten, even
below variable cost. That would be wise because variable costs for
production already on hand are sunk costs as far as those units are
concerned. Thus, if the choice were "sell at $2 or don't sell them at all,"
the sale at $2 would be beneficial.
Note to the Instructor: Income statements following GAAP would show
the wisdom of such a sale because the inventory could not be carried at $16
per unit standard cost if the units had little or no market value. (If $12
is the best available price now, the inventory should be written down.) The
following points are relevant.
1. The results shown depend on the use of absorption costing, which might
not always reflect the wisdom of decisions.
2. Because inventory was overstocked, and the company did not produce
additional units, the price of $12 is adequate. A price below variable cost
is appropriate if it were the best available price for units already
13-32
produced.
13-44 Actual versus Standard Costs Multiple Products (35 minutes)
1. Standard cost for each model:

#108 #380 #460
Direct labor hours required 0.5 0.8 1.5
Direct labor at $8 per hour $ 4.00 $ 6.40 $12.00
Variable overhead at $7 per hour 3.50 5.60 10.50
Fixed overhead at $15 per hour* 7.50 12.00 22.50
Materials as given 12.00 14.00 18.00
Total standard cost per unit $27.00 $38.00 $63.00
* $90,000/6,000 hours.
2. Inventory of finished goods is $55,400 ($16,200 + $26,600 + $12,600).
#108 #380 #460
Units on hand (production minus sales) 600 700 200
Standard cost per unit $27 $38 $63
Inventory amounts $16,200 $26,600 $12,600
3. Income statement for April
Sales ($84,000 + $90,000 + $85,000) $259,000
Standard cost of sales:
#108 $27 x 2,400 $ 64,800
#380 $38 x 1,800 68,400
#460 $63 x 1,000 63,000 196,200
Fixed cost variances:
Budget variance ($92,000 - $90,000) 2,000U
Volume variance* 10,500U 12,500
Income $ 22,300
* The volume variance is 700 direct labor hours at $15 per hour. Actual and
standard direct labor hours were 5,300, computed as follows,
#108 3,000 units x .5 per unit 1,500
#380 2,500 units x .8 per unit 2,000
#460 1,200 units x 1.5 per unit 1,800
Total hours 5,300
Note to the Instructor: Class discussion can develop along the lines
of the relative ease of application of standard costing (as opposed to the
actual cost system in previous use) as well as its advantages for cost
control and planning. Allocating costs based on relative material costs does
not provide good data. In the three models the ratios of material costs do
not correspond to direct labor ratios and it is direct labor hours with which
variable overhead (as well as direct labor) is variable. Hence, relative
material cost is a poor measure of activity.
13-33
13-45 Income Statements and Balance Sheets (35 minutes)
1. MicroCook
20X3 Income Statements (000s)
January-June July-December Total

Sales $9,000 (30,000 x $300) $12,000 (40,000 x $300) $21,000
Cost of sales:
Beg. inv. 225 675 225
Production costs:
Variable 5,760 (32,000 x $180) 7,560 (42,000 x $180) 13,320
Applied fixed 1,440 (32,000 x $45) 1,890 (42,000 x $45) 3,330
Total 7,425 10,125 16,875
Ending inventory 675 (3,000 x $225) 1,125 (5,000 x $225) 1,125
Cost of sales 6,750 (30,000 x $225) 9,000 15,750
Gross profit 2,250 3,000 5,250
Underabsorbed or
overabsorbed
overhead 360 (8,000 x $45) (90) (2,000 x $45) 270
S & A expenses
Variable at 10% 900 1,200 2,100
Fixed 1,200 1,200 2,400
Total 2,460 2,310 4,770
Income (loss) ( $210) $ 690 $ 480
2. MicroCook
Balance Sheets
(In Thousands)
June 30, 20X3 December 31,
20X3
Cash* $ 140 $ 780
Inventory 675 1,125
Plant and equipment (beginning less $400
and $800) 2,600 2,200
Total assets $3,415 $4,105
Common stock $3,000 $3,000
Retained earnings (beginning balance less
$210 loss, plus $690 profit) 415 1,105
Total equities $3,415 $4,105
*Cash balances
June 30 December 31
Beginning balance $ 400 $ 140
Sales 9,000 12,000
Available 9,400 12,140
Disbursements:
Fixed production costs
$1,800 - $400 depreciation 1,400 1,400
Total disbursements 9,260 11,360
Ending balance $ 140 $ 780
13-34
13-46 Pricing Dispute (15-20 minutes)
1.
Sales [(100,000 x $5) + (10,000 x $4.50)] $545,000
Cost of goods sold at standard:
Beginning inventory, given $ 80,000
Variable production costs, given 250,000
Fixed production costs, given 150,000
Cost of goods available for sale 480,000
Cost of goods sold at standard 440,000
Volume variance (20,000 x $1.50) $ 30,000F
Income $ 85,000
This income statement, and the one given in the problem, contain more
data than are necessary. It would be sufficient to show standard cost of
sales at $4 per unit. The company does show $5,000 more gross profit than it
did before considering the order, which is $0.50 per unit for 10,000 units.
2. The controller of Phelan Company could well argue that the $4.50 price
provides $2 in gross profit, considering the variable cost of production
($2.50) as the only product cost. Thus, $3 per unit ($2.50 variable cost
plus $.50 gross profit) would be the rock-bottom price. The problem is the
meaning of "gross profit." Because Calligeris Company did not produce the
additional 10,000 units, its gross profit and income increased by $5,000,
which is the amount allowable under the agreement. Had the company produced
an additional 10,000 units, its income statement (abbreviated) would have
appeared as follows:
Sales $545,000
Standard cost of goods sold (110,000 x $4) 440,000
Volume variance (30,000 x $1.50) $45,000F
Income $100,000
Gross profit at standard cost would still be only $5,000 higher, but
income would increase by $20,000 over that shown in the problem. The
increase is the contribution margin of $2 per unit ($4.50 - $2.50).
At the very least the controller of Phelan Company would argue that the
standard fixed cost per unit is based on too low an activity level. The
standard is based on 80,000 units because the volume variance is 20,000 units
favorable at production of 100,000 units. Even if the actual fixed cost per
unit based on production of 100,000 units is used, which is $1.20 per unit
($1.50 x 80,000 = $120,000 fixed production cost/100,000 units = $1.20), the
appropriate price would be $4.20.
Note to the Instructor: One purpose of this problem is to show that the
meanings of terms such as "cost" and "gross profit" are not fixed and
constant. Given the way Calligeris Company computes its gross profit, the
$4.50 price does provide a gross profit and income of $5,000. If an
additional 10,000 units had been produced, the company's gross profit at
13-35
standard would still have been increased by $5,000, its income by $20,000, as
the income statement above shows.
Perhaps the moral is that the Phelan Company should have specified the
meaning of "gross profit" more clearly than it did.
13-47 Predetermined Overhead Rates--Multiple Products (20 minutes)
1. The predetermined overhead rate per direct labor hour is $6 ($300,000
budgeted fixed costs divided by 50,000 direct labor hours at normal
activity). The standard costs are computed from this figure as follows.
Model 84 Model 204 Model 340
Predetermined fixed overhead rate $6.00 $6.00 $6.00
Standard fixed cost per unit $3.00 $4.80 $9.00
2.
Variable production costs per unit $4.00 $ 7.00 $11.00
Standard fixed cost per unit 3.00 4.80 9.00
Total inventory cost per unit $7.00 $11.80 $20.00
Ending inventory in units
(production minus sales) 5,000 4,000 2,000
Ending inventory in dollars $35,000 $47,200 $40,000
Salmon Company
Income Statement for 20X1
Sales ($250,000 + $280,000 + $450,000) $980,000
Cost of sales at standard:
Model 84 (25,000 x $7) $175,000
Model 204 (20.000 x $11.80) 236,000
Model 340 (18,000 x $20) 360,000 771,000
Volume variance, favorable (see below) 85,200
Income $154,200
The volume variance can be calculated in either of two ways. The method
illustrated in the chapter is perhaps slightly simpler.
Production 30,000 24,000 20,000
Standard fixed cost per unit $3.00 $4.80 $9.00
Total fixed costs applied $90,000 $115,200 $180,000
Total for the three products is $385,200, which is $85,200 more than
budgeted.
Note to the Instructor: You may wish to illustrate the computation
based on direct labor hours and the predetermined overhead rate of $6 per
hour.
Production 30,000 24,000 20,000
Direct labor hours worked 15,000 19,200 30,000
Total direct labor hours worked were 64,200 (15,000 + 19,200 + 30,000),
13-36
which is 14,200 more than the 50,000 hours used to set the predetermined
rate.
Actual hours 64,200
Hours at normal activity 50,000
Difference 14,200
Predetermined rate $6
Favorable volume variance $85,200
13-48 Comprehensive Review, Budgeting, Overhead Application (75 minutes)
1. Budgeted income statement
Sales (880,000 x $20) $17,600,000
Cost of sales [880,000 x ($6.50 + $3.50)] 8,800,000
Gross profit 8,800,000
Underabsorbed overhead* (100,000 x $3.50) $ 350,000
Variable selling costs ($2 unit) 1,760,000
Fixed selling and administrative expenses 5,550,000 7,660,000
Profit before taxes 1,140,000
Income taxes at 40% 456,000
Net income $ 684,000
* $3,500,000/$3.50 = 1,000,000 unit base for overhead application.
Production of 900,000 units is 100,000 fewer than the base.
2. The easiest way to approach this part is to develop data for the end of
the fourth quarter. These data will also be used for the pro forma balance
sheet.
Sales in fourth quarter (880,000 x 30% x $20) $5,280,000
Divided by 3 equals monthly sales 1,760,000
Multiplied by 2 gives accounts receivable at
year-end $3,520,000
Cash receipts
Beginning accounts receivable $ 2,800,000
Plus sales 17,600,000
Subtotal 20,400,000
Less ending accounts receivable 3,520,000
Cash receipts $16,880,000
Cash disbursements for commissions

Sales in December (1/3 of fourth quarter) $1,760,000
At 10% commission rate ($2/$20), ending balance $ 176,000
Beginning liability, beginning balance sheet $ 120,000
Commissions earned, income statement 1,760,000
Subtotal 1,880,000
Ending balance of liability, above 176,000
Cash disbursements for commissions $1,704,000
Cash disbursements--direct labor
Production in fourth quarter 210,000
Direct labor cost at $2.00 $ 420,000
Percentage unpaid at quarter end 10%
Accrued payroll at year end $ 42,000
13-37
Beginning accrual, opening balance sheet $ 64,000
Wages earned (900,000 units x $2.00 per unit) 1,800,000
Subtotal 1,864,000
Accrual at year end, above 42,000
Cash disbursements--direct labor $1,822,000

Payments for raw materials
Purchases in 1st month of fourth quarter (795,000/3) 265,000 lbs.
Price per pound $0.80
Accounts payable at year end $212,000
Beginning accounts payable, opening balance sheet $ 240,000
Purchases (3,382,000 lbs. x $0.80 per lb.) 2,705,600
Subtotal 2,945,600
Ending accounts payable, above 212,000
Cash disbursements for materials $2,733,600
Cash disbursements for taxes
Year-end accrual ($456,000 x 25%) $114,000
Beginning accrual, opening balance sheet $ 80,000
Expense for year, per income statement 456,000
Subtotal 536,000
Year-end accrual, above 114,000
Cash disbursements-taxes $ 422,000
Cash budget
Beginning balance $ 840,000
Receipts 16,880,000
Total available 17,720,000
Disbursements
Materials 2,733,600
Direct labor 1,822,000
Other manufacturing costs:
Fixed ($3,500,000 - $1,900,000) 1,600,000
Variable [($6.50 - $3.20 - $2.00 = $1.30)
x 900,000] 1,170,000
Selling and administrative:
Commissions 1,704,000
Other 5,550,000
Taxes 422,000
Dividends 300,000
Plant and equipment purchases 2,100,000
Total disbursements 17,401,600
Balance at year end $ 318,400
3.
Ruland Company
Pro Forma Balance Sheet
December 31, 20X2
(In Thousands of Dollars)
Assets Equities
13-38
Cash (cash budget) $ 318.4 Accounts payable $ 212.0
Accounts receivable 3,520.0 Accrued commissions 176.0
Inventory--finished goods* 1,660.0 Accrued payroll 42.0
Inventory--materials* 249.6 Accrued taxes 114.0
Plant and equipment 18,300.0 Long-term debt 4,000.0
Accumulated depreciation (10,300.0) Common stock 7,000.0
Retained earnings** 2,204.0
Total $13,748.0 Total $13,748.0
* Inventories:
Dollars Units
Finished goods, beginning of year $ 1,460,000 146,000
Production, $10 per unit 9,000,000 900,000
Available for sale 10,460,000 1,046,000
Cost of sales, per income statement 8,800,000 880,000
Ending inventory $ 1,660,000 166,000
Raw materials, beginning of year $ 424,000 530,000
Purchases 2,705,600 3,382,000
Available 3,129,600 3,912,000
Used in production (900,000 x 4 x $.80) 2,880,000 3,600,000
Ending inventory $ 249,600 312,000
** Beginning balance of $1,820,000 plus $684,000 net income less $300,000
dividend
You could also prepare the pro forma balance sheet before the cash
budget by calculating the ending balances in the asset and equity accounts,
except for cash, and plugging cash. The cash figure can then be checked for
accuracy when the cash budget is prepared.
4. The major differences would be in the finished goods inventories and
retained earnings. Each would be lower by $581,000, the amount of fixed cost
in the inventory (166,000 x $3.50). This answer assumes that the company
would still have paid income taxes based on absorption costing income. If
variable costing were acceptable for tax purposes, the difference in retained
earnings would be reduced by a lower tax liability.
13-49 Standard Costs and Pricing (30-35 minutes)
1. $2,740,000
Total manufacturing cost [$7,680,000 + (2,400,000 x $4.25)] $17,880,000
Divided by 2,400,000 hours = hourly rate $ 7.45
Multiplied by 1.50 = hourly price $11.175
Revenues (2,400,000 x $11.175) $26,820,000
Manufacturing costs 17,880,000
Profit $ 2,740,000
In this case, standard fixed cost per hour is $3.20 ($7,680,000/2,400,000).
2. $4,015,000
Total manufacturing costs [$7,680,000 + (3,000,000 x $4.25)] $20,430,000
Divided by 3,000,000 hours = hourly rate $ 6.81
Multiplied by 1.50 = hourly price
$10.215
13-39
Revenues (3,000,000 x $10.215) $30,645,000
Manufacturing costs 20,430,000*
Profit $ 4,015,000
In this case, standard fixed cost per hour is $2.56 ($7,680,000/3,000,000).
3. The real issue is the likely level of sales at specific prices--price-
volume relationships--not the volume to use to compute standard costs.
Because of the company's pricing formula, the lower the volume used to set
prices, the higher the prices it will set, so that a given level of sales
will tend to be less achievable as long as there is a relationship between
prices and volume. But, simply using a particular higher level of volume to
set prices does not guarantee that those prices will produce sales at that
level.
Quite possibly, as the treasurer says, the $11.175 price (requirement 1)
will mean a loss of sales. But from what starting point? Sales at 3,000,000
hours? At 2,400,000 hours? The controller's comments suggest an expected
sales level of something less than 3,000,000 (large underapplied overhead at
that level). Would a price of $10.215 (requirement 2) raise sales
expectations to the 3,000,000 hour level?

If 3,000,000 hours is the basis for standard cost, the price is set at
$10.215 per hour, and sales of only 2,400,000 hours materialize, income will
be $436,000 [2,400,000 x ($10.215 - $4.25) - $7,680,000 - $6,200,000]. From
earlier chapters we know that at any given sales volume, the higher price
(and contribution margin) will produce more profit. Hence, the issue here is
whether the lower price will produce sufficient volume to offset the decline
in contribution margin. In this particular case, to produce the same total
contribution margin under either price, the sales volume at the lower price
must be approximately 16% greater than at the higher price.
($10.215 - $4.25)X = ($11.175 - $4.25)Y
X/Y = 1.16
X = required volume, in hours, at lower price
Y = required volume, in hours, at higher price
The available facts are insufficient to allow determining an appropriate
price (and, hence, absorption basis).

13-50 Product Costing Methods and CVP Analysis (30 minutes)
1. 152,000 units ($630,000 + $434,000)/($16 - $7 - $2). Variable production
costs of $7 per unit are $1,330,000/190,000.
2. 123,500 units. Gross profit using the $3 predetermined overhead rate
($630,000/210,000) is $6 ($16 - $7 - $3) and variable selling costs are $2.
The company will have underabsorbed overhead of $60,000 [(210,000 - 190,000)
x $3] and so the net $4 per unit ($6 - $2) must cover fixed selling and
administrative costs of $434,000 plus the $60,000 underabsorbed overhead, a
total of $494,000. This amount, when divided by $4, gives 123,500. As
proof:
Sales (123,500 x $16) $1,976,000
Production costs:
Variable $1,330,000
Fixed ($3 x 190,000) 570,000
13-40
Total 1,900,000
Less ending inventory (66,500 units at $10) 665,000 1,235,000
Less:
Underabsorbed overhead 60,000
Variable selling costs 247,000
Fixed selling and administrative expenses 434,000 741,000
Income $ 0
3. The answers differ in the amount of fixed costs that would be included
in the ending inventory under absorption costing. The ending inventory
contains fixed costs of $199,500 ($3 x 66,500 units). These costs would be
charged to the income statement under variable costing, requiring that much
additional contribution margin. At the contribution margin of $7 per unit
($16 - $7 - $2), the difference in units is 28,500 ($199,500/$7), which is
the difference between the break-even points (152,000 - 123,500 = 28,500).
4. The answer to requirement 2 would be the same. The beginning inventory
would be $100,000 at $10 per unit. The ending inventory would be 76,500
units, which is 10,000 units and $100,000 higher than currently. Therefore,
cost of sales would be the same and so would underabsorbed overhead.

Note to the Instructor: This problem illustrates one of the assumptions
of break-even and cost-volume-profit analysis--either that variable costing
is used or that inventories do not change. Some extensions of the problem
are to ask about the break-even point if production were to be 220,000 units,
in which case overhead would be overabsorbed by $30,000 and break-even would
fall to 101,000 units [($434,000 - $30,000)/$4]. Or, a comparison of incomes
at 152,000 units, absorption costing and variable costing, or at 123,500
units can easily be done. At 152,000 units, the break-even point under
variable costing, absorption costing would show the following, at production
of 190,000.
Sales (152,000 x $16) $2,432,000
Cost of sales at $10 1,520,000
Gross profit at $6 912,000
Underabsorbed overhead (20,000 x $3) $ 60,000
Variable selling costs (152,000 x $2) 304,000
Fixed selling and administrative expenses 434,000 798,000
Income $ 114,000
The $114,000 income is the fixed costs in the ending inventory, 38,000 units
(190,000 - 152,000) at $3.
A major point of this problem, then, is that if production is known, the
overabsorbed or underabsorbed fixed costs are treated like fixed costs in
cost-volume-profit calculations. But "fixed costs" include only selling and
administrative costs plus underabsorbed overhead or less overabsorbed
overhead, and the divisor is:
Selling price - variable production - fixed production - variable
costs costs per unit selling costs
rather than contribution margin.
13-51 Costing Methods and Evaluation of Performance (25 minutes)
1. Wallace Division Income Statement, Second Quarter
Sales (25,000 units) $2,500,000
13-41
Cost of sales:
Beginning inventory (10,000 units) $ 625,000
Production costs applied (50,000 x $62.50)* 3,125,000
Available for sale 3,750,000
Less ending inventory (35,000 x $62.50)* 2,187,500
Standard cost of sales 1,562,500
Volume variance** 125,000F
Gross profit 1,062,500
Income $ 562,500
* Variable cost per unit of $50 + fixed cost per unit of $12.50 ($500,000/
40,000) = $62.50 total cost per unit
** $12.50 x (50,000 - 40,000) = $125,000 favorable
2. The income statement for the second quarter reflects Boroff's skill at
selecting a strategy that makes her performance appear better than it would
if she pursued a more reasonable production-inventory policy. An advocate of
absorption cost accounting would argue that a buildup of inventory prior to
an expected heavy selling period creates values that should be recognized in
the cost assigned to inventory. Such a buildup is not the case here; Boroff
has no expectation of increasing sales to bolster her decision to double
production for the second quarter.
The division now has what seems to be excessive inventory if 10,000
units has been sufficient to meet demand in the past. Boroff has made a bad
decision, but her performance improves when measured by income determined
under absorption costing.
The use of variable costing would eliminate the possibility of such
manipulations as Boroff performed. Another way of proceeding is to keep the
present costing method but require that managers justify large increases in
production. The company could also discourage the buildup of unneeded
inventory by charging the managers a specified amount or percentage on
inventory above a preset level. Such a charge would offset, at least
partially, the tendency to take actions such as Boroff's.
With respect to Boroff's fitness for the presidency, the prevailing
answer is probably going to be no. One might also wonder if she is one of
the leading candidates because of apparent good performance in the past.
13-52 Costing Methods and Performance Evaluation (25-30 minutes)
1. This assignment is difficult, with limited information and several
irrelevancies. The explanation of results is that production changed greatly
among the three months and so therefore did the volume variance. Because the
volume variance is not shown separately, it must be calculated from the cost
of sales figures and the additional information. The clue is that production
in April was equal to the normal production used to set the standard fixed
cost at $9. In April, then, cost of sales equals the total standard cost per
unit because there is no volume variance. Selling price is $20 per unit,
which gives sales in units of 22,000 in April ($440,000/$20). Standard total
cost is then $12 ($264,000/22,000). This gives a standard variable cost of
$3 ($12 - $9). Production volume and volume variances for the months are
calculated below.
March May
Sales volume ($ sales/$20 per unit) 18,000 28,000
Standard cost of sales at $12 per unit $216,000 $336,000
13-42
Cost of sales shown on statements 198,000 381,000
Volume variance (unfavorable) $ 18,000
($45,000)
Divided by standard fixed cost per unit of $9
= volume above (below) normal activity, 25,000 units 2,000
(5,000)
Actual production 27,000 20,000
Part of the explanation, then, is the volume variance, which in April
was zero, but which in March gave a boost to income of $18,000 and in May a
drop in income of $45,000, in relation to what income would have been if
25,000 units had been produced each month.
Also, "other expenses" changed with sales volume, suggesting that there
is a variable component. These expenses increased from $142,000 in March to
$150,000 in April, and to $162,000 in May. The changes give a 10% of sales
dollars ($2 per unit) variable component and $106,000 fixed amount calculated
as follows.
For March to April,
Change in cost = $8,000 = 10%
Change in sales $80,000
and, for April to May, $12,000 = 10%
$120,000
Done in units, the result will show a $2 variable cost per unit. At any
volume, the fixed component will be computed as $106,000. In March, variable
costs are $36,000 ($360,000 x 10%, or 18,000 x $2), which when subtracted
from the total cost of $142,000 leaves $106,000.
2. Income statements using variable costing follow.
March April May
Sales $360,000 $440,000
$560,000
Variable costs ($3 production plus $2 other)
(volumes of 18,000, 22,000, and 28,000) 90,000 110,000
140,000
Contribution margin at $15 per unit 270,000 330,000
420,000
Fixed costs ($225,000 production* plus
$106,000 other) 331,000 331,000
331,000
Income (loss) ($ 61,000) ($ 1,000) $
89,000
* $9 per unit x 25,000 units
You might point out that the change in inventory over the period (4,000
units, computed below) times the $9 standard fixed cost per unit explains the
$36,000 difference between the series of incomes computed under the two
alternative approaches.
Income
Units of Variable Absorption
Sales Production Costing Costing
March 18,000 27,000 ($61,000) $20,000
April 22,000 25,000 (1,000) 26,000
May 28,000 20,000 89,000 17,000
Totals 68,000 72,000 $27,000 $63,000
- 68,000 - 27,000
13-43
Inventory increase 4,000
Difference in income (due to inventory increase) $36,000
Note to the Instructor: One of the major points of this case is
behavioral: Gannon does not want to explain to Progman why the results came
out the way they did and uses the reasoning that generally accepted
accounting principles for external reporting are used to prepare the internal
statements. It is possible to discuss the merits of using normal absorption
costing for internal purposes without getting into the rationale for using
absorption costing for external purposes.
Additionally, the case gives the data in relatively compact form, which
should give the students an idea how difficult it can be to interpret income
statements even without introducing a large number of categories on the
statement.
As to the question whether Progman has turned the division around, it
could be argued that he has, based on the results using variable costing and
assuming that he has had little opportunity to implement his policies and
procedures. Income computed on a variable costing basis has increased by
$150,000 from a loss of $61,000 to a profit of $89,000. We need more
information to decide whether the corner had in fact been turned, including
information about seasonality (whether April and May are high sales months),
and about past performance. It would also be important to know whether the
apparent improvement has been purchased at the expense of reduced long-term
prospects for the division or the company.

13-53 Costing Methods and Product Profitability (30 minutes)

Neither manager recognized the differing time requirements for
different valves. The relative profitabilities are as follows.
101-27 101-34 101-56
Contribution margin per unit $ 4 $ 6 $ 9
Number produced in one hour 10 8 4
Contribution margin per hour $40 $48 $36
The order of profitability does not depend on the contribution margin
per unit in situations where all output can be sold and there is a fixed
resource. The 101-56 is the least profitable product and should be made only
up to the committed requirements. The 101-27 should also be made up to
commitments, and all excess hours should be devoted to 101-34.
In this case, the allocation suggested by Emerson does no harm, for if
the profitability per hour of grinding time is computed on a full-cost basis,
the same sequence of profitability is maintained.
101-27 101-34 101-56
Profit per unit, Emerson's example $ 3.00 $ 4.75 $ 6.50
Hourly production 10 8 4
Hourly profit $30.00 $38.00 $26.00
The hourly "profits" are all $10 less than hourly contribution margins,
which is due to the $10 fixed cost per hour. The reason that relative
profitability is not distorted by this allocation is that the number of units
used to determine the fixed cost per unit, which is one hour, is also the
number of units used to determine the output because the analysis is done per
grinding hour. Because the company can use all available grinding hours,
given the demand for the products, the highest profit-per-hour product should
be made with the discretionary time available.
13-44
Emerson was wrong in giving the selling prices of the products that
would equalize their profitability, except in the sense that the prices she
gave would equalize per-unit profit. Neither per-unit contribution nor
contribution per hour would be equalized using her method. If an "equitable
price" is one that provides the company with the same total profit for
whichever product is made using its scarce resources, and if the $38 per hour
profit now earned on 101- 34s is considered "fair," the following prices will
achieve the result:
101-27 101-56
Desired hourly profit $38 $38
Divided by hourly production 10 4
Equals required profit per unit $ 3.80 $9.50
Full cost ($5.00 + $1.00) and ($8.40 + $2.50) 6.00 10.90
Required price $ 9.80 $20.40
The same results follow from using the required contribution margin of
$48 per hour and ignoring the fixed costs.
13-54 Budgeting, Cash Flow, Product Costing, Motivation (35 minutes)
The break-even point is 1,406,250 units.
Fixed costs:
Total $6,750,000
Contribution margin:
Selling price $12.00
Variable costs:
Manufacturing 4.80
Selling and administrative 2.40
Total 7.20
Contribution margin $ 4.80
Break-even ($6,750,000/$4.80) 1,406,250 units
The new break-even point is 1,500,000 units.
Fixed costs--old, as above $6,750,000
--new advertising campaign 450,000
Total fixed costs $7,200,000
Divided by contribution margin per unit, as above $4.80
New break-even point 1,500,000 units
Because 20X3 sales are 1,406,250 units, and the only change in cost
structure is an additional outlay for advertising ($450,000), it should be
immediately apparent that reported income for the year 20X8 ($420,000) is
peculiar. Sales are at the old break-even point, fixed costs are up, a
provision has been made for a profit-sharing pool and income taxes, and the
company is still reporting a profit. A decline in variable costs could
explain this but the variable costs per unit shown on the 20X3 income
statement are the same as in the prior year.
The new break-even point, based on the change in fixed costs of
$450,000, is 1,500,000 units ($7,200,000/$4.80 per unit), or 93,750 units
more than were sold in 20X3. Hence, the profit reported in 20X3 is
definitely peculiar. Given the data regarding production and sales in units,
13-45
and the ending inventory, the next step is to determine the extent to which
fixed costs in inventory are related to the reported profit in 20X3.
Fixed manufacturing costs are $6,000,000, for a capacity of 1,875,000
units, giving a per-unit fixed cost, based on absorption at normal capacity,
of $3.20 per unit. Since the ending inventory contains 468,750 units, the
fixed cost in inventory is $1,500,000 (468,750 x $3.20). (Note that the
$3.20 per-unit fixed cost added to the per-unit variable manufacturing cost
of $4.80 gives the inventory cost per unit of $8, as stated in the problem.)
The $1,050,000 profit before profit-sharing and taxes in 20X3 is now
understandable.
Contribution short of break-even
(1,500,000 units - 1,406,250 units) x $4.80 ($ 450,000)
Current costs carried in ending inventory
(468,750 x $3.20) 1,500,000
Reported profit $1,050,000
Having determined that the 20X3 profit is a result of deferring fixed
costs in inventory, the questions of continued profits, distribution of the
profit-sharing pool, and even the payment of the declared dividend are
particularly interesting. Consider the cash forecast for the coming year.
Variable costs if production and sales
are maintained at present levels:
Manufacturing $ 9,000,000
Selling 3,375,000
Total 12,375,000
Taxes to be paid 420,000
Dividends to pay 200,000
Total outlays without provision for additional
advertising, out-of-pocket fixed costs,
or profit-sharing pool 12,995,000
Sales, if all collected 16,875,000
Cash available for meeting out-of-pocket
fixed costs and profit-sharing distribution
profit-sharing pool $ 3,880,000
Fixed costs (some of which must be cash costs) 6,750,000
Maximum possible shortfall $ 2,870,000
Since the total fixed costs are not identified as to cash costs and noncash
costs, we cannot determine whether the $3,880,000 is sufficient to cover cash
costs. It is unlikely that there will be sufficient cash flow to pay the
dividend, the taxes, and the distribution from the pool.
Of course, we cannot predict what sales will be in 20X4. We can,
however, suggest that discontinuance of the sales campaign should be
considered carefully. With an outlay of $450,000, sales increased by 206,250
units, bringing a contribution margin of $990,000. Thus, $1 spent on
advertising returned $2.20 in contribution. For the potential for future
reported profits we can point out that if inventories remain at current
levels, earning future profits depends on sales reaching levels higher than
in the current year.
It seems clear from the case that the company has no system for
implementing the management functions of planning and control. A system of
comprehensive budgeting encourages the interrelating of established goals.
Had such a system been in force, the production plan would have been
13-46
identified as out of line with sales forecasts. The independent action of
the president further underscores the absence of coordination at the highest
levels of the firm.
There is no evidence that the profit-sharing plan, with its monetary
incentive, has contributed to efficiency, cost reduction, or a return to
profitable operations. Fixed costs remained unchanged, as did per-unit
variable costs, and the "profitable" operations have been explained earlier.
If inflation had been significant during the year and the company managed to
maintain cost levels equal to last year's, the plan might have been
successful.
The problems of motivating employees cannot be resolved, according to
most current organizational behavior experts, simply by providing monetary
incentives. We do not know enough in this case to identify all of the
problems that might prevail at this company, but at least we can note that
the beliefs of the chief executive are clearly considered as paramount. If
his personal beliefs about motivation cannot be shaken by thorough discussion
with his peers (at the recent seminar), it seems unlikely that they will be
influenced by comments of lower-level executives in his own company.
From the independent action of the president in urging production without
limits and sales at a maximum effort, and given the comments of the
executives, it appears that communication with the president is basically
one-way. That is, the production and sales managers might well have foreseen
the results of the uncoordinated efforts but were unable to discuss this with
the senior officer. Given that the executives' performances were going to be
measured (and rewarded) based on their ability to follow the senior officer's
instructions, it should not be surprising that they followed the
instructions.
The comments among the lower-level executives at the time of the last
directors' meeting also identify a seldom discussed but not uncommon
problem-- nepotism. This practice can create motivation problems with
unrelated employees (including executives). There are, of course, some good
effects that may come from this practice. For example, employees may take a
proprietary interest in the firm.
One final note with respect to motivation. Despite the apparent lack of
success of the profit-sharing plan, it is obvious that management should go
ahead with the distribution because failing to do so would create even more
serious problems.

13-47

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CHAPTER 13

STANDARD COSTING AND VARIABLE COSTING

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