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8-2 Timing is the key in distinguishing between absorption and variable costing. All
manufacturing costs will ultimately be expensed under either absorption costing or
variable costing. The difference between the two methods lies in the time period
during which fixed manufacturing-overhead costs are expensed. Under variable
costing, the fixed manufacturing-overhead costs are expensed during the period in
which they are incurred. Under absorption costing, fixed manufacturing-overhead
costs are held in inventory as product costs until the period during which the units
are sold. Then those costs flow into cost-of-goods-sold expense.
8-3 The term direct costing is a misnomer. Variable costing is a better term for this
product-costing method. Under variable costing, the variable costs of direct material,
direct labor, and variable overhead are treated as product costs. Fixed
manufacturing-overhead costs are not treated as product costs. Thus, the important
characteristic of a cost that determines whether it is treated as a product cost under
variable costing is its cost behavior. Direct costing is a misnomer because variable-
overhead costs are not direct costs, but they are treated as product costs under the
variable-costing method.
8-4 When inventory increases, the income reported under absorption costing will be
greater than the income reported under variable costing. This difference results from
the fact that under absorption costing, some of the fixed manufacturing costs
incurred during the period will not be expensed. In contrast, under variable costing
all of the fixed manufacturing costs incurred during the period will be expensed
during that period.
8-5 Many managers prefer variable costing over absorption costing because income
statements prepared under variable costing more closely reflect operations. For
example, when sales increase, other things being equal, income will also increase
under variable costing. Under absorption costing, however, income will not
necessarily increase when sales increase.
8-7 Some managerial accountants believe that absorption costing may provide an
incentive for managers to overproduce inventory so that the fixed manufacturing
overhead costs may be spread over a larger number of product units, thereby
lowering the reported product cost per unit. Throughput costing avoids this
potential problem by not assigning fixed manufacturing overhead as a product cost.
8-8 Variable and absorption costing will not result in significantly different income
measures in a JIT setting. Under JIT inventory and production management,
inventories are minimal and as a result inventory changes are also minimal. Variable
and absorption costing result in significantly different income measures only when
inventory changes significantly from period to period.
8-9 Many managers prefer absorption-costing data for cost-based pricing decisions.
They argue that fixed manufacturing overhead is a necessary cost of production. To
exclude this fixed cost from the inventoried cost of a product, as is done under
variable costing, is to understate the cost of the product. This, in turn, could lead to
setting cost-based prices too low.
8-10 Proponents of variable costing argue that a products variable cost provides a better
basis for the pricing decision. They point out that any price above a products
variable cost makes a positive contribution toward covering fixed cost and profit.
Difference in
reported income = $7.40 2,000 = $14,800
Difference in
reported income = $9.04 5,000 = $45,200
b. No difference.
*Under this scenario, direct material cost is the only throughput cost.
1. Variable costing:
2. Absorption costing:
= $21,000
Difference in reported income:
Since inventory decreased during the year, income reported under absorption
costing will be $21,000 lower than income reported under variable costing.
1. Variable costing:
2. Absorption costing:
= $10,500
Difference in reported income:
Since inventory increased during the year, income reported under absorption
costing will be $10,500 higher than income reported under variable costing.
3. Throughput costing:
Difference in
= $110 3,000 = $330,000
reported income
b. No difference.
Difference in
= $200 2,000 = $400,000
reported income
$5
Break-even point:
Total cost 14,667 units
$4 (rounded)
Revenue
$3
$2
Fixed cost
$1 ($2,200,000)
Units (in
5 10 15 thousands)
fixed cost
Break-even point =
unit contribution margin
$2,200,000
=
$350 $200
Absorption costing, in contrast, does not maintain the separation of fixed and
variable costs. Fixed costs are unitized in the fixed overhead rate and inventoried as
product costs along with variable manufacturing costs.
The specifics of the answer will vary, depending on the company and product selected.
However, the relative merits of absorption, variable and throughput costing as the basis for
pricing decisions are generally the same, regardless of the company and product.
Many managers prefer absorption-costing data for cost-based pricing decisions. They argue
that fixed manufacturing overhead is a necessary cost of production. To exclude this fixed
cost from the inventoried cost of a product, as is done under variable costing, is to
understate the cost of the product. This, in turn, could lead to setting cost-based prices too
low.
Proponents of variable costing argue that a products variable cost provides a better basis
for the pricing decision. They point out that any price above a products variable cost
makes a positive contribution toward covering fixed cost and profit.
Proponents of throughput costing take the variable-costing argument a step further and
argue that a products throughput cost provides the best basis for a cost-based pricing
decision. They argue that any price above a products unit-level spending for direct costs
(e.g., throughput costs) makes a positive contribution toward covering fixed cost and profit.
budgetedfixed overhead
Predetermined fixed overhead rate =
budgetedproduction
$300,000
= = $2 per unit
150,000
2. a. DELIZIOSO S.P.A.
ABSORPTION-COSTING INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X1
Sales revenue (130,000 units sold at $20 per unit) ........................ $2,600,000
Less: Cost of goods sold (at
absorption cost of $15 per unit) ................................................... 1,950,000
Gross margin ................................................................................... $ 650,000
Less: Selling and administrative expenses:
Variable (at $1 per unit) ....................................................... 130,000
Fixed ..................................................................................... 150,000
Operating income ............................................................................ $ 370,000
b. DELIZIOSO S.P.A.
VARIABLE-COSTING INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X1
Sales revenue (130,000 units sold at $20 per unit) ........................ $2,600,000
Less: Variable expenses:
Variable manufacturing costs
(at variable cost of $13 per unit) ....................................... 1,690,000
Variable selling and administrative costs
(at $1 per unit) .................................................................... 130,000
Contribution margin ........................................................................ $ 780,000
Less: Fixed expenses:
Fixed manufacturing overhead ........................................... 300,000
Fixed selling and administrative expenses ....................... 150,000
Operating income ............................................................................ $ 330,000
= $40,000
As shown in requirement (2), reported income is $40,000 lower under variable
costing.
5. In the electronic version of the solutions manual, press the CTRL key and click on
the following link: Build a Spreadsheet 08-21.xls
1. Delizioso S.p.A. produced 150,000 units (i.e., containers) and sold 130,000, which
leaves an ending finished-goods inventory of 20,000 units. Because only direct
material qualifies as a throughput cost, the cost of the ending inventory is $120,000
(20,000 containers x $6).
2.
DELIZIOSO S.P.A.
THROUGHPUT-COSTING INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X1
3. Gross margin is computed by subtracting cost of goods sold from sales revenue.
The cost of a unit differs and depends on whether a firm uses absorption costing
or throughput costing. With absorption costing, the product cost consists of four
elements: direct material, direct labor, variable manufacturing overhead, and fixed
manufacturing overhead. Throughput costing, on the other hand, assigns only the
unit-level spending for direct costs (in this case, direct material) as the cost of a
product.
4. In the electronic version of the solutions manual, press the CTRL key and click on
the following link: Build a Spreadsheet 08-22.xls
1. Since the planned production volume was 100,000 units, actual production was also
100,000 units.
Since inventory increased during the year, reported income is higher under
absorption costing.
fixed overhead
$20,000 = 20,000 units
100,000 units
Dollars
$250,000
Profit = $220,000 at
80,000 unit sales volume
$200,000
$150,000
$100,000
$50,000 Break-even
point 25,000 units
Profit
0 Sales in units
Loss 25,000 50,000 75, 000 100,000
$(50,000)
$(100,000)
$(150,000)
Outback Corporations reported 20x1 income will be higher under absorption costing
because actual production exceeded actual sales. Therefore, inventory increased and some
fixed costs will remain in inventory under absorption costing which would be expensed
under variable costing.
= $1,200,000
= $1,000,000
= 5,000 units
$700,000
Budgeted fixed manufacturing overhead per unit =
140,000 units
= $5 per unit
Income reported under absorption costing will be higher than that reported under
variable costing, because inventory increased during the year.
a. It is unlikely that the company would have manufactured 5,000 more units than it
sold. Under JIT, production and sales would be nearly equal.
b. Reported income under variable and absorption costing would most likely be
nearly the same. Differences in reported income are caused by changes in
inventory levels. Under JIT, inventory levels would be minimal. Therefore, the
change in these levels would be minimal.
4. If Stars Above had implemented JIT and installed a flexible manufacturing system at
the beginning of 20x1, it is unlikely that reported income would have differed by as
great a magnitude. Under this scenario, production and sales would have been
nearly the same. As a result, reported income under variable and absorption costing
would have been nearly equal. Differences in reported income are caused by
significant changes in inventory levels, which do not occur under JIT because
inventory is minimal.
1. Reported income will be lower under variable costing, because inventory is expected
to increase by 1,000 units during the year. (Twenty thousand units will be produced
in the last two months, but 19,000 units will be sold.)
2. a. Variable costing: Total contribution during first 10 months is equal to the fixed
costs plus profit for that period.
$2,200,000
Contribution margin per unit = = $22 per unit
100,000
Projected total sales for the year are 119,000 units (100,000 in first 10 months
plus 19,000 units in last 2 months). We can compute projected income for the
year as follows:
The operating income projected for the year under variable costing is $218,000.
Note: The problem states that the prior periods cost rates are the same as those
of the current period.
Absorption costing: The gross margin for the first 10 months is $200,000. Notice
that income and gross margin are the same, since there are no selling or
administrative expenses. Therefore, during the first 10 months:
$200,000
Gross margin per unit = = $2 per unit
100,000 units
Projected sales for the year are 119,000 units, so we can compute projected
income for the year as follows:
There are no selling and administrative costs, so projected operating income for
the year under absorption costing is also $238,000.
Therefore, reported income will be $20,000 lower under variable costing than
under absorption costing.
(a) Pricing decisions: Many managers prefer to use absorption-costing data in cost-
based pricing decisions. They argue that fixed manufacturing overhead is a
necessary cost incurred in the production process. To exclude this fixed cost from
the inventoried cost of a product, as is done under variable costing, is to understate
the cost of the product. For this reason, most companies that use cost-based pricing
base their prices on absorption-costing data.
(b) Definition of an asset: Another controversy about absorption and variable costing
hinges on the definition of an asset. An asset is a thing of value owned by the
organization with future service potential. By accounting convention, assets are
valued at their cost. Since fixed costs comprise part of the cost of production,
advocates of absorption costing argue that inventory (an asset) should be valued at
its full (absorption) cost of production. Moreover, they argue that these costs have
future service potential since the inventory can be sold in the future to generate sales
revenue.
1. Total cost:
2. The cost of the year-end inventory of 400 units (10,000 units produced 9,600 units
sold) is computed as follows:
3. The total costs would be allocated between the current periods income statement
and the year-end inventory on the balance sheet. Thus:
5. In the electronic version of the solutions manual, press the CTRL key and click on
the following link: Build a Spreadsheet 08-28.xls
$800,000
+ $32
80,000
2. Reconciliation:
Difference In
Difference Predetermined Fixed Overhead
Reported Income
in Change in Fixed Expensed Under
Absorption Variable Reported Inventory Overhead Absorption and
Year Costing Costing Income (in units) Rate* Variable Costing
1 $485,000 $485,000 -0- -0- $10 0
2 345,000 145,000 $200,000 20,000 10 $200,000
3 555,000 655,000 (100,000) (10,000) 10 (100,000)
$800,000
*Predetermined fixed manufacturing overhead rate =
80,000
Change in Predetermined
inventory fixed overhead
(in units) rate
Income reported under absorption costing will be lower, because inventory will
decline during year 4.
b. Over the four-year period, the total of all reported operating income will be the
same under absorption and variable costing. This result will occur because
inventory does not change over the four-year period. It starts out at zero on
January 1 of year 1, and it ends up at zero on December 31 of year 4.