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CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila

MANAGEMENT ADVISORY SERVICES


VARIABLE COSTING & ABSORPTION COSTING

THEORY
1. To apply direct costing method it is necessary that you know
A. Standard production rate and times of production elements
B. Contribution margin and break even point in production
C. Variable and fixed cost related to production
D. Controllable and uncontrollable cost of production

2. The following statements about the adoption of variable costing are true, except:
A. All fixed manufacturing costs are recognized as period costs.
B. A direct cost may not become a product cost.
C. It is an acceptable method for general reporting purposes.
D. An indirect cost may be assigned as part of product cost.

3. The change in period-to-period operating income when using variable costing can be
explained by the change in the
A. Unit sales level multiplied by the unit sales price.
B. Finished goods inventory level multiplied by the unit sales price.
C. Unit sales level multiplied by a constant unit contribution margin.
D. Finished goods inventory level multiplied by a constant unit contribution margin.

4. Which of the following is NOT an advantage of using variable costing for internal reporting
purposes?
A. Fixed costs are reported at incurred values, not absorbed values, thus improving control
over those costs.
B. Profits are directly influenced by changes in sales volume.
C. The impact of fixed costs on profits is emphasized.
D. Total costs may be overlooked when evaluating profits.

5. Cay Co.’s 1995 fixed manufacturing overhead costs totaled $100,000, and variable selling
costs totaled $80,000. Under variable costing, how should those costs be classified?
A. B. C. D.
Period Costs $0 $ 80,000 $100,000 $180,000
Product Costs $180,000 $100,000 $ 80,000 $0

6. A cost that is included as part of product costs under both absorption costing and direct
costing is:
A. managerial staff costs D. taxes on factory building
B. insurance E. variable materials handling labor
C. variable marketing expenses.

7. Under variable costing,


A. all product costs are variable. C. all product costs are fixed
B. all period costs are variable. D. product costs are both fixed and variable.

8. Which of the following is not associated with absorption costing?


A. functional format B. gross margin C. Period costs D. contribution margin

9. Calculating income under variable costing does NOT require knowing


A. unit sales. C. selling price.
B. unit variable manufacturing costs. D. unit production.
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10. A criticism of variable costing for managerial accounting purposes is that it
A. is not acceptable for product line segmented reporting.
B. does not reflect cost-volume-profit relationships.
C. overstates inventories.
D. might encourage managers to emphasize the short term at the expense of the long term.

11. All of the following are names for the product costing method in which both fixed and
variable costs are included in overhead rates, except:
A. absorption costing C. direct costing
B. conventional costing D. full costing

12. Under the variable-costing concept, unit product cost would most likely be increased by
A. A decrease in the remaining useful life of factory machinery depreciated on the units-of-
production method.
B. A decrease in the number of units produced.
C. An increase in the remaining useful life of factory machinery depreciated on the sum-of-
the-year’s digits method.
D. An increase in the commission paid to salesman for each unit sold.

13. Under absorption costing, fixed manufacturing overhead could be found in all of the
following except the
A. work-in-process account. C. Cost of Goods Sold.
B. finished goods inventory account. D. period costs.

14. If unit costs remain unchanged and sales volume and sales price per unit both increase from
the preceding period when operating profits were earned, operating profits must
A. Increase under the absorption costing method.
B. Increase under the variable costing method.
C. Decrease under the absorption costing method.
D. Decrease under the variable costing method.

15. When comparing absorption costing with variable costing, which of the following statements
is not true?
A. Absorption costing enables managers to increase operating profits in the short run by
increasing inventories.
B. When sales volume is more than production volume, variable costing will result in higher
operating profit.
C. A manager who is evaluated based on variable costing operating profit would be tempted
to increase production at the end of a period in order to get a more favorable review.
D. Under absorption costing, operating profit is a function of both sales volume and
production volume.

16. Jansen, Inc. pays bonuses to its managers based on operating income. The company uses
absorption costing, and overhead is applied on the basis of direct labor hours. To increase
bonuses, Jansen’s managers may do all of the following except
A. Produce those products requiring the most direct labor.
B. Defer expenses such as maintenance to a future period.
C. Increase production schedules independent of customer demands.
D. Decrease production of those items requiring the most direct labor.

17. A firm presently has total sales of $100,000. If its sales rise, its
A. net income based on variable costing will go up more than its net income based on
absorption costing.
B. net income based on absorption costing will go up more than its net income based on
variable costing.
C. fixed costs will also rise.
D. per unit variable costs will rise.

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18. Both Company Y and Company Z produce similar products that need negligible distribution
costs. Their assets operation and accounting are very similar in all respects except that
Company Y uses direct costing and Company Z uses absorption costing.
A. Co. Y would report a higher inventory value than Co. Z for the years in which production
exceeds sales
B. Co. Y would report a higher inventory value than Co. Z for the years in which production
exceeds the normal or practical capacity
C. Co. Z would report a higher inventory value than Co. Y for the years in which production
exceeds sales
D. Co. Z would report a higher net income than Co. Y for the years in which production
equals sales

19. Which of the following statements is true for a firm that uses variable costing?
A. The cost of a unit of product changes because of changes in number of units
manufactured.
B. Profits fluctuate with sales.
C. An idle facility variation is calculated.
D. Product costs include variable administrative costs.

20. Absorption costing and variable costing are two different methods of assigning costs to units
produced. Of the following five cost items listed, identify the one that is not correctly
accounted for as a product cost.
Part of Product Cost under
Absorption Cost Variable Cost
A. Manufacturing supplies Yes Yes
B. Insurance on factory Yes No
C. Direct labor cost Yes Yes
D. Packaging and shipping costs Yes Yes

21. A company’s net income recently increased by 30% while its inventory increased to equal a
full year’s sales requirements. Which of the following accounting methods would be most
likely to produce the favorable income results?
A. Absorption costing. C. Variable costing.
B. Direct costing. D. Standard direct costing.

22. Unabsorbed fixed overhead costs in an absorption costing system are


A. fixed manufacturing costs not allocated to units produced.
B. variable overhead costs not allocated to units produced.
C. excess variable overhead costs.
D. costs that cannot be controlled.

23. When a firm prepares financial reports by using absorption costing


A. Profits will always increase with increases in sales.
B. Profits may decrease with increased sales even if there is no change in selling prices and
costs.
C. Decreased output and constant sales result in increased profits.
D. Profits will always decrease with decreases in sales.

24. Variable costing and absorption costing will show the same incomes when there are no
A. beginning inventories. C. variable costs.
B. ending inventories. D. beginning and ending inventories.

25. Absorption costing differs from variable costing in that


A. standards can be used with absorption costing, but not with variable costing.
B. absorption costing inventories are more correctly valued.
C. production influences income under absorption costing, but not under variable costing.
D. companies using absorption costing have lower fixed costs.
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26. In a recent period, Marvel Co. incurred $20,000 of fixed manufacturing overhead and
deducted $30,000 of fixed manufacturing overhead. Marvel Co. must be using
A. absorption costing. C. direct costing.
B. variable costing. D. standard costing.

27. Under absorption costing, if sales remain constant from period 1 to period 2, the company
will report a larger income in period 2 when
A. period 2 production exceeds period 1 production.
B. period 1 production exceeds period 2 production.
C. variable production costs are larger in period 2 than period 1.
D. fixed production costs are larger in period 2 than period 1.

28. Other things being equal, net income computed by direct costing method would exceed net
income computed by absorption costing method if
A. Units sold were to exceed units produced.
B. Fixed manufacturing costs were to increase.
C. Units produced were to exceed units sold.
D. Variable manufacturing costs were to increase.

29. Net income is lower under variable costing than under absorption costing when
A. Production increases from the previous period.
B. Production exceeds sales.
C. Production equals sales.
D. Production is less than sales.

30. President X of WXY Corporation requested you to explain the difference of net income
between the variable costing income statements presentation and the absorption costing
method. You would say that the difference
A. Is none if there is no change in the fixed costs in the beginning and ending inventories.
B. Is equal to the fixed costs per unit times the number of units sold.
C. Is attributable to the variable costs in the inventory.
D. Is attributable to the fixed costs in ending inventory.

31. If inventory quantities increase during a period,


A. Variable costing profits will exceed absorption costing profits.
B. Absorption costing profits will exceed variable costing profits.
C. Variable costing profits will equal absorption costing profits.
D. Variable costing will show a higher inventory value than absorption costing.

32. A manufacturing company prepares income statements using both absorption- and variable-
costing methods. At the end of the period, actual sales revenues, total gross margin, and total
contribution margin approximated budgeted figures, whereas net income was substantially
below the budgeted amount. There were no beginning or ending inventories. The most
likely explanation of the net income shortfall is that, compared to budget, actual
A. Sales price and variable costs had declined proportionately.
B. Sales prices had declined proportionately more than variable costs.
C. Manufacturing fixed costs had increased.
D. Selling and administrative fixed expenses had increased.

33. As compared with total absorption costing profit over the entire life of a company, total
variable costing profit will
A. Be less.
B. Be greater.
C. Be equal.
D. Be substantially greater or less depending upon external factors

34. How will a favorable volume variance affect net income under each of the following methods?

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A. B. C. D.
Absorption Reduce Reduce Increase Increase
Variable No effect Increase No effect Reduce

35. A single-product company prepares income statements using both absorption and variable
costing methods. Manufacturing overhead cost applied per unit produced in 2001 was the
same as in 2000. The 2001 variable costing statement reported a profit whereas the 2001
absorption costing statement reported a loss. The difference in reported income could be
explained by units produced in 2001 being
A. Less than units sold in 2001.
B. Less than the activity level used for allocating overhead to the product.
C. In excess of the activity level used for allocating overhead to the product.
D. In excess of units sold in 2001.

PROBLEMS
1. MNO Products, Inc. planned and actually manufactured 200,000 units of its single product in
2000, its first year of operations. Variable manufacturing costs were P30 per unit of product.
Planned and actual fixed manufacturing costs were P600,000, and marketing and
administrative costs totaled P400,000 in 2000. MNO sold 120,000 units of product in 2000
at a selling price of P40 per unit. What is the cost of the ending inventory assuming variable
costing is used?
A. P2,400,000 B. P2,750,000 C. P2,250,000 D. P2,640,000

2. LY & Company completed its first year of operations during which time the following
information were generated:
Total units produced 100,000
Total units sold @ P100 per unit 80,000
Work in process ending inventory 20,000
Costs Variable Cost per Unit Fixed Costs
Raw materials P20.00
Direct labor 12.50
Factory overhead 7.50 P1.2 million
Selling and administrative 10.00 0.7 million
If the company used variable (direct) costing method, the operating income would be
A. P2,100,000 B. P4,000,000c. C. P2,480,000 D. P3,040,000

3. West Co.’s 1988 manufacturing costs were as follows:


Direct materials and direct labor $700,000
Other variable manufacturing costs 100,000
Depreciation of factory building and manufacturing equipment 80,000
Other fixed manufacturing overhead 18,000
What amount should be considered product cost for external reporting purposes?
A. $700,000 B. $800,000 C. $880,000 D. $898,000

4. The total production cost for 20,000 units was P21,000 and the total production cost for
making 50,000 units was P34,000. Once production exceeds 25,000 units, additional fixed
costs of P4,000 were incurred. The full production cost per unit for making 30,000 units is:
A. P0.30 B. P0.68 C. P0.84 D. P0.93

5. At the end of Killo Co.’s first year of operations, 1,000 units of inventory remained on hand.
Variable and fixed manufacturing cost per unit were $90 and $20, respectively. If Killo uses
absorption costing rather than direct (variable) costing, the result would be a higher pretax
income of
A. $20,000. B. $70,000. C. $0. D. $90,000.

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6. Coomber Industries manufactures a single product using standard costing. Variable
production costs are $13 and fixed production costs are $125,000. Coomber uses a normal
activity of 12,500 units to set its standard costs. Coomber began the year with 1,000 units in
inventory, produced 11,000 units, and sold 11,500 units. The standard cost of goods sold
under absorption costing would be
A. $115,000 B. $149,500 C. $253,000 D. $264,500

7. Z Corp. incurred the following costs in 2001 (its first year of operations) based on production
of 10,000 units:
Direct material $5 per unit
Direct labor $3 per unit
Variable product costs $2 per unit
Fixed product costs (in total) $100,000
When Z Corp. prepared its 2001 financial statements, its Cost of Goods Sold was listed at
$100,000. Based on this information, which of the following statements must be true:
A. Z Corp. sold all 10,000 units that it produced.
B. Z Corp. sold 5,000 units.
C. Z Corp. had a very profitable year.
D. From the information given, one cannot tell whether Z Corp.'s financial statements were
prepared based on variable or absorption costing.

8. The Blue Company has failed to reach its planned activity level during its first 2 years of
operation. The following table shows the relationship among units produced, sales, and
normal activity for these years and the projected relationship for Year 3. All prices and costs
have remained the same for the last 2 years and are expected to do so in Year 3. Income has
been positive in both Year 1 and Year 2.
Units Produced Sales Planned Activity
Year 1 90,000 90,000 100,000
Year 2 95,000 95,000 100,000
Year 3 90,000 90,000 100,000
Because Blue Company uses an absorption-costing system, gross margin for year 3 should be
A. Greater than Year 1. C. Equal to Year 1.
B. Greater than Year 2. D. Equal to Year 2.

9. Fleet, Inc. manufactured 700 units of Product A, a new product, during the year. Product A’s
variable and fixed manufacturing costs per unit were $6.00 and $2.00 respectively. The
inventory of Product A on December 31, consisted of 100 units. There was no inventory of
Product A on January 1. What would be the change in the dollar amount of inventory on
December 31 if variable costing were used instead of absorption costing?
A. $800 decrease. B. $200 decrease. C. $0 D. $200 increase.

10. GHI Company had P100,000 income using absorption costing. GHI has no variable
manufacturing costs. Beginning inventory was P5,000 and ending inventory was P12,000.
What is the income under variable costing?
A. P100,000. B. P107,000 C. P88,000 D. P93,000

11. Don Juan Ltd. Manufactures a single product for which the costs and selling prices are:
Variable production costs P 50 per unit
Selling price¶ P125 per unit
Fixed production overhead P200,000 per quarter
Fixed selling and administrative overhead P80,000 per quarter
Normal capacity 20,000 units per quarter
Production in first quarter was 19,000 units and sales volume was 16,000 units. No opening
inventory for the quarter.
The absorption costing profit for the quarter was
A. P920,000 B. P950,000 C. P960,000 D. P970,000

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12. Youthful Biscuits manufactures and sells boxed coconut cookies. The biggest market for
these cookies are as gifts that college students buy for their business teachers. There are 100
cookies per box. The following income statement shows the result of the first year of
operations. This statement was the one included in the company’s annual report to the
stockholders.
Sales (400 boxes at P12.50 a box) P5,000.00
Less: Cost of goods sold (400 boxes at P8 per box) 3,200.00
Gross margin 1,800.00
Less: Selling and administrative expenses 800.00
Net income 1,000.00
Variable selling and administrative expenses are P0.90 per box sold. The company produced
500 boxes during the year. Variable manufacturing costs are P5.25 per box and fixed
manufacturing overhead costs total P1,375 for the year.
What is the company’s direct costing net income?
A. P2,540 B. P2,265 C. P1,000 D. P 725

13. During its first year of operations, a company produced 275,000 units and sold 250,000 units.
The following costs were incurred during the year:
Variable Cost per Unit Fixed Costs
Direct materials $15.00
Direct labor 10.00
Manufacturing overhead 12.50 $2,200,000
Selling and administrative 2.50 1,375,000
The difference between operating income calculated on the absorption-costing basis and on
the variable costing basis is that absorption-costing operating income is
A. $200,000 greater. B. $220,000 greater. C. $325,000 greater. D. $62,500 lesser.

14. A company has the following cost data:


Fixed manufacturing costs $2,000
Fixed selling, general, and administrative costs 1,000
Variable selling costs per unit sold 1
Variable manufacturing costs per unit 2

Beginning inventory 0 units


Production 100 units
Sales 90units at $40 per unit
Variable and absorption-cost net incomes are:
A. $320 variable, $520 absorption C. $520 variable, $320 absorption
B. $330 variable, $530 absorption D. $530 variable, $330 absorption

15. A company manufactures 50,000 units of a product and sells 40,000 units. Total
manufacturing cost per unit is $50 (variable manufacturing cost, $10; fixed manufacturing
cost, $40). Assuming no beginning inventory, the effect on net income if absorption costing
is used instead of variable costing is that:
A. net income is $400,000 lower C. net income is the same
B. net income is $400,000 higher D. net income is $200,000 higher

16. A company had an income of P50,000 using direct costing for a given month. Beginning and
ending inventories for the month are 13,000 units and 18,000 units, respectively. Ignoring
income tax, if the fixed overhead application rate was P2 per unit, what was the income using
absorption costing?
A. P40,000 B. P50,000 C. P60,000 D. P70,000

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Questions 17 through 19 are based on the following information.
The following information is available for X Co. for its first year of operations:
Sales in units 5,000
Production in units 8,000
Manufacturing costs:
Direct labor $3 per unit
Direct material 5 per unit
Variable overhead 1 per unit
Fixed overhead $100,000
Net income (absorption method) $30,000
Sales price per unit $40

17. What would X Co. have reported as its income before income taxes if it had used variable
costing?
A. $30,000 B. ($7,500) C. $67,500 D. ($30,000)

18. What was the total amount of SG&A expense incurred by X Co.?
A. $30,000 B. $62,500 C. $6,000 D. $36,000

19. Based on variable costing, what would X Co. show as the value of its ending inventory?
A. $120,000 B. $64,500 C. $27,000 D. $24,000

Questions 20 through 23 are based on the following information.


The annual flexible budget below was prepared for use in making decisions relations to Product
X.
100,000 units 150,000 units 200,000 units
Sales volume $ 800,000 $1,200,000 $1,600,000
Manufacturing costs:
Variable $300,000 $450,000 $600,000
Fixed 200,000 200,000 200,000
$500,000 $650,000 $800,000
Selling & other expenses
Variable $200,000 $300,000 $400,000
Fixed 160,000 160,000 160,000
$360,000 $460,000 $560,000
Income (or loss) $(60,000) $90000 $240,000
The 200,000 unit budget has been adopted and will be used for allocating fixed manufacturing
costs to units of Product X. At the end of the first 6 months, the following information is
available:
Units
Production completed 120,000
Sales 60,000
All fixed costs are budgeted and incurred uniformly throughout the year, and all costs incurred
coincide with the budget. Over- and under-applied fixed manufacturing costs are deferred until
year-end. Annual sales have the following seasonal pattern.
Portion of Annual Sales
First quarter 10%
Second quarter 20%
Third quarter 30%
Fourth quarter 40%
20. The amount of fixed factory costs applied to product during the first 6 months under
absorption costing is
A. Over-applied by $20,000. C. Under-applied by $40,000.
B. Equal to the fixed costs incurred. D. Under-applied by $80,000.

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21. Reported net income (or loss) for the first 6 months under absorption costing is
A. $160,000 B. $0 C. $40,000 D. $(40,000)

22. Reported net income (or loss) for the first 6 months under variable costing is
A. $180,000 B. $40,000 C. $0 D. $(180,000)

23. Assuming that 90,000 units of Product X were sold during the first 6 months and that this is
to be used as a basis, the revised budget estimate for the total number of units to be sold
during this year is
A. 360,000 B. 240,000 C. 200,000 D. None of the above

Questions 24 through 29 are based on the following information.


Valyn Corporation employs an absorption costing system for internal reporting purposes; however, the company is
considering using variable costing. Data regarding Valyn’s planned and actual operations for the 1995 calendar year
are presented below.
Planned Activity Actual Activity
Beginning finished goods inventory in units 35,000 35,000
Sales in units 140,000 125,000
Production in units 140,000 130,000
The planned per unit cost figures shown in the next schedule were based on the estimated production and sale of
140,000 units in 1995. Valyn uses a predetermined manufacturing overhead rate for applying manufacturing
overhead to its product. Thus, a combined manufacturing overhead rate of $9.00 per unit was employed for
absorption costing purposes in1995. Any over- or under-applied manufacturing overhead is closed to the cost of
goods sold account at the end of the reporting year.
Planned Cost Incurred
Per Unit Total Costs
Direct materials $12.00 $1,680,000 $1,560,000
Direct labor 9.00 1,260,000 1,170,000
Variable manufacturing overhead 4.00 560,000 520,000
Fixed manufacturing overhead 5.00 700,000 715,000
Variable selling expenses 8.00 1,120,000 1,000,000
Fixed selling expenses 7.00 980,000 980,000
Variable administrative expenses 2.00 280,000 250,000
Fixed administrative expenses 3.00 420,000 425,000
Total $50.00 $7,000,000 $6,620,000
The 1995 beginning finished goods inventory for absorption costing purposes was valued at the
1994 planned unit manufacturing cost, which was the same as the 1995 planned unit
manufacturing cost. There are no work-in-process inventories at either the beginning or the end
of the year. The planned and actual unit selling price for 1995 was $70.00 per unit.

24. The value of Valyn Corporation’s 1995 actual ending finished goods inventory on the
absorption costing bases was
A. $900,000 B. $1,200,000 C. $1,220,000 D. $1,350,000

25. The value of Valyn Corporation’s 1995 actual ending finished goods inventory on the
variable costing basis was
A. $1,400,000. B. $1,125,000. C. $1,000,000. D. $750,000

26. Valyn Corporation’s total fixed costs expensed in 1995 on the absorption costing bases were
A. $2,095,000 B. $2,120,000 C. $2,055,000 D. $2,030,000

27. Valyn Corporation’s actual manufacturing contribution margin for 1995 calculated on the
variable costing basis was
A. $4,375,000 B. $4,935,000 C. $4,910,000 D. $5,625,000.

28. The total variable costs expensed in 1995 by Valyn Corporation on the variable costing basis
was

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A. $4,375,000 B. $4,500,000 C. $4,325,000 D. $4,550,000

29. The difference between Valyn Corporation’s 1995 operating income calculated on the
absorption costing basis and calculated on the variable costing basis was
A. $65,000 B. $25,000 C. $40,000 D. $90,000

Questions 30 through 35 are based on the following information.


Louder Industries manufactures a single product. Variable production costs are $20 and fixed
production costs are $150,000. Louder uses a normal activity of 10,000 units to set its standard
costs. Louder began the year with no inventory, produced 11,000 units, and sold 10,500 units.

30. Ending inventory under variable costing would be


A. $10,000 B. $15,000 C. $17,500 D. $20,000

31. Ending inventory under absorption costing would be


A. $10,000 B. $15,000 C. $17,500 D. $20,000

32. The volume variance under variable costing would be


A. $0 B. $10,000 C. $15,000 D. Some other number.

33. The volume variance under absorption costing would be


A. $0 B. $10,000 C. $15,000 D. Some other number.

34. The standard cost of goods sold under variable costing would be
A. $200,000 B. $210,000 C. $367,500 D. Some other number.

35. The standard cost of goods sold under absorption costing would be
A. $200,000 B. $210,000 C. $367,500 D. Some other number.

36. In the ABC Company, sales are P800,000, cost of goods under absorption costing is
P600,000, and total operating expenses are P120,000. If cost of goods sold is 70% variable
and total operating expenses are 60% fixed, what is the contribution margin under variable
costing?
A. P332,000. B. P308,000. C. P260,000. D. P380,000.

37. A company manufactures a single product for its customers by contracting in advance of
production. Thus, the company produces only units that will be sold by the end of each
period. For the last period, the following data were available:
Sales $40,000
Direct materials 9,050
Direct labor 6,050
Rent (9/10 factory, 1/10 office) 3,000
Depreciation on factory equipment 2,000
Supervision (2/3 factory, 1/3 office) 1,500
Salespeople’s salaries 1,300
Insurance (2/3 factory, 1/3 office) 1,200
Office supplies 750
Advertising 700
Depreciation on office equipment 500
Interest on loan 300
The gross profit margin percentage (rounded) was
A. 34% B. 41% C. 44% D. 46%

When the going gets tough, the tough gets going.

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ANSWER KEY
Theory Problem
1. D 21. A 1. A 21. C
2. C 22. A 2. A 22. C
3. C 23. B 3. D 23. D
4. D 24. D 4. D 24. B
5. D 25. C 5. A 25. C
6. E 26. A 6. D 26. A
7. A 27. A 7. B 27. D
8. D 28. A 8. C 28. A
9. D 29. B 9. B 29. B
10. D 30. A 10. D 30. A
11. C 31. B 11. B 31. C
12. A 32. D 12. D 32. A
13. D 33. C 13. A 33. C
14. B 34. C 14. B 34. B
15. C 35. A 15. B 35. C
16. D 16. C 36. A
17. A 17. B 37. D
18. C 18. B
19. B 19. C
20. D 20. A

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