costacctg13_sm_ch09

costacctg13_sm_ch09 - CHAPTER 9 INVENTORY COSTING AND...

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Unformatted text preview: CHAPTER 9 INVENTORY COSTING AND CAPACITY ANALYSIS 9­1 No. Differences in operating inco me between variable costing and absorption costing are due to accounting for fixed manufacturing costs. Under variable cost ing only variable manufacturing costs are included as inventoriable costs. Under absorption costing both variable and fixed manufacturing costs are included as inventoriable costs. Fixed marketing and distribut ion costs are not accounted for differently under variable costing and absorption costing. 9­2 The term direct costing is a misno mer for variable costing for two reasons: a. Variable costing does not include all direct costs as inventoriable costs. Only variable direct manufacturing costs are included. Any fixed direct manufacturing costs, and any direct nonmanufacturing costs (either variable or fixed), are excluded fro m inventoriable costs. b. Variable costing includes as inventoriable costs not only direct manufacturing costs but also some indirect costs (variable indirect manufacturing costs). 9­3 No. The difference between absorption costing and variable costs is due to accounting for fixed manufacturing costs. As service or merchandising co mpanies have no fixed manufacturing costs, these companies do not make cho ices between absorption costing and variable costing. 9­4 The main issue between variable costing and absorption costing is the proper timing of the release o f fixed manufacturing costs as costs of the period: a. at the time of incurrence, or b. at the time the finished units to which the fixed overhead relates are sold. Variable costing uses (a) and absorption costing uses (b). 9­5 No. A company that makes a variable­cost/fixed­cost dist inct ion is not forced to use any specific cost ing method. The Stassen Co mpany example in the text of Chapter 9 makes a variable­cost/fixed­cost dist inct ion. As illustrated, it can use variable costing, absorption costing, or throughput costing. A co mpany that does not make a variable­cost/fixed­cost distinction cannot use variable costing or throughput costing. However, it is not forced to adopt absorption costing. For interna l reporting, it could, for example, classify all costs as costs of the period in which they are incurred. 9­6 Variable costing does not view fixed costs as unimportant or irrelevant, but it maintains that the distinction between behaviors of different costs is crucial for certain decisio ns. The planning and management of fixed costs is critical, irrespective of what inventory costing method is used. 9­7 Under absorption costing, heavy reduct ions o f inventory during the account ing period might combine wit h low production and a large production vo lume variance. This co mbinat ion could result in lower operating inco me even if the unit sales level rises. 9­8 (a) The factors that affect the breakeven point under variable costing are: 1. Fixed (manufacturing and operating) costs. 2. Contribut ion margin per unit. 9­1 (b) The factors that affect the breakeven po int under absorption costing are: 1. Fixed (manufacturing and operating) costs. 2. Contribut ion margin per unit. 3. Production level in units in excess of breakeven sales in unit s. 4. Deno minator level chosen to set the fixed manufacturing cost rate. 9­9 Examples o f dysfunct ional decisio ns managers may make to increase reported operating inco me are: a. Plant managers may switch production to those orders that absorb the highest amount of fixed manufacturing overhead, irrespect ive of the demand by customers. b. Plant managers may accept a particular order to increase production even though another plant in the same company is better suited to handle that order. c. Plant managers may defer maintenance beyo nd the current period to free up more time for production. 9­10 Approaches used to reduce the negative aspects associated with using absorption costing include: a. Change the accounting system: · Adopt either variable or throughput costing, both of which reduce the incentives of managers to produce for inventory. · Adopt an inventory ho lding charge for managers who tie up funds in inventory. b. Extend the time period used to evaluate performance. By evaluating performance over a longer time period (say, 3 to 5 years), the incentive to take short­run actions that reduce long­term inco me is lessened. c. Include nonfinancial as well as financial variables in the measures used to evaluate performance. 9­11 The theoretical capacity and practical capacity deno minator­level concepts emphasize what a plant can supply. The normal capacity utilization and master­budget capacity utilization concepts emphasize what customers demand for products produced by a plant. 9­12 The down ward demand spiral is the continuing reduction in demand for a company’s product that occurs when the prices of co mpet itors’ products are not met and (as demand drops further), higher and higher unit costs result in more and more reluctance to meet compet itors’ prices. Pr icing decisio ns need to consider compet itors and customers as well as costs. 9­13 No. It depends on how a company handles the production­vo lume variance in the end­o f­ period financial statements. For example, if the adjusted allocation­rate approach is used, each deno minator­level capacit y concept will give the same financial statement numbers at year­end. 9­14 For tax reporting in the U.S., the IRS requires companies to use the practical capacit y concept. At year­end, proration of any variances between inventories and cost of goods sold is required (unless the variance is immaterial in amo unt). 9­15 No. The costs of having too much capacit y/too little capacit y invo lve revenue opportunit ies potentially forgone as well as costs of mo ney t ied up in plant assets. 9­2 9­16 (30 min.) Variable and absorption costing, explaining operating­income differences. 1. Key inputs for inco me statement computations are April Beginning inventory Production Goods available for sale Units so ld Ending inventory 0 500 500 350 150 May 150 400 550 520 30 The budgeted fixed cost per unit and budgeted total manufacturing cost per unit under absorption costing are April May $2,000,000 $2,000,000 500 500 $4,000 $4,000 $10,000 $10,000 $14,000 $14,000 (a) (b) (c)=(a)÷(b) (d) (e)=(c)+(d) (a) Budgeted fixed manufacturing costs Budgeted production Budgeted fixed manufacturing cost per unit Budgeted variable manufacturing cost per unit Budgeted total manufacturing cost per unit Variable costing a Revenues Variable costs Beginning inventory Variable manufacturing costsb Cost of goods available for sale c Deduct ending inventory Variable cost of goods sold d Variable operating costs Total variable costs Contribut ion margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income a $24,000 × 350; $24,000 × 520 b $10,000 × 500; $10,000 × 400 April 2008 $8,400,000 $ 0 5,000,000 5,000,000 (1,500,000) 3,500,000 1,050,000 4,550,000 3,850,000 2,000,000 600,000 2,600,000 $1,250,000 c $10,000 × 150; $10,000 × 30 d $3,000 × 350; $3,000 × 520 May 2008 $12,480,000 $1,500,000 4,000,000 5,500,000 (300,000) 5,200,000 1,560,000 6,760,000 5,720,000 2,000,000 600,000 2,600,000 $3,120,000 9­3 (b) Absorption costing April 2008 $8,400,000 $ 0 5,000,000 2,000,000 7,000,000 (2,100,000) 0 4,900,000 3,500,000 1,050,000 600,000 1,650,000 $1,850,000 1,560,000 600,000 2,160,000 $ 2,640,000 May 2008 $12,480,000 $2,100,000 4,000,000 1,600,000 7,700,000 (420,000) 400,000 U 7,680,000 4,800,000 Revenuesa Cost of goods sold Beginning inventory Variable manufacturing costsb Allocated fixed manufacturing costsc Cost of goods available for sale d Deduct ending inventory e Adjust ment for prod.­vol. variance Cost of goods sold Gross margin Operating costs Variable operating costsf Fixed operating costs Total operating costs Operating income a $24,000 × 350; $24,000 × 520 $10,000 × 500; $10,000 × 400 c $4,000 × 500; $4,000 × 400 b d e $14,000 × 150; $14,000 × 30 $2,000,000 – $2,000,000; $2,000,000 – $1,600,000 f $3,000 × 350; $3,000 × 520 2. Absorption­costing Variable­costing – operating income operating income = Fixed manufacturing costs Fixed manufacturing costs – in ending inventory in beginning inventory April: $1,850,000 – $1,250,000 = ($4,000 × 150) – ($0) $600,000 = $600,000 May: $2,640,000 – $3,120,000 = ($4,000 × 30) – ($4,000 × 150) – $480,000 = $120,000 – $600,000 – $480,000 = – $480,000 The difference between absorption and variable costing is due so lely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May). 9­4 9­17 (20 min.) Throughput costing (continuation of Exercise 9­16). 1. a Revenues Direct material cost of goods sold Beginning inventory b Direct materials in goods manufactured Cost of goods available for sale c Deduct ending inventory Total direct material cost of goods sold Throughput contribution Other costs Manufacturing costs Other operating costs Total other costs Operating income a April 2008 $8,400,000 $ 0 3,350,000 3,350,000 (1,005,000) 2,345,000 6,055,000 d 3,650,000 f 1,650,000 May 2008 $12,480,000 $1,005,000 2,680,000 3,685,000 (201,000) 3,484,000 8,996,000 e 3,320,000 g 2,160,000 5,300,000 $ 755,000 e f 5,480,000 $ 3,516,000 $24,000 × 350; $24,000 × 520 $6,700 × 500; $6,700 × 400 c $6,700 × 150; $6,700 × 30 d ($3,300 × 500) + $2,000,000 b ($3,300 × 400) + $2,000,000 ($3,000 × 350) + $600,000 g ($3,000 × 520) + $600,000 2. Operating income under: Absorption costing Variable costing Throughput costing April $1,850,000 1,250,000 755,000 May $2,640,000 3,120,000 3,516,000 In April, throughput costing has the lowest operating inco me, whereas in May throughput costing has the highest operating inco me. Throughput costing puts greater emphasis on sales as the source of operating inco me than does either absorption or variable costing. 3. Throughput costing puts a penalt y on production wit hout a corresponding sale in the same period. Costs other than direct materials that are variable wit h respect to production are expensed in the period of incurrence, whereas under variable costing they would be capitalized. As a result, throughput costing provides less incent ive to produce for inventory than eit her variable costing or absorption costing. 9­5 9­18 (40 min.) Variable and absorption costing, explaining operating­income differences. 1. Key inputs for inco me statement computations are: January 0 1,000 1,000 700 300 February 300 800 1,100 800 300 March 300 1,250 1,550 1,500 50 Beginning inventory Production Goods available for sale Units so ld Ending inventory The budgeted fixed manufacturing cost per unit and budgeted total manufacturing cost per unit under absorption costing are: January $400,000 1,000 $400 $900 $1,300 February $400,000 1,000 $400 $900 $1,300 March $400,000 1,000 $400 $900 $1,300 (a) Budgeted fixed manufacturing costs (b) Budgeted production (c)=(a)÷(b) Budgeted fixed manufacturing cost per unit (d) Budgeted variable manufacturing cost per unit (e)=(c)+(d) Budgeted total manufacturing cost per unit 9­6 (a) a Variable Costing January 2009 $1,750,000 $ 0 900,000 900,000 (270,000) 630,000 420,000 1,050,000 700,000 400,000 140,000 540,000 $ 160,000 400,000 140,000 540,000 $ 260,000 February 2009 $2,000,000 $270,000 720,000 990,000 (270,000) 720,000 480,000 1,200,000 800,000 400,000 140,000 540,000 $ 960,000 March 2009 $3,750,000 $ 270,000 1,125,000 1,395,000 (45,000) 1,350,000 900,000 2,250,000 1,500,000 Revenues Variable costs b Beginning inventory Variable manufacturing costsc Cost of goods available for sale d Deduct ending inventory Variable cost of goods sold Variable operating costse Total variable costs Contribut ion margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income a $2,500 × 700; $2,500 × 800; $2,500 × 1,500 b $? × 0; $900 × 300; $900 × 300 c $900 × 1,000; $900 × 800; $900 × 1,250 d $900 × 300; $900 × 300; $900 × 50 e $600 × 700; $600 × 800; $600 × 1,500 9­7 (b) Absorption Costing January 2009 $1,750,000 $ 0 900,000 400,000 1,300,000 (390,000) 0 910,000 840,000 420,000 140,000 560,000 $ 280,000 480,000 140,000 620,000 $ 260,000 February 2009 $2,000,000 $ 390,000 720,000 320,000 1,430,000 (390,000) 80,000 U 1,120,000 880,000 900,000 140,000 1,040,000 $ 860,000 March 2009 $3,750,000 $ 390,000 1,125,000 500,000 2,015,000 (65,000) (100,000) F 1,850,000 1,900,000 a Revenues Cost of goods sold b Beginning inventory Variable manufacturing costsc Allocated fixed manufacturing costsd Cost of goods available for sale e Deduct ending inventory Adjust ment for prod. vol. var.f Cost of goods sold Gross margin Operating costs Variable operating costsg Fixed operating costs Total operating costs Operating income a b $2,500 × 700; $2,500 × 800; $2,500 × 1,500 $?× 0; $1,300 × 300; $1,300 × 300 c $900 × 1,000; $900 × 800; $900 × 1,250 d $400 × 1,000; $400 × 800; $400 × 1,250 e $1,300 × 300; $1,300 × 300; $1,300 × 50 f $400,000 – $400,000; $400,000 – $320,000; $400,000 – $500,000 g $600 × 700; $600 × 800; $600 × 1,500 9­8 Fixed manufacturing æFixed manufacturing ö ö æAbsorption­costing – æ Variable costing ö = æ ö cos n ç è operating income ø èoperating incomeø è ending itsvientory ÷ – ç beginncost s in ntory ÷ øè ø n ing inve January: $280,000 – $160,000 = ($400 × 300) – $0 $120,000 = $120,000 February: $260,000 – $260,000 = ($400 × 300) – ($400 × 300) $0 = $0 March: $860,000 – $960,000 = ($400 × 50) – ($400 × 300) – $100,000 = – $100,000 The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in January) and out of inventories as they decrease (as in March). 2. 9­9 9­19 (20–30 min.) Throughput costing (continuation of Exercise 9­18). 1. January Revenues Direct material cost of goods sold b Beginning inventory Direct materials in goods c ma nufactured Cost of goods available for sale d Deduct ending inventor y Total direct material cost of goods sold Throughput contribution Other costs e Manufacturing f Operating Total other costs Operating income a b a February March $ 0 $1,750,000 $150,000 $2,000,000 $ 150,000 625,000 775,000 (25,000) 400,000 1,600,000 720,000 620,000 900,000 1,040,000 1,340,000 $ 260,000 $3,750,000 500,000 500,000 (150,000) 350,000 1,400,000 800,000 560,000 1,360,000 $ 40,000 400,000 550,000 (150,000) 750,000 3,000,000 1,940,000 $1,060,000 $2,500 × 700; $2,500 × 800; $2,500 × 1,500 $? × 0; $500 × 300; $500 × 300 c $500 × 1,000; $500 × 800; $500 × 1,250 d $500 × 300; $500 × 300; $500 ×50 e ($400 × 1,000) + $400,000; ($400 × 800) + $400,000; ($400 × 1,250) + $400,000 f ($600 × 700) + $140,000; ($600 × 800) + $140,000; ($600 × 1,500) + $140,000 2. Operating income under: January $280,000 160,000 40,000 February $260,000 260,000 260,000 March $860,000 960,000 1,060,000 Absorption costing Variable costing Throughput costing Throughput costing puts greater emphasis on sales as the source of operating inco me than does absorption or variable costing. 3. Throughput costing puts a penalt y on producing without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed when incurred, whereas under variable costing they would be capitalized as an inventoriable cost. 9­10 9­20 (40 min) Variable versus absorption costing. 1. Income Statement for the Zwatch Company, Variable Costing for the Year Ended December 31, 2009 Revenues: $22 × 345,400 Variable costs Beginning inventory: $5.10 × 85,000 Variable manufacturing costs: $5.10 × 294,900 Cost of goods available for sale Deduct ending inventory: $5.10 × 34,500 Variable cost of goods sold Variable operating costs: $1.10 × 345,400 Adjust ment for variances Total variable costs Contribut ion margin Fixed costs Fixed manufacturing overhead costs Fixed operating costs Total fixed costs Operating income Absorption Costing Data Fixed manufacturing overhead allocation rate = Fixed manufacturing overhead/Deno minator level machine­hours = $1,440,000 ¸ 6,000 = $240 per machine­hour Fixed manufacturing overhead allocation rate per unit = Fixed manufacturing overhead allocation rate/standard production rate = $240 ¸ 50 = $4.80 per unit $7,598,800 $ 433,500 1,503,990 1,937,490 (175,950) 1,761,540 379,940 0 2,141,480 5,457,320 1,440,000 1,080,000 2,520,000 $2,937,320 9­11 Income Statement for the Zwatch Company, Absorption Costing for the Year Ended December 31, 2009 Revenues: $22 × 345,400 Cost of goods sold Beginning inventory ($5.10 + $4.80) × 85,000 Variable manuf. costs: $5.10 × 294,900 Allo cated fixed manuf. costs: $4.80 × 294,900 Cost of goods available for sale Deduct ending inventory: ($5.10 + $4.80) × 34,500 Adjust for manuf. variances ($4.80 × 5,100)a Cost of goods sold Gross margin Operating costs Variable operating costs: $1.10 × 345,400 Fixed operating costs Total operating costs Operating income a $7,598,800 $ 841,500 1,503,990 1,415,520 $3,761,010 (341,550) 24,480 U 3,443,940 4,154,860 $ 379,940 1,080,000 1,459,940 $2,694,920 Production volume variance = [(6,000 hours × 50) – 294,900] × $4.80 = (300,000 – 294,900) × $4.80 = $24,480 2. Zwatch’s operating margins as a percentage of revenues are Under variable costing: Revenues Operating inco me Operating inco me as percentage of revenues Under absorption costing: Revenues Operating inco me Operating inco me as percentage of revenues $7,598,800 2,937,320 38.7% $7,598,800 2,694,920 35.5% 3. Operating inco me using variable costing is about 9% higher than operating inco me calculated using absorption costing. Variable costing operating inco me – Absorption costing operating inco me = $2,937,320 – $2,694,920 = $242,400 Fixed manufacturing costs in beginning inventory under absorption costing – Fixed manufacturing costs in ending inventory under absorption costing = ($4.80 × 85,000) – ($4.80 × 34,500) = $242,400 9­12 4. The factors the CFO should consider include (a) Effect on managerial behavior. (b) Effect on external users o f financial statements. I would reco mmend absorption costing because it considers all the manufacturing resources (whether variable or fixed) used to produce units of output. Absorption costing has many crit ics. However, the dysfunct ional aspects associated with absorption costing can be reduced by · Careful budgeting and inventory planning. · Adding a capital charge to reduce the incentives to build up inventory. · Monitoring nonfinancial performance measures. 9­21 (10 min.) Absorption and variable costing. The answers are 1(a) and 2(c). Computations: 1. Absorption Costing: Revenuesa Cost of goods sold: Variable manufacturing costsb Allocated fixed manufacturing costsc Gross margin Operating costs: d Variable operating Fixed operating Operating income a b $4,800,000 $2,400,000 360,000 2,760,000 2,040,000 1,200,000 400,000 1,600,000 $ 440,000 $40 × 120,000 $20 × 120,000 c Fixed manufacturing rate = $600,000 ÷ 200,000 = $3 per output unit Fixed manufacturing costs = $3 × 120,000 d $10 × 120,000 2. Variable Costing: Revenuesa Variable costs: b Variable manufacturing cost of goods sold c Variable operating costs Contribut ion margin Fixed costs: Fixed manufacturing costs Fixed operating costs Operating income a $4,800,000 $2,400,000 1,200,000 3,600,000 1,200,000 600,000 400,000 1,000,000 $ 200,000 $40 × 120,000 $20 × 120,000 c $10 × 120,000 b 9­13 9­22 (40 min) Absorption versus variable costing. 1. The variable manufacturing cost per unit is $55 + $45 + $120 = $220. 2009 Variable­Costing Based Operating Income Statement Revenues (8,960 ´ $1,200 per unit) Variable costs Beginning inventory Variable manufacturing costs (10,000 units ´ $220 per unit) Cost of goods available for sale a Deduct: Ending inventory (1,040 units ´ $220 per unit) Variable cost of goods sold Variable market ing costs (8,960 units ´ $75 per unit) Total variable costs Contribut ion margin Fixed costs Fixed manufacturing costs Fixed R&D Fixed market ing Total fixed costs Operating income a $10,752,000 $ 0 2,200,000 2,200,000 (228,800) 1,971,200 672,000 2,643,200 8,108,800 1,471,680 981,120 3,124,480 5,577,280 $2,531,520 Beginning Inventory 0 + Production 10,000 – Sales 8,960 = Ending Inventory 1,040 units 2. 2009 Absorption­Costing Based Operating Income Statement Revenues (8,960 units ´ $1,200 per unit) Cost of goods sold Beginning inventory Variable manufacturing costs (10,000 units ´ $220 per unit) Allo cated fixed manufacturing costs (10,000 units ´ $165 per unit) Cost of goods available for sale Deduct ending inventory (1,040 units ´ ($220 + $165) per unit) Deduct favorable production vo lume variance Cost of goods sold Gross margin Operating costs Variable market ing costs (8,960 units ´ $75 per unit) Fixed R&D Fixed market ing Total operating costs Operating income a $10,752,000 $ 0 2,200,000 1,650,000 3,850,000 (400,400) (178,320)a F 3,271,280 7,480,720 672,000 981,120 3,124,480 4,777,600 $2,703,120 PVV = Allocated $1,650,000 ($165 ´ 10,000) – Actual $1,471,680 = $178,320 9­14 3. 2009 operating inco me under absorption costing is greater than the operating inco me under variable costing because in 2009 inventories increased by 1,040 units, and under absorption costing fixed overhead remained in the ending inventory, and resulted in a lower cost of goods sold (relat ive to variable costing). As shown below, the difference in the two operating inco mes is exactly the same as the difference in the fixed manufacturing costs included in ending vs. beginning inventory (under absorption costing). Operating income under absorption costing Operating income under variable costing Difference in operating inco me under absorption vs. variable costing $2,703,120 2,531,520 $ 171,600 Under absorption costing: Fixed mfg. costs in ending inventory (1,040 units ´ $165 per unit) $ 171,600 Fixed mfg. costs in beginning inventory (0 units ´ $165 per unit) 0 Change in fixed mfg. costs between ending and beginning inventory $ 171,600 4. Relative to the obvious alternat ive of using contribut ion margin (fro m variable costing), the absorption­costing based gross margin has some pros and cons as a performance measure for Electron’s supervisors. It takes into account both variable costs and fixed costs—costs that the supervisors should be able to control in the lo ng­run—and therefore it is a more complete measure than contribut ion margin which ignores fixed costs (and may cause the supervisors to pay less attention to fixed costs). The downside of using absorption­costing­based gross margin is the supervisor’s temptation to use inventory levels to control the gross margin—in part icular, to shore up a sagging gross margin by building up inventories. This can be o ffset by specifying, or limit ing, the inventory build­up that can occur, charging the supervisor a carrying cost for ho lding inventory, and using nonfinancial performance measures such as the ratio of ending to beginning inventory. 9­15 9­23 (20–30 min.) Comparison of actual­costing methods. The numbers are simplified to ease computations. This problem avo ids standard costing and its complicat ions. 1. Variable­costing inco me statements: 2008 Sales 1,000 units Production 1,400 units $3,000 $ 0 700 700 (200) 500 1,000 1,500 1,500 700 400 1,100 $ 400 700 400 1,100 $ 700 2009 Sales 1,200 units Production 1,000 units $3,600 $ 200 500 700 (100) 600 1,200 1,800 1,800 Revenues ($3 per unit) Variable costs: Beginning inventory Variable cost of goods manufactured Cost of goods available for sale a Deduct ending inventor y Variable cost of goods sold Variable operating costs Variable costs Contribution margin Fixed costs Fixed ma nufacturing costs Fixed operating costs Total fixed costs Operating income a Unit inventoriable costs: Year 1: $700 ÷ 1,400 = $0.50 per unit; $0.50 × (1,400 – 1,000) Year 2: $500 ÷ 1,000 = $0.50 per unit; $0.50 × (400 + 1,000 – 1,200) 2. Absorption­costing inco me statements: 2008 Sales 1,000 units Production 1,400 units $3,000 $ 0 700 700 1,400 (400) 1,000 2,000 1,000 400 1,400 $ 600 1,200 400 1,600 $ 640 2009 Sales 1,200 units Production 1,000 units $3,600 $ 400 500 700 1,600 (240) 1,360 2,240 Revenues ($3 per unit) Cost of goods sold: Beginning inventory Variable manufacturing costs a Fixed ma nufacturing costs Cost of goods available for sale b Deduct ending inventor y Cost of goods sold Gross margin Operating costs: Variable operating costs Fixed operating costs Total operating costs Operating income a Fixed manufacturing cost rate: Year 1: $700 ÷ 1,400 = $0.50 per unit Year 2: $700 ÷ 1,000 = $0.70 per unit b Unit inventoriable costs: Year 1: $1,400 ÷ 1,400 = $1.00 per unit; $1.00 × (1400 – 1000) Year 2: $1,200 ÷ 1,000 = $1.20 per unit $1.20 × (400 + 1,000 – 1,200) 9­16 3. Variable Costing: Operating income Ending inventory Absorption Costing: Operating income Ending inventory Fixed manuf. overhead • in beginning inventory • in ending inventory io ble æAbsortpntg n Varsitang ö cos i co i ç operating – operating ÷ è income income ø Year 1: $600 – $400 $200 Year 2: $640 – $700 –$60 2008 $400 200 $600 400 0 200 2009 $700 100 $640 240 200 140 = Fi Fi æmanuxed sts manuxed stsö f. co f. co ç in ending – in beginning ÷ è inventory inventory ø $0.50 × 400 – $0 $200 ($0.70 × 200) – ($0.50 × 400) –$60 = = = = The difference in reported operating inco me is due to the amount of fixed manufacturing overhead in the beginning and ending inventories. In Year 1, absorption costing has a higher operating inco me of $200 due to ending inventory having $200 more in fixed manufacturing overhead than does beginning inventory. In Year 2, variable costing has a higher operating inco me of $60 due to ending inventory under absorption costing having $60 less in fixed manufacturing overhead than does beginning inventory. 4. a. Absorption costing is more likely to lead to inventory build­ups than variable costing. Under absorption costing, operating inco me in a given accounting period is increased by inventory buildup, because so me fixed manufacturing costs are accounted for as an asset (inventory) instead of as a cost of the period of production. b. Alt hough variable costing will counteract undesirable inventory build­ups, other measures can be used without abandoning absorption costing. Examples include: (1) careful budget ing and inventory planning, (2) incorporating a carr ying charge for inventory, (3) changing the period used to evaluate performance to be long­term, (4) including nonfinancial variables that measure inventory levels in performance evaluat ions. 9­17 9­24 (40 min.) Variable and absorption costing, sales, and operating­income changes. 1. Headsmart’s annual fixed manufacturing costs are $1,200,000. It allocates $24 of fixed manufacturing costs to each unit produced. Therefore, it must be using $1,200,000 ¸ $24 = 50,000 units (annually) as the deno minator level to allocate fixed manufacturing costs to the units produced. We can see fro m Headsmart’s inco me statements that it disposes off any production vo lume variance against cost of goods sold. In 2009, 60,000 units were produced instead of the budgeted 50,000 units. This resulted in a favorable production volume variance of $240,000 F ((60,000 – 50,000) units ´ $24 per unit), which, when written off against cost of goods sold, increased gross margin by that amount. 2. The breakeven calculat ion, same for each year, is shown below: Calculation of breakeven volume 2008 2009 2010 Selling price ($2,100,000 ¸ 50,000; $2,100,000 ¸ 50,000; $2,520,000 ¸ 60,000) $42 $42 $42 Variable cost per unit (all manufacturing) 14 14 14 Contribut ion margin per unit $28 $28 $28 Total fixed costs (fixed mfg. costs + fixed selling & admin. costs) $1,400,000 $1,400,000 $1,400,000 Breakeven quant it y = Total fixed costs ¸ contribut ion margin per unit 50,000 50,000 50,000 3. Variable Costing Sales (units) Revenues Variable cost of goods sold Beginning inventory $14 ´ 0; 0; 10,000 Variable manuf. costs $14 ´ 50,000; 60,000; 50,000 Deduct ending inventory $14 ´ 0; 10,000; 0 Variable cost of goods sold Contribut ion margin Fixed manufacturing costs Fixed selling and administrative expenses Operating income Explaining variable costing operating income Contribut ion margin ($28 contribut ion margin per unit ´ sales units) Total fixed costs Operating income 2008 2009 2010 50,000 50,000 60,000 $2,100,000 $2,100,000 $2,520,000 0 0 140,000 700,000 840,000 700,000 0 (140,000) 0 700,000 700,000 840,000 $1,400,000 $1,400,000 $1,680,000 $1,200,000 $1,200,000 $1,200,000 200,000 200,000 200,000 $ 0 $ 0 $ 280,000 $1,400,000 $1,400,000 $1,680,000 1,400,000 1,400,000 1,400,000 $ 0 $ 0 $ 280,000 9­18 4. Reconciliation of absorption/variable costing operating incomes (1) Absorption costing operating income (ACOI) (2) Variable costing operating inco me (VCOI) (3) Difference (ACOI – VCOI) (4) Fixed mfg. costs in ending inventory under absorption costing (ending inventory in units ´ $24 per unit) (5) Fixed mfg. costs in beginning inventory under absorption costing (beginning inventory in units ´ $24 per unit) (6) Difference = (4) – (5) 2008 $0 0 $0 $0 2009 $240,000 0 $240,000 $240,000 2010 $ 40,000 280,000 $(240,000) $ 0 0 $0 0 $240,000 240,000 $(240,000) In the table above, row (3) shows the difference between the operating inco me under absorption costing and the operating inco me under variable costing, for each of the three years. In 2008, the difference is $0; in 2009, absorption costing inco me is greater by $240,000; and in 2010, it is less by $240,000. Row (6) above shows the difference between the fixed costs in ending inventory and the fixed costs in beginning inventory under absorption costing, which is $0 in 2008, $240,000 in 2009 and ­$240,000 in 2010. Row (3) and row (6) explain and reconcile the operating inco me differences between absorption costing and variable costing. Stuart Weil is surprised at the non­zero, posit ive net inco me (reported under absorption costing) in 2009, when sales were at the ‘breakeven vo lume’ of 50,000; further, he is concerned about the drop in operating inco me in 2010, when, in fact, sales increased to 60,000 units. In 2009, starting with zero inventories, 60,000 units were produced, 50,000 were sold, i.e., at the end o f the year, 10,000 units remained in inventory. These 10,000 units had each absorbed $24 of fixed costs (total of $240,000), which would remain as assets on Headsmart’s balance sheet unt il they were so ld. Cost of goods sold, represent ing only the costs of the 50,000 units sold in 2009, was accordingly reduced by $240,000, the production vo lume variance, resulting in a posit ive operating inco me even though sales were at breakeven levels. The fo llowing year, in 2010, production was 50,000 units, sales were 60,000 units i.e., all of the fixed costs that were included in 2009 ending inventory, flowed through COGS in 2010. Contribut ion margin in 2010 was $1,680,000 (60,000 units ´ $28), but, in absorption costing, COGS also contains the allocated fixed manufacturing costs of the units sold, which were $1,440,000 (60,000 units ´ $24), result ing in an operating inco me of $40,000 = 1,680,000 – $1,440,000 – $200,000 (fixed sales and admin.) Hence the drop in operating inco me under absorption costing, even though sales were greater than the computed breakeven volume: inventory levels decreased sufficient ly in 2010 to cause 2010’s operating inco me to be lower than 2009 operating inco me. Note that beginning and ending with zero inventories during the 2008–2010 period, under both costing methods, Headsmart’s total operating inco me was $280,000. 9­19 9­25 (10 min.) Capacity management, denominator­level capacity concepts. 1. a, b 2. a 3. d 4. c, d 5. c 6. d 7. a 8. b (or a) 9. b 10. c, d 11. a, b 9­26 (25 min.) Denominator­level problem. 1. Budgeted fixed manufacturing overhead costs rates: Budgeted Fixed Manufacturing Overhead per Period $ 4,000,000 4,000,000 4,000,000 4,000,000 Budgeted Fixed Manufacturing Overhead Cost Rate $ 1,388.89 2,083.33 3,333.33 2,666,67 Denominator Level Capacity Concept Theoretical Practical Normal Master­budget Budgeted Capacity Level 2,880 1,920 1,200 1,500 The rates are different because of varying deno minator­level concepts. Theoretical and practica l capacit y levels are driven by supply­side concepts, i.e., “how much can I produce?” Normal and master­budget capacity levels are driven by demand­side concepts, i.e., “how much can I sell?” (or “how much should I produce?”) The variances that arise fro m use of the theoretical or practical level concepts will signal that there is a divergence between the supply of capacit y and the demand for capacit y. This is useful input to managers. As a general rule, however, it is important not to place undue reliance on the production vo lume variance as a measure of the economic costs of unused capacit y. 2. 3. Under a cost­based pricing system, the cho ice o f a master­budget level deno minator will lead to high prices when demand is low (more fixed costs allocated to the individual product level), further eroding demand; conversely, it will lead to low prices when demand is high, forgoing profits. This has been referred to as the downward demand spiral—the continuing reduction in demand that occurs when the prices of co mpet itors are not met and demand drops, result ing in even higher unit costs and even more reluctance to meet the prices of competitors. The posit ive aspects of the master­budget denominator level are that it is based on demand for the product and indicates the price at which all costs per unit would be recovered to enable the company to make a profit. Master­budget denominator level is also a good benchmark against which to evaluate performance. 9­20 9­27 (55 min.) Variable and absorption costing and breakeven points 1. a. 2009 Variable­Costing Based Operating Income Statement Revenues (800 cat trees x $300 per tree) Variable costs Beginning inventory Variable manufacturing costs (1,000 trees ´ $75 per tree.) Cost of goods available for sale Deduct: Ending inventory (200 trees ´ $75 per tree) Variable cost of goods sold Variable shipping costs (800 trees ´ $25 per tree) Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed selling and administrative Total fixed costs Operating income $240,000 $ 0 75,000 75,000 (15,000) 60,000 20,000 80,000 160,000 100,000 50,000 150,000 $ 10,000 1. b. 2009 Absorption­Costing Based Operating Income Statement Revenues (800 cat trees x $300 per tree) Cost of goods sold Beginning inventory Variable manufacturing costs (1,000 trees. ´ $75 per tree) Allocated fixed manufacturing costs (1,000 trees ´ $100* per tree) Cost of goods available for sale Deduct ending inventory (200 trees ´ ($75 + $100) per tree) Cost of goods sold Gross margin Operating costs Variable marketing costs (800 trees ´ $25 per pkg.) Fixed selling and administrative Total operating costs Operating income *Fixed manufacturing rate = Fixed manufacturing cost/production = $100,000/1000 trees = $100 per tree $240,000 $ 0 75,000 100,000 175,000 (35,000) 140,000 100,000 20,000 50,000 70,000 $ 30,000 9­21 2. Breakeven point in units: a. Variable Costing: QT = Total Fixed Costs + Target Operating Income Contributi n Margin Per Unit o ($100 000 + $ ,000 + $ , 50 ) 0 $ - ($ + $ ) 300 75 25 $150, 00 0 $200 QT = QT QT = = 750 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree Total Fixed + Target + é Fixed Manuf. ´ ê Cost Rate Cost OI ë B eakeven (Salres in Units Units ù Produced ú û QT = ) Contribution Margin Per Unit $150, 00 + [$100 ( T - 1, 00) 0 Q 0 ] $200 $150, 000 + $100 QT - $100,000 $200 QT = QT = $200 QT - $100 QT = $150,000 – $100,000 $100 QT = $50,000 QT = 500 cat trees 9­22 3. Breakeven point in units: a. Variable Costing: QT = Total Fixed Costs + Target Operating Income Contributi n Margin Per Unit o ($100 000 + $ ,000 + $ , 50 ) 0 $ - ($ + $ ) 300 100 25 $150, 00 0 $175 QT = QT QT = = 857.14 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree Total Fixed + Target + é Fixed Manuf. ´ ê Cost Rate Cost OI ë B eakeven (Salres in Units Units ù Produced ú û QT = ) Contribution Margin Per Unit $150, 00 + [$100 ( T - 1, 00) 0 Q 0 ] $175 $150, 000 + $100 QT - $100,000 $175 QT = QT = $175 QT - $100 QT = $150,000 – $100,000 $75 QT = $50,000 QT = 666.66 cat trees 9­23 4. Units needed to achieve target operating inco me: a. Variable Costing: QT = Total Fixed Costs + Target Operating Income Contributi n Margin Per Unit o ($100 000 + $ ,000 + $ ,000 , 50 ) 10 $ 300 - ($ + $ ) 75 25 $160, 00 0 $200 QT = QT QT = = 800 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree Total Fixed + Target + é Fixed Manuf. ´ ê Cost Rate Cost OI ë B eakeven (Salres in Units Units ù Produced ú û QT = ) Contribution Margin Per Unit $150, 000 + $30, 000 + [ $100 (QT - 1, 000) ] $200 $180, 000 + $100 QT - $100,000 $200 QT = QT = $200 QT - $100 QT = $180,000 – $100,000 $100 QT = $80,000 QT = 800 cat trees 9­24 9­28 (40 min.) Variable costing versus absorption costing. 1. Absorption Costing: Mavis Company Income Statement For the Year Ended Dece mber 31, 2009 Revenues (540,000 × $5.00) Cost of goods sold: a Beginning inventory (30,000 × $3.70 ) Variable manufacturing costs (550,000 × $3.00) Allocated fixed manufacturing costs (550,000 × $0.70) Cost of goods available for sale Deduct ending inventor y (40,000 × $3.70) b Add adjustment for prod.­vol. variance (50,000 × $0.70) Cost of goods sold Gross margin Operating costs: Variable operating costs (540,000 × $1) Fixed operating costs Total operating costs Operating income $2,700,000 $ 111,000 1,650,000 385,000 2,146,000 (148,000) 35,000 U 2,033,,000 667,000 540,000 120,000 660,000 $ 7,000 a $3.00 + ($7.00 ÷ 10) = $3.00 + $0.70 = $3.70 b [(10 units per mach. hr. × 60,000 mach. hrs.) – 550,000 units)] = 50,000 units unfavorable 2. Variable Costing: Mavis Company Income Statement For the Year Ended Dece mber 31, 2009 Revenues Variable cost of goods sold: Beginning inventory (30,000 × $3.00) Variable manufacturing costs (550,000 × $3.00) Cost of goods available for sale Deduct ending inventor y (40,000 × $3.00) Variable cost of goods sold Variable operating costs Contribution margin Fixed costs: Fixed ma nufacturing over hea d costs Fixed operating costs Total fixed costs Operating income $2,700,000 $ 90,000 1,650,000 1,740,000 (120,000) 1,620,000 540,000 540,000 420,000 120,000 540,000 $ 0 9­25 3. The difference in operating inco me between the two costing methods is: to e­ Fi Fi æAbsosrtpnig n­ Varsiaiblg ö æmanuxed sts manuxed stsö co i co t n f. co f. co ç operating – operating ÷ = ç in ending – in beginning ÷ è income income ø è inventory inventory ø $7,000 – $0 $7,000 $7,000 = [(40,000 × $0.70) – (30,000 × $0.70)] = $28,000 – $21,000 = $7,000 The absorption­costing operating inco me exceeds the variable costing figure by $7,000 because of the increase of $7,000 during 2009 of the amount of fixed manufacturing costs in ending inventory vis­a­vis beginning inventory. 4. Total fixed manufacturing costs Actual and budget line $420,000 $385,000 Unfavorable production­volume variance rabl u vol a } Favuome ve rpiraondcec tion­ Allocated line @ $7.00 { 55,000 Machine­hours 60,000 5. Absorption costing is more likely to lead to buildups of inventory than does variable costing. Absorption costing enables managers to increase reported operating inco me by building up inventory which reduces the amount of fixed manufacturing overhead included in the current period’s cost of goods sold. Ways to reduce this incent ive include (a) Careful budgeting and inventory planning. (b) Change the accounting system to variable costing or throughput costing. (c) Incorporate a carrying charge for carrying inventory. (d) Use a longer time period to evaluate performance than a quarter or a year. (e) Include nonfinancial as well as financial measures when evaluating management performance. 9­26 9­29 (40 min.) Variable costing and absorption costing, the All­Fixed Company. This problem always generates active classroom discussion. 1. The treatment of fixed manufacturing overhead in absorption costing is affected primarily by what deno minator level is selected as a base fo r allocating fixed manufacturing costs to units produced. In this case, is 10,000 tons per year, 20,000 tons, or some other denominator level the most appropriate base? We usually place the fo llowing possibilit ies on the board or overhead projector and then ask the students to indicate by vote how many used one denominator level versus another. Incidentally, discussio n tends to move more clearly if variable­costing inco me statements are discussed first, because there is litt le disagreement as to computations under variable costing. a. Variable­Costing Inco me Statement: 2008 $300,000 $280,000 40,000 2009 $300,000 Together $600,000 Revenues (and contribution margin) Fixed costs: Manufacturing costs Operating costs Operating income 320,000 $ (20,000) 320,000 $ (20,000) 640,000 $ (40,000) 9­27 b. Absorption­Costing Income Statement: The ambiguit y about the 10,000­ or 20,000­unit deno minator level is intentional. IF YOU WISH, THE AMBIGUITY MAY BE AVOIDED BY GIVING THE STUDENTS A SPECIFIC DENOMINATOR LEVEL IN ADVANCE. Alternat ive 1. Use 20,000 units as a deno minator; fixed manufacturing overhead per unit is $280,000 ¸ 20,000 = $14. 2008 2009 Together Revenues $300,000 $ 300,000 $600,000 Cost of goods sold * Beginning inventory 0 140,000 0 Allo cated fixed manufacturing costs at $14 280,000 — 280,000 Deduct ending inventory (140,000) — — Adjust ment for production­vo lume variance 0 280,000 U 280,000 U Cost of goods sold 140,000 420,000 560,000 Gross margin 160,000 (120,000) 40,000 Operating costs 40,000 40,000 80,000 Operating income $120,000 $(160,000) $ (40,000) * Inventory carried forward from 2008 and sold in 2009. Alternat ive 2. Use 10,000 units as a deno minator; fixed manufacturing overhead per unit is $280,000 ¸ 0,000 = $28. 1 2008 $300,000 0 560,000 (280,000) (280,000) F 0 300,000 40,000 $260,000 2009 $300,000 * 280,000 — — 280,000 U 560,000 (260,000) 40,000 $(300,000) Revenues Cost of goods sold Beginning inventory Allo cated fixed manufacturing costs at $28 Deduct ending inventory Adjust ment for production­vo lume variance Cost of goods sold Gross margin Operating costs Operating income * Together $600,000 0 560,000 — 0 560,000 40,000 80,000 $ (40,000) Inventory carried forward from 2008 and sold in 2009. Note that operating income under variable costing fo llows sales and is not affected by inventory changes. Note also that students will understand the variable­costing presentation much more easily than the alternat ives presented under absorptio n costing. 9­28 2. Breakeven point Fixed costs $320, 000 under variable = = Contributi n margin per ton o $30 costing = 10,667 (rounded) tons per year or 21,334 for two years. If the co mpany could sell 667 more tons per year at $30 each, it could get the extra $20,000 contribution margin needed to break even. Most students will say that the breakeven point is 10,667 tons per year under both absorption costing and variable costing. The logical quest ion to ask a student who answers 10,667 tons for variable costing is: “What operating inco me do you show for 2008 under absorption costing?” If a student answers $120,000 (alternat ive 1 above), or $260,000 (alternative 2 above), ask: “But you say your breakeven po int is 10,667 tons. How can you show an operating inco me on only 10,000 tons so ld during 2008?” The answer to the above dilemma lies in the fact that operating inco me is affected by both sales and production under absorption costing. Given that sales would be 10,000 tons in 2008, solve for the production level that will provide a breakeven level of zero operating income. Using the formula in the chapter, sales of 10,000 units, and a fixed manufacturing overhead rate of $14 (based on $280,000 ÷ 20,000 units deno minator level = $14): Let P = Production level æ Target ö éæ Fixed manuf. ö æ Breakeven öù ÷ êç ÷ç Units ÷ú æ To tal fixed ö ç ç ç co sts ÷ + ç o perat ing ÷ + êç o verhead ÷ ´ ç sales in - pro duced ÷ú ÷ è øç Breakeven ÷ç ÷ ç units ÷ú rat e è inco me ø êè øè øû ë sales = Unit co ntributi n margin o in unit s $320‚000 + $0 + $14(10‚000 - P ) 10,000 tons = $30 $300,000 = $320,000 + $140,000 – $14P $14P = $160,000 P = 11,429 units (rounded) Proof: Gross margin, 10,000 × ($30 – $14) Production­vo lume variance, (20,000 – 11,429) × $14 Marketing and administrative costs Operating income (due to rounding) $160,000 $119,994 40,000 159,994 $ 6 9­29 Given that production would be 20,000 tons in 2008, solve for the breakeven unit sales level. Using the formula in the chapter and a fixed manufacturing overhead rate of $14 (based on a deno minator level o f 20,000 units): Let N = Breakeven sales in units ù æ Target ö éæ Fixed manuf. ö ÷ êç ÷æ Units ö ú æ To tal fixed ö ç ç ç co sts ÷ + ç o perat ing ÷ + êç o verhead ÷ ´ ç N - pro duced ÷ ú ÷ ç ÷ è øç øú ÷ êç ÷è rat e è inco me ø ëè ø û N = Unit co ntributi n margin o $320,000 + $0 + $14(N - 20,000) N = $30 $30N = $320,000 + $14N – $280,000 $16N = $40,000 N = 2,500 units Proof: Gross margin, 2,500 × ($30 – $14) $40,000 Production­vo lume variance $ 0 Marketing and administrative costs 40,000 40,000 Operating income $ 0 We find it helpful to put the fo llowing co mparisons on the board: Variable costing breakeven = f(sales) = 10,667 tons = f(sales and production) = f(10,000 and 11,429) = f(2,500 and 20,000) Absorption costing breakeven 3. Absorption costing inventory cost: Either $140,000 or $280,000 at the end of 2008 and zero at the end of 2009. Variable costing: Zero at all times. This is a major crit icism o f variable costing and focuses on the issue o f the definit io n of an asset. 4. Operating inco me is affected by both production and sales under absorption costing. Hence, most managers would prefer absorption costing because their performance in any given reporting period, at least in the short run, is influenced by how much production is scheduled near the end of a period. 9­30 9­30 (30–35 min.) Comparison of variable costing and absorption costing. 1. Since production vo lume variance is unfavorable, the budgeted fixed manufacturing overhead must be larger than the fixed manufacturing overhead allocated. Production ­ volume variance $400,000 Budgeted fixed Fixed manufacturing = manufacturing overhead – overhead allocated = $1,200,000 – Allocated Allocated = $800,000, which is 67% of $1,200,000 If 67% of the budgeted fixed costs were allocated, the plant must have been operating at 67% of deno minator level in 2009. 2. The problem provides the beginning and ending inventory balances under both, variable and absorption costing. Under variable costing, all fixed costs are written off as period costs, i.e., they are not inventoried. Under absorption costing, inventories include variable and fixed costs. Therefore the difference between inventory under absorption costing and inventory under variable costing is the amount of fixed costs included in the inventory. Fixed Manuf. Overhead in Inventory $520,000 140,000 Absorption Costing Inventories: December 31, 2008 December 31, 2009 $1,720,000 206,000 Variable Costing $1,200,000 66,000 3. Note that the answer to (3) is independent of (1). The difference in operating inco me o f $380,000 ($1,520,000 – $1,140,000) is explained by the release of $380,000 of fixed manufacturing costs when the inventories were decreased dur ing 2009: Fixed Manuf. Overhead in Inventory $520,000 140,000 $380,000 Absorption Costing Inventories: December 31, 2008 December 31, 2009 Release o f fixed manuf. costs $1,720,000 206,000 Variable Costing $1,200,000 66,000 The above schedule in this requirement is a formal presentation of the equation: in ble æAbsortpntg g Varsitang ö cos i co i ç operating – operating ÷ è income income ø ($1,140,000 – $1,520,000) – $380,000 = æmanuFi.xed ts in manuFi.xed ts in ö f cos f cos ç ending – beginning ÷ è inventory inventory ø ($140,000 – $520,000) – $380,000 9­31 = = Alternat ively, the presence of fixed manufacturing overhead costs in each inco me statement can be analyzed: Absorption costing, Fixed manuf. costs in cost of goods sold ($5,860,000 − $4,680,000) Production­volume variance Variable costing, fixed manuf. costs charged to expense Difference in operating inco me explained $1,180,000 400,000 1,580,000 (1,200,000) $ 380,000 4. Under absorption costing, operating inco me is a funct ion of both sales and production (i.e., change in inventory levels). During 2009, Hinkle experienced a severe decline in inventory levels: sales were probably higher than ant icipated, production was probably lower than planned (at 67% of deno minator level), resulting in much of the 2009 beginning inventory passing through cost of goods sold in 2009. This means that under absorption costing, large amounts of inventoried fixed costs have flowed through 2009 cost of goods sold, result ing in a smaller operating inco me than in 2008, despite an increase in sales volume. 9­31 (30 min.) Effects of differing production levels on absorption costing income: Metrics to minimize inventory buildups. 1. 10,000 12,000 books books Revenues $1,000,000 $1,000,000 a Cost of goods sold 720,000 720,000 b c Production­vo lume variance 0 ( 24,000) Net cost of goods sold 720,000 696,000 Gross Margin $ 280,000 $ 304,000 a 16,000 books $1,000,000 720,000 (72,000)d 648,000 $ 352,000 cost per unit = ($60 + $120,000/10,000 books) = $72 per book CGS = $72 ´ 10,000 = $720,000 b vo lume variance = Budgeted fixed cost – fixed overhead rate ´ production $120,000 – $12 ´ 10,000 books = $0 c vo lume variance = Budgeted fixed cost – fixed overhead rate ´ production $120,000 – $12 ´ 12,000 books = $24,000 d vo lume variance = Budgeted fixed cost – fixed overhead rate ´ production $120,000 – $12 ´ 16,000 books = $72,000 9­32 2. 10,000 books 0 10,000 books 10,000 10,000 0 books × $72 $0 12,000 books 0 12,000 books 12,000 10,000 2,000 books × $72 $144,000 16,000 books 0 16,000 books 16,000 10,000 6,000 books × $72 $432,000 Beginning inventory + Production ─ Books sold Ending inventory ´ Cost per book Cost of Ending Inventory 3a. 10,000 books Gross margin $280,000 Less 10% ´ Ending inventory 0 Adjusted gross margin $280,000 12,000 books $304,000 (14,400) $289,600 16,000 books $352,000 (43,200) $308,800 While adjust ing for ending inventory does to some degree mit igate the increase in inventory associated with excess production, it may be difficult to mechanically co mpensate for all of the increased inco me. In addit ion, it does nothing to hold the manager responsible for the poor decisio ns fro m the organizat ion’s standpo int. 3b. 10,000 books 1) Inventory change: End inventory ─ begin inventory 2) Excess production (%) Production ÷ sales 0 12,000 books 2,000 books 16,000 books 6,000 books 10000 ÷ 10,000 1.0 12000 ÷ 10000 1.2 16000 ÷10000 1.6 · A ratio of ending inventory to beginning inventory, as suggested inthe book, is not possible since beginning inventory was 0, so we subst ituted change in inventory level. · For these non­financial measures to be useful they must be incorporated into the reward funct ion of the manager. 9­33 9­32 (25–30 min.) Alternative denominator­level capacity concepts, effect on operating income. 1. Denominator­Level Capacity Concept Theor etical capacity Practical capacity Nor mal capacity utilization Master­budget utilization (a) January­June 2009 (b) July­December 2009 Budgeted Fixed Days of Hours of Budgeted Manuf. Overhead Production Production Barrels Denominator Level per Period per Period per Day per Hour (Barrels) (1) (2) (3) (4) (5) = (2) ´ (3) ´ (4) $28,000,000 360 24 540 4,665,600 28,000,000 350 20 500 3,500,000 28,000,000 350 20 400 2,800,000 14,000,000 14,000,000 175 175 20 20 320 480 1,120,000 1,680,000 Budgeted Fixed Manufacturing Overhead Rate per Barrel (6) = (1) ¸ (5) $ 6.00 8.00 10.00 12.50 8.33 The differences arise for several reasons: a. The theoretical and practical capacit y concepts emphasize supply factors, while normal capacit y utilizat ion and master­budget utilizat ion emphasiz e demand factors. b. The two separate six­mo nth rates for the master­budget utilizat ion concept differ because o f seasonal differences in budgeted production. 2. Using co lumn (6) from above, Per Barrel Budgeted Budgeted Fixed Mfg. Variable Overhead Mfg. Rate per Barrel Cost Rate (6) (7) a $6.00 $30.20 8.00 30.20 10.00 30.20 Denominator­Level Capacity Concept Theor etical capacity Practical capacity Nor mal capacity utilization a Budgeted Total Mfg Cost Rate (8) = (6) + (7) $36.20 38.20 40.20 Fixed Mfg. Overhead Costs Allocated (9) = 2,600,000 ´ (6) $15,600,000 20,800,000 26,000,000 Fixed Mfg. Overhead Variance (10) = $27,088,000 – (9) $11,488,000 U 6,288,000 U 1,088,000 U $78,520,000 ¸ 2,600,000 barrels 9­34 Absorption­Costing Income Statement Theoretical Capacity $108,000,000 0 78,520,000 15,600,000 94,120,000 (7,240,000) 11,488,000 U 98,368,000 9,632,000 0 $ 9,632,000 Practical Capacity $108,000,000 0 78,520,000 20,800,000 99,320,000 (7,640,000) 6,288,000 U 97,968,000 10,032,000 0 $ 10,032,000 Normal Capacity Utilization $108,000,000 0 78,520,000 26,000,000 104,520,000 (8,040,000) 1,088,000 U 97,568,000 10,432,000 0 $ 10,432,000 Revenues (2,400,000 bbls. ´ $45 per bbl.) Cost of goods sold Beginning inventory Variable mfg. costs Fixed mfg. overhea d costs allocated (2,600,000 units ´ $6.00; $8.00; $10.00 per unit) Cost of goods available for sale Deduct ending inventory (200,000 units ´ $36.20; $38.20; $40.20 per unit) Adjustment for variances (add: all unfavorable) Cost of goods sold Gross margin Other costs Operating income 9­33 (20 min.) Motivational considerations in denominator­level capacity selection (continuation of 9­32). 1. If the plant manager gets a bonus based on operating inco me, he/she will prefer the deno minator­level capacit y to be based on normal capacit y utilizat ion (or master­budget utilizat ion). In times of rising inventories, as in 2009, this deno minator level will maximize the fixed overhead trapped in ending inventories and will minimize COGS and maximize operating inco me. Of course, the plant manager cannot always hope to increase inventories every period, but on the whole, he/she would st ill prefer to use normal capacit y ut ilizat ion because the smaller the deno minator, the higher the amount of overhead costs capitalized for inventory units. Thus, if the plant manager wishes to be able to “adjust” plant operating inco me by building inventory, normal capacit y ut ilizat ion (or master­budget capacit y utilizat ion) would be preferred. 2. Given the data in this quest ion, the theoretical capacit y concept reports the lowest operating inco me and thus (other things being equal) the lowest tax bill for 2009. Lucky Lager benefits by having deduct ions as early as possible. The theoretical capacit y denominator­leve l concept maximizes the deductions for manufacturing costs. 3. The IRS may restrict the flexibilit y of a co mpany in several ways: a. Restrict the deno minator­level concept cho ice (to say, practical capacit y). b. Restrict the cost line items that can be expensed rather than inventoried. c. Restrict the abilit y o f a co mpany to use shorter write­off periods or more accelerated write­off periods for inventoriable costs. d. Require proration or allocat ion of variances to represent actual costs and actual capacit y used. 9­35 9­34 (25 min.) Denominator­level choices, changes in inventory levels, effect on operating income. 1. Theoretical Capacity 144,000 $1,440,000 $ 10.00 104,000 $1,040,000 $ 400,000 U Practical Capacity 120,000 $1,440,000 $ 12.00 104,000 $1,248,000 $ 192,000 U Normal Utilization Capacity 96,000 $1,440,000 $ 15.00 104,000 $1,560,000 $ 120,000 F Denominator level in units Budgeted fixed ma nuf. costs Budgeted fixed ma nuf. cost allocated per unit Production in units Allocated fixed manuf. costs (production in units ´ budgeted fixed manuf. cost allocated per unit) Production volume variance (Budgeted fixed manuf. a costs – allocated fixed manuf. costs) a PVV is unfavorable if budgeted fixed manuf. costs are greater than allocated fixed costs 2. Theoretical Capacity 112,000 $10 $ 3 $13 Practical Capacity 112,000 $12 $ 3 $15 Normal Utilization Capacity 112,000 $15 $ 3 $18 Units sold Budgeted fixed mfg. cost allocated per unit Budgeted var. mfg. cost per unit Budgeted cost per unit of inventory or production ABSORPTION­COSTING BASED INCOME STATEMENTS Revenues ($3 selling price per unit ´ units sold) Cost of goods sold Beginning inventory (10,000 units ´ budgeted cost per unit of inventor y) Variable ma nufacturing costs (104,000 units ´ $3 per unit) Allocated fixed ma nufacturing over head (104,000 units ´ budgeted fixed mfg. cost allocated per unit) Cost of goods available for sale b Deduct ending inventory (2,000 units ´ budgeted cost per unit of inventor y) Adjustment for production­volume variance Total cost of goods sold Gross margin Operating costs Operating income b $3,360,000 $3,360,000 $3,360,000 130,000 312,000 1,040,000 1,482,000 (26,000) 400,000 U 1,856,000 1,504,000 400,000 $1,104,000 150,000 312,000 1,248,000 1,710,000 (30,000) 192,000 U 1,872,000 1,488,000 400,000 $1,088,000 180,000 312,000 1,560,000 2,052,000 (36,000) (120,000) F 1,896,000 1,464,000 400,000 $1,064,000 Ending inventory = Beginning inventory + production – sales = 10,000 + 104,000 – 112,000 = 2,000 units 2,000 x $13; 2,000 x $15; 2,000 x $18 9­36 3. Koshu’s 2009 beginning inventory was 10,000 units; its ending inventory was 2,000 units. So, during 2009, there was a drop of 8,000 units in inventory levels (matching the 8,000 more unit s so ld than produced). The smaller the deno minator level, the larger is the budgeted fixed cost allocated to each unit of production, and, when those units are so ld (all the current production is sold, and then so me), the larger is the cost of each unit so ld, and the smaller is the operating inco me. Normal utilizat ion capacit y is the smallest capacit y of the three, hence in this year, when production was less than sales, the absorption­costing based operating inco me is the smallest when normal capacit y ut ilizat ion is used as the deno minator level. 4. Reconciliation Theoretical Capacit y Operating Inco me – Practical Capacit y Operat ing Inco me Decrease in inventory level during 2009 8,000 Fixed mfg cost allocated per unit under practical capacit y – fixed mfg. cost allocated per unit under theoretical capacit y ($12 – $10) $2 Addit io nal allo cated fixed cost included in COGS under practical capacit y = 8,000 units ´ $2 per unit = $16,000 $16,000 More fixed manufacturing costs are included in inventory under practical capacit y, so, when inventory level decreases (as it did in 2009), more fixed manufacturing costs are included in COGS under practical capacit y than under theoretical capacit y, result ing in a lower operating inco me. 9­37 9­35 (30­35 min.) Effects of denominator­level choice. 1. Normal capacit y ut ilizat ion. Givens denoted* Flexible Budget: Same Budgeted Same Budgeted Lump Sum Lump Sum (as in Static Budget) (as in Static Budget) Regardless of Regardless of Output Level Output Level (2) (3) Allocated: Budgeted Input Allowed for Actual Costs Actual Output Incurred × Budgeted Rate (1) (4) a 28,000 hrs.* × $2.00 $52,000 $48,000* $48,000* = $56,000 $4,000 U* $8,000 F* Spending variance Never a variance Prodn. volume variance Production Fixed overhead allocated ö æBudgeted ç fixed – using budgeted input allowed for÷ vo lume = ç ÷ variance overhead actual output achieved è ø – $8,000 X = ($48,000 – X) = $56,000 a Budgeted fixed manufacturing = $56,000 ÷ 28,000 machine­hours overhead rate per unit = $2 per machine­hour Deno minator level = $48,000 ÷ $2 per machine­hour = 24,000 machine­hours 9­38 2. Practical capacit y. Givens denoted* Flexible Budget: Same Lump Sum Same Lump Sum (as in Static Budget) (as in Static Budget) Regardless of Regardless of Budgeted Output Budgeted Output Level Level (2) (3) Allocated: Budgeted Input Allowed for Actual Costs Actual Output Incurred × Budgeted Rate (1) (4) a 28,000* × $1.20 $52,000 $48,000* $48,000* = $33,600 $4,000 U* $14,400 U* Spending variance Never a variance Prodn. volume variance Production­vo lume variance $14,400 Fixed overhead allocated ö æBudgeted ç fixed – using budgeted input allowed for ÷ =ç ÷ actual output achieved è overhead ø = ($48,000 – X) X = $33,600 a Budgeted manufacturing = $33,600 ÷ 28,000 machine­hours overhead rate per unit = $1.20 per machine­hour Denominator level = $48,000 ÷ $1.20 per machine­hour = 40,000 machine­hours 3. To maximize operating inco me, the execut ive vice president would favor using norma l capacit y ut ilizat ion rather than practical capacit y. Why? Because normal capacit y ut ilizat ion is a smaller base than practical capacit y, result ing in any year­end inventory having a higher unit cost. Thus, less fixed manufacturing overhead would beco me a 2009 expense as part of the production­vo lume variance if normal capacit y ut ilizat ion were used as the deno minator level. 9­39 9­36 (20 min.) Downward demand spiral. 1. and 2. Competitive Situation 7,500 6,000 $100 $2,250,000 100% Practical capacit y (units) Budgeted capacit y (units) Variable manufacturing cost per unit Fixed manufacturing costs Markup percentage Manufacturing cost per unit Variable Fixed (fixed mfg costs ¸ budgeted capacit y) ($2,250,000 ¸ 7,500; $2,250,000 ¸ 6,000) Full manufacturing cost per unit Selling Pr ice (200% of full manuf. cost per unit) Original 7,500 7,500 $100 $2,250,000 100% $100 300 $400 $800 $100 375 $475 $950 3. We can see that when the budgeted production is used as the deno minator level and this level changes with ant icipated demand, then the full manufacturing cost per unit and therefore the selling price can be quite sensit ive to the denominator level. In this case, the deno minator level has fallen by 20% [(7,500 – 6,000) ¸ 7,500] and the allocated fixed cost has increased by 25% [($375 – $300) ¸ 300], result ing in an 18.75% [($950 – $800) ¸ $800] increase in selling price. If Network’s market is beco ming more competit ive because of foreign entrants, raising the selling price could further drive away customers, lower the budgeted capacit y and raise the fixed cost per unit, that is, lead to a downward spiral. If Network’s production plant was built for a practical capacit y of 7,500 units, a denominator level o f 7,500 units should be used, and the cost of excess capacit y should not be charged to the units produced and sold. This will focus managerial attention on the unused capacit y. If the co mpet itive trends continue, Network will need to cut back its installed capacit y to stay co mpetit ive. 4. Suppose Network sells x unit s each year. Its total cost to manufacture the x units would be $100x + $2,250,000. Its total cost to purchase x units would be $400x + $450,000. Therefore, Network should manufacture in­house, if $100x + $2,250,000 < $400x + $450,000; i.e., if x > 6,000 units. In­house, the cost structure is a low variable cost, high fixed cost structure, and only worth pursuing for high vo lumes. The source­outside cost structure is a high variable cost, low fixed cost structure, and only worth pursuing for small vo lumes. Currently, demand is exact ly at 6,000 units. Network should conduct some research to forecast future demand patterns. If it seems likely that demand is going to fall belo w 6,000, it may be better to shut down its production capacit y and outsource all o f its needed units. This may also allow the management to examine and pursue other business options, as its current business gets increasingly co mpet it ive. 9­40 9­37 (35 min.) Absorption costing and production volume variance ­­ alternative capacity bases 1. Inventoriable cost per unit = Variable production cost + Fixed manufacturing overhead/Capacit y Fixed Mfg. Overhead Rate $1.25 $2.00 $4.00 $5.00 Variable Production Inventoriable Cost Cost Per Unit $2.50 $3.75 $2.50 $4.50 $2.50 $6.50 $2.50 $7.50 Capacity Type Theor etical Practical Nor mal Master Budget Capacity Level 800,000 500,000 250,000 200,000 Fixed Mfg. Overhead $1,000,000 $1,000,000 $1,000,000 $1,000,000 2. ELF’s actual production level is 220,000 bulbs. We can compute the production­vo lume variance as: Production Volume Variance = Budgeted Fixed Mfg. Overhead – (Fixed Mfg. Overhead Rate × Actual Production Level) Fixed Mfg. Overhead Rate $1.25 $2.00 $4.00 $5.00 Fixed Mfg. Overhead Rate × Actual Production $ 275,000 $ 440,000 $ 880,000 $1,100,000 Production Volume Variance $725,000 U $560,000 U $120,000 U $100,000 F Capacity Type Theor etical Practical Nor mal Master Budget Capacity Level 800,000 500,000 250,000 200,000 Fixed Mfg. Overhead $1,000,000 $1,000,000 $1,000,000 $1,000,000 3. Operating Inco me for ELF given production of 220,000 bulbs and sales of 200,000 bulbs @ $9 apiece: Revenue Less: Cost of goods sold a Production­ volume variance Gross margin Variable selling b Fixed selling Operating income a Theoretical $1,800,000 750,000 725,000 U 325,000 50,000 250,000 $ 25,000 Practical $1,800,000 900,000 560,000 U 340,000 50,000 250,000 $ 40,000 Normal $1,800,000 1,300,000 120,000 U 380,000 50,000 250,000 $ 80,000 Master Budget $1,800,000 1,500,000 (100,000)F 400,000 50,000 250,000 $ 100,000 b 200,000 × 3.75, × 4.50, × 6.50, × 7.50 200,000 × 0.25 9­41 9­38 (35 min.) Operating income effects of denominator­level choice and disposal of production­volume variance (continuation of 9­37) 1. Since no beginning inventories exist, if ELF sells all 220,000 bulbs manufactured, its operating inco me will be the same under all four capacit y options. Calculat ions are provided below: Revenue Less: Cost of goods sold a Production volume variance Gross margin Variable selling b Fixed selling Operating income a b Theoretical $1,980,000 825,000 725,000 U 430,000 55,000 250,000 $ 125,000 Practical $1,980,000 990,000 560,000 U 430,000 55,000 250,000 $ 125,000 Normal $1,980,000 1,430,000 120,000 U 430,000 55,000 250,000 $ 125,000 Master Budget $1,980,000 1,650,000 (100,000) F 430,000 55,000 250,000 $ 125,000 220,000 × 3.75, × 4.50, × 6.50, × 7.50 200,000 × 0.25 2. If the manager of ELF produces and sells 220,000 bulbs, then all capacit y levels will result in the same operating inco me of $125,000 (see requirement 1 above). If the manager of ELF is able to sell only 200,000 of the bulbs produced and if the production­vo lume variance is closed to cost of goods sold, then the operating inco me is given as in requirement 3 of 9­37. Both sets of numbers are reproduced below. Income with sales of 220,000 bulbs Income with sales of 200,000 bulbs Decrease in income when ther e is over production Theoretical $125,000 25,000 $100,000 Practical $125,000 40,000 $ 85,000 Normal $125,000 80,000 $ 45,000 Master Budget $125,000 100,000 $ 25,000 Comparing these results, it is clear that for a given level of overproduction relat ive to sales, the manager’s performance will appear better if he/she uses as the deno minator a level that is lower. In this example, setting the deno minator to equal the master budget (the lowest of the four capacit y levels here), minimizes the loss to the manager fro m being unable to sell the entire production quant it y of 220,000 bulbs. 9­42 3. In this scenario, the manager of ELF produces 220,000 bulbs and sells 200,000 of them, and the production vo lume variance is prorated. Given the absence of ending work in process inventory or beginning inventory of any kind, the fraction of the production vo lume variance that is absorbed into the cost of goods sold is given by 200,000/220,000 or 10/11. The operating inco me under various deno minator levels is then given by the fo llowing modificat ion of the solut ion to requirement 3 of 9­37: Revenue Less: Cost of goods sold Prorated production­ volume variance a Gross margin Variable selling b Fixed selling Operating income a Theoretical $1,800,000 750,000 659,091 U 390,909 50,000 250,000 $ 90,909 Practical $1,800,000 900,000 509,091 U 390,909 50,000 250,000 $ 90,909 Normal $1,800,000 1,300,000 109,091 U 390,909 50,000 250,000 $ 90,909 Master Budget $1,800,000 1,500,000 (90,909) F 390,909 50,000 250,000 $ 90,909 b (10/11) × 725,000, × 560,000, × 120,000, × 100,000 200,000 × 0.25 Under the proration approach, operating inco me is $90,909 regardless of the deno minator init ially used. Thus, in contrast to the case where the production vo lume variance is written off to cost of goods sold, there is no temptation under the proration approach for the manager to play games with the cho ice of denominator level. 9­43 9­39 (30 min.) Cost allocation, downward demand spiral. SOLUTION EXHIBIT 9­39 2009 2010 Practical Master Master Budget Capacity Budget (2) (1) (3) $1,533,000 $1,533,000 $1,533,000 1,022,000 1,460,000 876,000 Budgeted fixed costs Deno minator level Budgeted fixed cost per meal Budgeted fixed costs ¸ Deno minator level ($1,533,000 ¸ 1,022,000; $1,533,000 ¸ 1,460,000; $1,533,000 ¸ 876,000) $ 1.50 $ 1.05 $ 1.75 Budgeted variable cost per meal 4.50 4.50 4.50 Total budgeted cost per meal $ 6.00 $ 5.55 $ 6.25 1. The 2009 budgeted fixed costs are $1,533,000. Deliman budgets for 1,022,000 meals in 2009, and this is used as the denominator level to calculate the fixed cost per meal. $1,533,000 ¸ 1,022,000 = $1.50 fixed cost per meal. (see column (1) in Solut ion Exhibit 9­39). 2. In 2010, 3 hospitals have dropped out of the purchasing group and the master budget is 876,000 meals. If this is used as the deno minator level, fixed cost per meal = $1,533,000 ¸ 876,000 = $1.75 per meal, and the total budgeted cost per meal would be $6.25 (see co lumn (3) in So lut ion Exhibit 9­39). If the hospitals have already been complaining about qualit y and cost and are allowed to purchase fro m outside, they will not accept this higher price. More hospitals may begin to purchase meals fro m outside the system, leading to a downward demand spiral, possibly putting Deliman out of business. 3. The basic problem is that Deliman has excess capacit y and the associated excess fixed costs. If Smit h uses the practical capacit y of 1,460,000 meals as the deno minator level, the fixed cost per meal will be $1.05 (see co lumn (2) in So lution Exhibit 9­39), and the total budgeted cost per meal would be $5.55, probably a more acceptable price to the customers (it may even draw back the three hospitals that have chosen to buy outside). This deno minator level will also iso late the cost of unused capacit y and not allocate it to the meals produced. To make the $5.55 price per meal profitable in the lo ng run, Smit h will have to find ways to either use the extra capacit y or reduce Deliman’s practical capacit y and the related fixed costs. 9­44 9­40 (20 min.) Cost allocation, responsibility accounting, ethics (continuation of 9­39). 1. (See Solut ion Exhibit 9­39). If Deliman uses its master budget capacit y utilization to allocate fixed costs in 2010, it would allocate 806,840 ´ $1.75 = $1,411,970. Budgeted fixed costs are $1,533,000. Therefore, the production volume variance = $1,533,000 – $1,411,970 = $121,030 U. An unfavorable production vo lume variance will reduce operating inco me by this amount. (Note: in this business, there are no inventories. All variances are written off to cost of goods sold). 2. Hospitals are charged a budgeted variable cost rate and allocated budgeted fixed costs. By overest imat ing budgeted meal counts, the deno minator­level is larger, hence the amount charged to individual hospitals is lower. Consider 2010 where the budgeted fixed cost rate is computed as fo llows: $1,533,000/876,000 meals = $1.75 per meal If in fact, the hospital administrators had better estimated and revealed their true demand (say, 806,800 meals), the allocated fixed cost per meal would have been $1,533,000/806,800 meals = $1.90 per meal, 8.6% higher than the $1.75 per meal. Hence, by deliberately overstating budgeted meal count, hospitals are able to reduce the price charged by Deliman for each meal. In this scheme, Deliman bears the downside risk of demand overestimates. 3. Evidence that could be collected include: (a) Budgeted meal­count estimates and actual meal­count figures each year for each hospital controller. Over an extended t ime period, there should be a sizable number of both underest imates and overest imates. Controllers could be ranked on both their percentage of overestimat ion and the frequency o f their overest imat ion. (b) Look at the underlying demand est imates by patients at individual hospitals. Each hospital controller has other factors (such as hiring of nurses) that give insight into their expectations of future meal­count demands. If these factors are inconsistent with the meal­count demand figures provided to the central food­catering facilit y, explanations should be sought. 4. (a) Highlight the importance of a corporate culture of honest y and openness. Deli One could inst itute a Code of Ethics that highlights the upside of individual hospitals providing honest estimates of demand (and the penalt ies for those who do not). (b) Have individual hospitals contract in advance for their budgeted meal count. Unused amounts would be charged to each hospital at the end of the accounting period. This approach puts a penalt y on hospital administrators who overestimate demand. (c) Use an incentive scheme that has an explicit component for meal­count forecasting accuracy. Each meal­count “forecast ing error” would reduce the bonus by $0.05. Thus, if a hospital bids for 292,000 meals and actually uses 200,000 meals, its bonus would be reduced by $0.05 × (292,000 – 200,000) = $4,600. 9­45 Collaborative Learning Problem 9­41 (50 min.) Absorption, variable, and throughput costing (1) Variable Costing a Revenues Variable costs b Beginning inventory Variable manufacturing costsc Cost of goods available for sale d Deduct ending inventory Variable cost of goods sold Variable selling costse Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed administrative costs Total fixed costs Operating income April 2008 $300,000 $ 0 77,500 77,500 0 77,500 7,500 85,000 215,000 105,000 35,000 140,000 $ 75,000 May 2008 $300,000 $ 0 108,500 108,500 (31,000) 77,500 7,500 85,000 215,000 105,000 35,000 140,000 $ 75,000 June 2008 $300,000 $ 31,000 46,500 77,500 0 77,500 7,500 85,000 215,000 105,000 35,000 140,000 $ 75,000 a $6 × 50,000 b ? × 0; $1.55 × 0; $1.55 × 20,000 c $1.55 × 50,000; $1.55 × 70,000; $1.55 × 30,000 d $1.55 × 0; $1.55 × 20,000; $1.55 × 0 e $.15 × 50,000 9­46 (2) Absorption Costing Revenuesa Cost of goods sold b Beginning inventory c Variable manufacturing costs Allocated fixed manufacturing costsd Cost of goods available for sale e Deduct ending inventory Adjustment for prod. vol. var.f Cost of goods sold Gross margin Operating costs g Variable selling costs April 2008 $300,000 $ 0 77,500 105,000 182,500 0 0 182,500 117,500 May 2008 $300,000 $ 0 108,500 105,000 213,500 (61,000) 30,000 U 152,500 147,500 June 2008 $300,000 $ 61,000 46,500 105,000 212,500 0 0 212,500 87,500 7,500 35,000 42,500 $ 75,000 7,500 35,000 42,500 $105,000 7,500 35,000 42,500 $ 45,000 Fixed administrative costs Total operating costs Operating income a b $6 × 50,000 $?× 0; $3.65× 0; $3.05 × 20,000 c $1.55 × 50,000; $1.55 × 70,000; $1.55 × 30,000 d ($105,000/50,000)×50,000; ($105,000/70,000) ×70,000; (105,000/30,000)×30,000 e $3.65 × 0; $3.05 × 20,000; $5.05 × 0 f $105,000 – $105,000; $105,000 – $105,000; $105,000 – $105,000 g $.15 × 50,000 9­47 (3) Throughput costing Revenues Direct material cost of goods sold b Beginning inventory Direct materials in goods c ma nufactured Cost of goods available for sale d Deduct ending inventor y Total direct material cost of goods sold a April 2008 $300,000 May 2008 $300,000 June 2008 $300,000 $ 0 40,000 $ 0 56,000 $ 16,000 24,000 40,000 0 40,000 40,000 40,000 0 40,000 56,000 (16,000) Throughput contribution Other costs e Manufacturing f Operating Total other costs Operating income a b 260,000 142,500 42,500 185,000 $ 75,000 157,500 42,500 260,000 127,500 42,500 200,000 $ 60,000 260,000 170,000 $ 90,000 $6 × 50,000 $?× 0; $0.80× 0; $0.80 × 20,000 c $0.80 × 50,000; $0.80 × 70,000; $0.80 × 30,000 d $0.80 × 0; $0.80 × 20,000; $0.80 × 0 e ($0.75 × 50,000) + $105,000; ($0.75× 70,000) + $105,000; ($0.75 × 30,000) + $105,000 f ($0.15 × 50,000) + $35,000 9­48 4. The benefit of using throughput costing is that net inco me is reduced if managers produce more units than they can sell. By treating all costs, except direct material costs, as period costs, the inco me statement expenses not only the cost of goods sold but also thedirect labor and variable overhead costs associated with units in ending inventory. So reported inco me is reduced by the cost of unnecessary production. For performance evaluat ion purposes, variable costing is superior to absorption costing because it prevents managers from increasing inco me by just increasing production. In the same way, throughput costing may be considered superior to variable costing because not only is management not rewarded for producing more than can be sold, they are penalized for excess production. In this example, inco me is highest when management produced less than demand and therefore reduced inventory that already existed. 9­49 ...
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This note was uploaded on 10/11/2010 for the course ACCT 321 taught by Professor Cole during the Spring '10 term at University of Miami.

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