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Unformatted text preview: CHAPTER 10 QUESTIONS 1. Under absorption costing, all manufacturing costs—direct materials, direct labor, and fixed and variable factory overhead exp- enses—are charged to the cost of the product. Under variable costing, only those costs that vary directly with volume—direct materials, direct labor, and variable factory overhead expenses—are applied to produc- tion. Since fixed costs are not affected by changes in volume, they are not charged to the cost of the product but are expensed in the period they are incurred. 2. Normally income statements prepared under variable costing will reflect profits (or losses) that increase or decrease as sales increase or decrease—a logical pattern. When ab- sorption costing is used, this relationship be- tween sales and profits (or losses) does not exist, especially in instances where the vol- ume of production fluctuates widely. Use of variable costing will normally cause inventories to be reported on the bal- ance sheet at a lower figure than under ab- sorption costing because no fixed costs will be charged to the product. 3 . Advantages of variable costing are: (a) elimination of profit distortion in periods of fluctuating production and sales, (b) recognition of fixed manufacturing costs as they are incurred rather than defer- ring them as inventory costs until the goods are sold, and (c) presentation of a much clearer picture of the effect of additional production on costs and income. There are five disadvantages in using vari- able costing: (a) Cost categories are established through the use of historical trend data modified by future expectations; therefore, any unforeseen changes may have a signifi- cant effect on changing the cost catego- ries. (b) Since fixed costs are not product costs under variable costing, additional vol- ume or new projects, which may require the use of existing equipment or expan- sion of the company’s present facilities, will have no effect on the regularly cal- culated unit costs of the products. (c) Variable costing is effective only in situations where there are significant variations in production, which suggests only minor usage. (d) Many accountants feel that inventories do not reflect “true costs” because no element of fixed cost is charged to the inventory accounts. (e) The AICPA and IRS do not consider this method appropriate for inventory costs as used in published financial state- ments. 4. A segment report prepared using absorption costing may result in indirect costs being improperly allocated to the various seg- ments. Arbitrarily assigning indirect costs to a segment may distort the profitability of that segment because some or all of the indirect cost may be common to the other segments....
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This note was uploaded on 07/10/2011 for the course BUSINESS 550 taught by Professor Backer during the Spring '11 term at Limestone.
- Spring '11