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CHAPTER 8 ABSORPTION AND VARIABLE COSTING, AND INVENTORY MANAGEMENT DISCUSSION QUESTIONS 1. The only difference between absorption cost- ing and variable costing is the way in which fixed overhead costs are assigned. Under variable costing, fixed overhead is a period cost; under absorption costing, it is a product cost. 2. Absorption-costing income is greater because some of the period’s fixed overhead is placed in inventory and not recognized as part of Cost of Goods Sold on the absorption-costing income statement. 3. A segment is any subunit of sufficient import- ance to warrant production of performance re- ports. 4. Contribution margin is the amount available to cover fixed expenses and provide for profit. Segment margin is the amount available to cover common fixed expenses and provide for profit. Contribution margin is the difference between revenues and variable expenses. Segment margin is contribution margin less direct fixed expenses. 5. No, the purchase price is not part of the fun- damental EOQ formula. However, the poten- tial for quantity discounts may be considered by management in deciding whether or not to order the EOQ amount. For example, the company may order more than the EOQ amount if the quantity discount is larger than the additional carrying cost. 6. Ordering costs are the costs of placing and re- ceiving an order. Examples include clerical costs, documents, insurance, and unloading. Carrying costs are the costs of carrying in- ventory. Examples include insurance, taxes, handling costs, and the opportunity cost of capital tied up in inventory. 7. Stockout costs are the costs of insufficient in- ventory (e.g., lost sales and interrupted pro- duction). 8. Reasons for carrying inventory include the fol- lowing: (a) to balance setup and carrying costs, (b) to satisfy customer demand, (c) to avoid shutting down manufacturing facilities, (d) to take advantage of discounts, and (e) to hedge against future price increases. 9. If carrying costs increase, that implies that fewer orders are placed. However, the com- pany still needs the annual demand for the part. So fewer orders imply a larger number of parts ordered. This increases carrying costs. 10. The economic order quantity is the amount that should be ordered so as to minimize the sum of ordering and carrying costs. 11. Safety stock is the difference between maxim- um demand and average demand, multiplied by the lead time. By reordering whenever the inventory level hits the safety stock point, a company is ensured of always having suffi- cient inventory on hand to meet demand 12. JIT minimizes carrying costs by driving invent- ories to insignificant levels. Ordering costs are minimized by entering into long-term contracts with suppliers (or driving setup times to zero).
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