# Inventory passing through cost of goods sold in 2014

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inventory passing through cost of goods sold in 2014. This means that under absorption costing, large amounts of inventoried fixed costs have flowed through 2014 cost of goods sold, resulting in a smaller operating income than in 2013, despite an increase in sales volume. 9- 33
9-30 (30 min.) Effects of differing production levels on absorption costing income: Metrics to minimize inventory buildups. 1. 26,000 Books 32,500 Books 33,800 Books Revenues \$2,106,000 \$2,106,000 \$2,106,000 Cost of goods sold 1,586,000 a 1,586,000 1,586,000 Production-volume variance 0 b (104,000 ) c (124,800 ) d Net cost of goods sold 1,586,000 1,482,000 1,461,200 Gross Margin \$ 520,000 \$ 624,000 \$ 644,800 a Cost per unit = (\$45 + \$416,000/26,000 books sold) = \$61 per book CGS = \$61  26,000 = \$1,586,000 b volume variance = Budgeted fixed cost – fixed overhead rate  production \$416,000 – (\$16  26,000 books) = \$0 c volume variance = Budgeted fixed cost – fixed overhead rate  production \$416,000 – (\$16  32,500 books) = – \$104,000 d volume variance = Budgeted fixed cost – fixed overhead rate  production \$416,000 – (\$16  33,800 books) = – \$124,800 2. 26,000 Books 32,500 Books 33,800 Books Beginning inventory 0 0 0 + Production 26,000 books 32,500 books 33,800 books 26,000 32,500 33,800 – Books sold 26,000 26,000 26,000 Ending inventory 0 books 6,500 books 7,800 books  Cost per book × \$61 × \$61 × \$61 Cost of Ending Inventory \$0 \$396,500 \$475,800 9- 34
3a. 26,000 Books 32,500 Books 33,800 Books Gross margin \$520,000 \$624,000 \$644,800 Less 10%  Ending inventory 0 (19,825 ) (23,790 ) Adjusted gross margin \$520,000 \$604 ,175 \$621 ,0 10 While adjusting for ending inventory does to some degree mitigate the increase in inventory associated with excess production, it may be difficult to mechanically compensate for all of the increased income. In addition, it does nothing to hold the manager responsible for the poor decisions from the organization’s standpoint. 3b. 26,000 Books 32,500 Books 33,800 Books 1) Inventory change: End inventory ─ begin inventory 0 6,500 books 7,800 books 2) Excess production (%) Production ÷ sales 26,000 ÷ 26,000 32,500 ÷ 26,000 33,800 ÷26,000 1.0 1.25 1.3 A ratio of ending inventory to beginning inventory, as suggested in the book, is not possible because beginning inventory was zero, so we substituted change in inventory level. For these nonfinancial measures to be useful they must be incorporated into the reward function of the manager. 9- 35
9-31 (25–30 min.) Alternative denominator-level capacity concepts, effect on operating income. 1. Budgeted Fixed Budgeted Fixed Days of Hours of Budgeted Manufacturing Denominator-Level Capacity Concept Manuf. Overhead per Period Production per Period Production per Day Barrels per Hour Denominator Level (Barrels) Overhead Rate per Barrel (1) (2) (3) (4) (5) = (2) (3) (4) (6) = (1) (5) Theoretical capacity \$27,900,000 358 22 545 4,292,420 \$ 6.50 Practical capacity 27,900,000 348 20 510 3,549,600 7.86 Normal capacity utilization 27,900,000 348 20 410 2,853,600 9.78 Master-budget utilization (a) January–June 2014 13,950,000 174 20 315 1,096,200 12.73 (b) July–December 2014 13,950,000 174 20 505 1,757,400 7.94 The differences arise for several reasons: a. The theoretical and practical capacity concepts emphasize supply factors and are consequently higher, while normal capacity utilization and master-budget utilization emphasize demand factors. b. The two separate six-month rates for the master-budget utilization concept differ because of seasonal differences in budgeted production. 2. Using column (6) from above, Per Barrel Denominator- Level Capacity Concept Budgeted Fixed Mfg. Overhead Rate per Barrel (6) Budgeted Variable Mfg. Cost Rate (7) Budget ed Total Mfg Cost Rate (8) = (6) + (7) Fixed Mfg.