Exercise 8-1 (15 minutes)
1. Under absorption costing, all manufacturing costs (variable and fixed)
are included in product costs.
Direct materials............................................................
Direct labor..................................................................
Variable manufacturing overhead ..................................
Fixed manufacturing overhead ($60,000 ÷ 250 units) ....
Absorption costing unit product cost..............................
$100
320
40
240
$700
2. Under variable costing, only the variable manufacturing costs are
included in product costs.
Direct materials............................................................
Direct labor..................................................................
Variable manufacturing overhead ..................................
Variable costing unit product cost ..................................
$100
320
40
$460
Note that selling and administrative expenses are not treated as product
costs under either absorption or variable costing. These expenses are
always treated as period costs and are charged against the current
period’s revenue.
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Solutions Manual, Chapter 8
1
Exercise 8-2 (20 minutes)
1. 25 units in ending inventory × $240 per unit fixed manufacturing
overhead per unit = $6,000
2. The variable costing income statement appears below:
Sales ............................................................
Variable expenses:
Variable cost of goods sold
(225 units sold × $460 per unit) ...............
Variable selling and administrative expenses
(225 units × $20 per unit) ........................
Contribution margin ......................................
Fixed expenses:
Fixed manufacturing overhead.....................
Fixed selling and administrative expenses ....
Net operating income ....................................
$191,250
$103,500
4,500
60,000
20,000
108,000
83,250
80,000
$ 3,250
The difference in net operating income between variable and absorption
costing can be explained by the deferral of fixed manufacturing
overhead cost in inventory that has taken place under the absorption
costing approach. Note from part (1) that $6,000 of fixed manufacturing
overhead cost has been deferred in inventory to the next period. Thus,
net operating income under the absorption costing approach is $6,000
higher than it is under variable costing.
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Solutions Manual, Chapter 8
2
Exercise 8-3 (20 minutes)
1.
Beginning inventories
(units)..............................
Ending inventories (units) ....
Change in inventories
(units)..............................
Variable costing operating
income .............................
Add: Fixed manufacturing
overhead cost deferred in
inventory under
absorption costing (10
units × $2,500 per unit;
40 units × $2,500 per
unit) ................................
Deduct: Fixed
manufacturing overhead
cost released from
inventory under
absorption costing (30
units × $2,500 per unit) ....
Absorption costing
operating income ..............
Year 1
150
160
10
$292,400
Year 2
Year 3
180
150
160
200
(30)
40
$269,200
25,000
$251,800
100,000
(75,000)
$317,400
$194,200
$351,800
2. Because absorption costing operating income was less than variable
costing operating income in Year 4, inventories must have decreased
during the year and hence fixed manufacturing overhead was released
from inventories. The amount released is just the difference between
the two operating incomes or $35,000 = $240,200 - $205,200.
Note: Using the change in inventory to do reconciliation is easy when
production levels remain the same from year to year but students should
be cautioned that when production levels change, so do fixed overhead
costs per unit and you then must calculate overhead costs released and
deferred in inventories separately.
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Solutions Manual, Chapter 8
3
Exercise 8-4 (30 minutes)
1. a. By assumption, the unit selling price, unit variable costs, and total
fixed costs are constant from year to year. Consequently, operating
income will vary with sales using variable costing. If sales increase,
variable costing operating income will increase. If sales decrease,
variable costing operating income will decrease. If sales are
constant, variable costing operating income will be constant. Because
variable costing operating income was $16,847 each year, unit sales
must have been the same in each year.
The same is not true of absorption costing operating income. Sales
and absorption costing operating income do not necessarily move in
the same direction because changes in inventories also affect
absorption costing operating income.
b. When variable costing operating income exceeds absorption costing
operating income, sales exceeds production. Inventories shrink and
fixed manufacturing overhead costs are released from inventories. In
contrast, when variable costing operating income is less than absorption
costing operating income, production exceeds sales. Inventories grow
and fixed manufacturing overhead costs are deferred in inventories.
The year-by-year effects are shown below.
Year 1
Year 2
Year 3
Variable costing
OI = Absorption
costing OI
Production = Sales
Inventories remain
the same
Variable costing
OI < Absorption
costing OI
Production > Sales
Variable costing
OI > Absorption
costing OI
Production < Sales
Inventories grow
Inventories shrink
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Solutions Manual, Chapter 8
4
Exercise 8-4 (continued)
2. a. As discussed in part (1 a) above, unit sales and variable costing
operating income move in the same direction when unit selling prices
and the cost structure are constant. Because variable costing operating
income declined, unit sales must have also declined. This is true even
though the absorption costing operating income increased. How can
that be? By manipulating production (and inventories) it may be
possible to maintain or increase the level of absorption costing
operating income even though unit sales decline. However, eventually
inventories will grow to be so large that they cannot be ignored.
b. As stated in part (1 b) above, when variable costing operating income
is less than absorption costing operating income, production exceeds
sales. Inventories grow and fixed manufacturing overhead costs are
deferred in inventories. The year-by-year effects are shown below.
Year 1
Year 2
Year 3
Variable costing
OI = Absorption
costing OI
Production = Sales
Inventories remain
the same
Variable costing
OI < Absorption
costing OI
Production > Sales
Variable costing
OI < Absorption
costing OI
Production > Sales
Inventories grow
Inventories grow
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Solutions Manual, Chapter 8
5
Exercise 8-4 (continued)
3. Variable costing appears to provide a much better picture of economic
reality than absorption costing in the examples above. In the first case,
absorption costing operating income fluctuates even though unit sales
are the same each year and unit selling prices, unit variable costs, and
total fixed costs remain the same. In the second case, absorption costing
operating income increases from year to year even though unit sales
decline. Absorption costing operating income is potentially more subject
to manipulation than variable costing. Simply by changing production
levels (and thereby deferring or releasing costs from inventory)
absorption costing operating income can be manipulated upward or
downward.
Note: This exercise is based on the following data:
Common data:
Annual fixed manufacturing costs .......
Contribution margin per unit ..............
Annual fixed SGA costs ......................
Part 1:
Beginning inventory...........................
Production ........................................
Sales ................................................
Ending ..............................................
Variable costing operating income ......
Deduct Fixed manufacturing overhead
in beginning inventory* .................
Add Fixed manufacturing overhead in
ending inventory ...........................
Absorption costing operating income
$153,153
$35,000
$180,000
Year 1
Year 2
Year 3
$16,847
$16,847
$16,847
$15,315
$15,315
$27,846
$15,315
$16,847
$27,846
$29,378
$17,017
$6,018
1
10
10
1
1
11
10
2
2
9
10
1
* Fixed manufacturing overhead in beginning inventory is assumed in both
parts 1 and 2 for Year 1. A FIFO inventory flow assumption is used.
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Solutions Manual, Chapter 8
6
Exercise 8-4 (continued)
Part 2:
Beginning inventory....................
Production .................................
Sales .........................................
Ending .......................................
Variable costing operating
income (loss) .........................
Deduct Fixed manufacturing
overhead in beginning
inventory* .............................
Add Fixed manufacturing
overhead in ending inventory ..
Absorption costing operating
income ..................................
Year 1
Year 2
$16,847
($18,153)
($53,153)
$15,315
$15,315
$51,051
$15,315
$51,051
$122,522
$16,847
$17,583
$18,318
1
10
10
1
1
12
9
4
Year 3
4
20
8
16
* Fixed manufacturing overhead in beginning inventory is assumed in both
parts 1 and 2 for Year 1. A FIFO inventory flow assumption is used.
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Solutions Manual, Chapter 8
7
Exercise 8-5 (30 minutes)
1. Under variable costing, only the variable manufacturing costs are
included in product costs.
Direct materials ....................................
Direct labour ........................................
Variable manufacturing overhead ..........
Unit product cost ..................................
$ 8
10
2
$20
Note that selling and administrative expenses are not treated as product
costs; that is, they are not included in the costs that are inventoried.
These expenses are always treated as period costs and are charged
against the current period’s revenue.
2. The variable costing income statement appears below:
Sales (21,500 × $35)..........................
Variable expenses:
Variable cost of goods sold:
Beginning inventory ......................
Add variable manufacturing costs
(25,000 units × $20 per unit) ......
Goods available for sale .................
Less ending inventory (3,500 units
× $20 per unit) ..........................
Variable cost of goods sold* .............
Variable selling and administrative
(21,500 units × $4 per unit) ..........
Contribution margin............................
Fixed expenses:
Fixed manufacturing overhead ..........
Fixed selling and administrative ........
Operating profit..................................
$752,500
$
0
500,000
500,000
70,000
430,000
86,000
75,000
110,000
516,000
236,500
185,000
$51,500
* The variable cost of goods sold could be computed more simply as:
21,500 units sold × $20 per unit = $430,000.
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Solutions Manual, Chapter 8
8
Exercise 8-5 (continued)
3. The break-even point in units sold can be computed using the
contribution margin per unit as follows:
Selling price per unit .....................
Variable product cost per unit .......
Variable selling and admin cost per
unit………………………………………..
Contribution margin per unit .........
Break-even unit sales =
=
$35
20
4
$ 11
Fixed expenses
Unit contribution margin
$185,000
$11 per unit
= 16,819 units
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Solutions Manual, Chapter 8
9
Exercise 8-6 (20 minutes)
1. Under absorption costing, all manufacturing costs (variable and fixed)
are included in product costs.
Direct materials ....................................
Direct labour ........................................
Variable manufacturing overhead ..........
Fixed manufacturing overhead
($75,000 ÷ 25,000 units) ...................
Unit product cost ..................................
$ 8
10
2
3
$23
2. The absorption costing income statement appears below:
Sales (21,500 units × $35 per unit) .........
Cost of goods sold:
Beginning inventory .............................
Add cost of goods manufactured
(25,000 units × $23 per unit) ............
Goods available for sale .......................
Less ending inventory
(3,500 units × $23 per unit) ..............
Gross margin .........................................
Selling and administrative expenses:
Variable selling and administrative
(21,500 units × $4 per unit) ..............
Fixed selling and administrative ............
Operating income ...................................
$752,500
$
0
575,000
575,000
80,500
86,000
110,000
494,500
258,000
196,000
$ 62,000
Note: Operating income is larger under absorption costing because the
company holds back $10,500 ($3 x 3,500 units) worth of fixed costs in
ending inventory.
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Solutions Manual, Chapter 8
10
Exercise 8-7 (30 minutes)
1. a. The unit product cost under absorption costing would be:
Direct materials ................................................................
Direct labour ....................................................................
Variable manufacturing overhead ......................................
Total variable manufacturing costs.....................................
Fixed manufacturing overhead ($200,000 ÷ 25,000 units) ..
Unit product cost ..............................................................
$25
12
3
40
8
$48
b. The absorption costing income statement:
Sales (21,000 units × $65 per unit) ............
Cost of goods sold:
Beginning inventory (first year of
operations) ..........................................
Add cost of goods manufactured
(25,000 units × $48 per unit) ...............
Goods available for sale ..........................
Less ending inventory
(4,000 units × $48 per unit) .................
Gross margin ............................................
Selling and administrative expenses ...........
Operating income ......................................
$1,365,000
$
0
1,200,000
1,200,000
192,000
1,008,000
357,000
215,000 *
$ 142,000
*(21,000 units × $5 per unit) + $110,000 = $215,000.
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Solutions Manual, Chapter 8
11
Exercise 8-7 (continued)
2. a. The unit product cost under variable costing would be:
Direct materials ................................................
Direct labour ....................................................
Variable manufacturing overhead ......................
Unit product cost ..............................................
$25
12
3
$40
b. The variable costing income statement:
Sales (21,000 units × $65 per unit) ........
Less variable expenses:
Variable cost of goods sold:
Beginning inventory .........................
Add variable manufacturing costs
(25,000 units × $40 per unit) .........
Goods available for sale ....................
Less ending inventory
(4,000 units × $40 per unit) ...........
Variable cost of goods sold ..................
Variable selling expense
(21,000 units × $5 per unit) .............
Contribution margin...............................
Less fixed expenses:
Fixed manufacturing overhead .............
Fixed selling and administrative ...........
Operating income ..................................
$1,365,000
$
0
1,000,000
1,000,000
160,000
840,000 *
105,000
200,000
110,000
945,000
420,000
310,000
$ 110,000
* The variable cost of goods sold could be computed more simply
as: 21,000 units × $40 per unit = $840,000.
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Solutions Manual, Chapter 8
12
Exercise 8-8 (20 minutes)
1. The company is using variable costing. The computations are:
Direct materials ..............................
Direct labour ..................................
Variable manufacturing overhead ....
Fixed manufacturing overhead
($90,000 ÷ 30,000 units) .............
Unit product cost ............................
Total cost, 5,000 units ....................
Variable
Costing
$10
5
2
—
$17
$85,000
Absorption
Costing
$10
5
2
3
$20
$100,000
2. a. The total cost based on variable costing of $85,000 would be
acceptable for tax purposes, but not for external reporting.
b. The finished goods inventory account should be stated at $100,000,
which represents the absorption cost of the 5,000 unsold units. Thus,
the account should be increased by $15,000 for external reporting
purposes. This $15,000 consists of the amount of fixed manufacturing
overhead cost that is allocated to the 5,000 unsold units under
absorption costing:
5,000 units × $3 per unit fixed manufacturing overhead cost =
$15,000
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Solutions Manual, Chapter 8
13
Exercise 8-9 (20 minutes)
1. Sales (40,000 units × $33.75 per unit)…………
Variable expenses:
Variable cost of goods sold
(40,000 units × $16 per unit*)………………….. $640,000
Variable selling and administrative expenses
(40,000 units × $3 per unit) ………………………
120,000
Contribution margin…………………………………..
Fixed expenses:
Fixed manufacturing overhead…………………….
250,000
Fixed selling and administrative expenses…….. 300,000
Operating income………………………………………
* Direct materials………………………….
Direct labour………………………………
Variable manufacturing overhead…
Total variable manufacturing cost..
$1,350,000
760,000
590,000
550,000
$ 40,000
$10
4
2
$16
2. The difference in operating income can be explained by the $50,000 in
fixed manufacturing overhead deferred in inventory under the
absorption costing method:
Variable costing operating income …………………………
$40,000
Add: Fixed manufacturing overhead cost deferred in
inventory under absorption costing: 10,000 units × $5 per
unit in fixed manufacturing overhead cost……………….
50,000
Absorption costing operating income………………………
$90,000
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Solutions Manual, Chapter 8
14
Exercise 8-10 (10 minutes)
Sales were above the company’s break-even sales and yet the company
sustained a loss. The apparent contradiction is explained by the fact that
the CVP analysis is based on variable costing, whereas the income reported
to shareholders is prepared using absorption costing. Because sales were
above the break-even point, the variable costing net operating income
would have been positive. However, the absorption costing net operating
income was negative. Ordinarily, this would only happen if inventories
decreased and fixed manufacturing overhead deferred in inventories was
released to the income statement on the absorption costing income
statement. This added fixed manufacturing overhead cost resulted in a loss
on an absorption costing basis even though the company operated at its
break-even point on a variable costing basis.
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Solutions Manual, Chapter 8
15
Problem 8-11 (30 minutes)
1. The unit product cost under the variable costing approach would be
computed as follows:
Direct materials ....................................
Direct labour ........................................
Variable manufacturing overhead ..........
Unit product cost ..................................
$ 8
10
2
$20
With this figure, the variable costing income statements can be
prepared:
Year 1
Year 2
Sales .......................................................... $1,000,000 $1,500,000
Variable expenses:
Variable cost of goods sold @ $20 per unit .
400,000
600,000
Variable selling and administrative @ $3
per unit .................................................
60,000
90,000
Total variable expenses ................................
460,000
690,000
Contribution margin.....................................
540,000
810,000
Fixed expenses:
Fixed manufacturing overhead ...................
350,000
350,000
Fixed selling and administrative .................
250,000
250,000
Total fixed expenses ....................................
600,000
600,000
Operating income (loss) ............................... $ (60,000) $ 210,000
2. Variable costing operating income (loss) ....... $ (60,000) $ 210,000
Add: Fixed manufacturing overhead cost
deferred in inventory under absorption
costing (5,000 units × $14 per unit) ..........
70,000
Deduct: Fixed manufacturing overhead cost
released from inventory under absorption
costing (5,000 units × $14 per unit) ..........
(70,000)
Absorption costing operating income ............ $ 10,000 $ 140,000
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Solutions Manual, Chapter 8
16