Chapter 5
Variable Costing
QUESTIONS
1.
In full costing, fixed manufacturing overhead is treated as a product cost. In variable
costing, fixed manufacturing overhead is treated as a period cost.
2.
When production exceeds sales, part of fixed manufacturing overhead will remain in
inventory. In variable costing, the entire amount of fixed manufacturing overhead will be
expensed since it is treated as a period cost. Thus, income computed under full costing will
exceed income computed under variable costing when production exceeds sales.
3.
Variable costing facilitates C-V-P analysis since fixed and variable costs are separated and
a contribution margin is calculated. Also, under variable costing, managers cannot
artificially inflate profit by producing more units than they sell and burying fixed
manufacturing overhead in inventory.
4.
Companies using JIT generally have low levels of work in process and finished goods
inventory. Thus, even when a company uses full costing, very little of fixed manufacturing
overhead is in inventory at the end of a period. Rather, most of it is in cost of goods
sold—an expense.
5.
Under full costing, ending inventory includes direct material, direct labor, variable
manufacturing overhead, and fixed manufacturing overhead. Under variable costing,
ending inventory includes each of these items except fixed manufacturing overhead. Thus,
the inventory balance under variable costing is always less than the balance under full
costing (assuming the balance is not zero).
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Jiambalvo Managerial Accounting
EXERCISES
E1. The income statement produced using variable costing provides a contribution
margin. If we divide this by sales, we have the contribution margin ratio (the
contribution margin per dollar of sales). Once we have this value, we can
estimate the incremental effect on profit of an increase in sales.
E2. Increasing production will increase profit since more fixed manufacturing
overhead will be buried in ending inventory rather than expensed in cost of
goods sold. For example, if the company produced and sold 40,000 items, the
entire $20,000,000 of fixed manufacturing overhead would be in cost of goods
sold. However, if the company produces 50,000 units, the fixed
manufacturing overhead per unit will be $400. Then $16,000,000 will end up
in cost of goods sold when the company sells only 40,000 units (i.e., $400 x
40,000) and $4,000,000 will be in ending inventory ($400 x 10,000).
E3. Most Web sites make the point that variable costing aids planning and
decision making. And, it prevents managers from artificially inflating profit
by over-producing.
Some Web sites seem to imply that variable costing is simply “wrong”
because fixed overhead is a real cost and it is not included in inventory under
variable costing. However, these same Web sites state or imply that variable
costing is more useful for decision making. Frankly, it’s hard to see how the
method can be more useful for decision making and still be “wrong.”
E4. Variable cost per unit
Fixed manufacturing overhead per unit
($600,000 ÷ 1,000 units)
Full cost per unit
Ending inventory under full costing:
$900 x 100 units = $90,000
$300
600
$900
Chapter 5 Variable Costing
5-3
E5. Ending inventory under variable costing:
$300 x 100 = $30,000
E6. Full cost per unit is $900 per exercise 4. Therefore, cost of goods sold under
full costing is $900 x 900 units sold = $81,000.
E7. Variable cost per unit is $300. Therefore variable cost of goods sold is $300 x
900 = $27,000. Under variable costing, the $600,000 of fixed manufacturing
overhead is treated as a period expense.
E8. Sales ($1,500 x 900 pairs)
Less cost of goods sold ($900 x 900 pairs)
Gross margin
Less selling expense
Less administrative expense
Net income
$1,350,000
810,000
540,000
200,000
100,000
$ 240,000
E9. Sales ($1,500 x 900 pairs)
Less variable cost of goods sold ($300 x 900 pairs)
Contribution margin
Less fixed manufacturing overhead
Less selling expense
Less administrative expense
Net income
$1,350,000
270,000
1,080,000
600,000
200,000
100,000
$ 180,000
E10.The difference in net income between full and variable costing is $240,000 $180,000 = $60,000. This is equal to the amount of fixed manufacturing
overhead in ending inventory under full costing ($600 x 100 pairs = $60,000).
5-4
Jiambalvo Managerial Accounting
PROBLEMS
P1. a.
Fixed manufacturing overhead
Divided by units produced
Fixed manufacturing overhead per unit
Variable manufacturing costs
Full cost per unit
Sales ($200 x 10,000 units)
Less cost of goods sold:
($160 x 10,000)
($150 x 10,000)
($150 x 2,000 + $175 x $8,000)
Gross margin
Less selling and administrative expense
Net income
2006
$ 600,000
10,000
60
100
$
160
2007
$ 600,000
12,000
50
100
$
150
2008
$ 600,000
8,000
75
100
$
175
$2,000,000
$2,000,000
$2,000,000
1,600,000
1,500,000
400,000
200,000
$ 200,000
500,000
200,000
$ 300,000
1,700,000
300,000
200,000
$ 100,000
$ 600,000
Ending inventory
-0($150 x 2,000)
$ 300,000
-0-
b. Even though sales is the same in each period, profit fluctuates. That results
because different quantities are produced each period which affects the
fixed manufacturing overhead in cost of goods sold versus ending
inventory.
Chapter 5 Variable Costing
5-5
c.
Fixed manufacturing overhead
Variable manufacturing costs per unit
Sales ($200 x 10,000 units)
Less variable cost of goods sold:
($100 x 10,000)
Contribution margin
Less fixed costs:
Manufacturing
Selling and administrative
Net income
2006
$ 600,000
100
2007
$ 600,000
100
2008
$ 600,000
100
$2,000,000
$2,000,000
$2,000,000
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
600,000
200,000
$ 200,000
600,000
200,000
$ 200,000
600,000
200,000
$ 200,000
$ 600,000
Ending inventory
-0($100 x 2,000)
$ 200,000
-0-
d. Profit does not fluctuate each period because fixed manufacturing overhead
is treated as a period cost and expensed each year even if more units are
produced than sold.
Note that income is the same under variable and full costing in 2006 since
the quantity produced is equal to the quantity sold. Income under full
costing is higher than variable costing income in 2007 since the quantity
produced is greater than the quantity sold. Income under full costing is less
than income under variable costing in 2008 since the quantity produced is
less than the quantity sold.
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Jiambalvo Managerial Accounting
P2. a.
Fixed manufacturing overhead
Divided by units produced
Fixed manufacturing overhead per unit
Variable manufacturing costs per unit
Full cost per unit
Sales
($2,000 x 20,000 units)
($2,000 x 18,000)
($2,000 x 16,000)
Less cost of goods sold:
($1,800.00 x 20,000)
($1,800.00 x 18,000)
($1,800.00 x 2,000 + 2,228.57 x 14,000)
Gross margin
Less selling and administrative expense
Net income
2006
$ 20,000,000.00
20,000.00
1,000.00
800.00
$
1,800.00
2007
$ 20,000,000.00
20,000.00
1,000.00
800.00
$
1,800.00
2008
$ 20,000,000.00
14,000.00
1,428.57
800.00
$
2,228.57
$ 40,000,000.00
$ 36,000,000.00
$ 32,000,000.00
36,000,000.00
32,400,000.00
$
4,000,000.00
300,000.00
3,700,000.00
3,600,000.00
300,000.00
$ 3,300,000.00
34,799,980.00
(2,799,980.00)
300,000.00
$ (3,099,980.00)
$ 3,900,020.00
Ending inventory
-0($1,800 x 2,000)
$ 3,600,000.00
-0-
b.
Fixed manufacturing overhead
Variable manufacturing costs per unit
Sales
($2,000 x 20,000 units)
($2,000 x 18,000)
($2,000 x 16,000)
Less variable cost of goods sold:
($800 x 20,000 units)
($800 x 18,000)
($800 x 16,000)
Contribution margin
Less fixed costs:
Manufacturing
Selling and administrative
Net income
2006
$ 20,000,000.00
$
800.00
2007
$ 20,000,000.00
$
800.00
2008
$ 20,000,000.00
$
800.00
$ 40,000,000.00
$ 36,000,000.00
$ 32,000,000.00
16,000,000.00
14,400,000.00
12,800,000.00
24,000,000.00
21,600,000.00
20,000,000.00
300,000.00
$ 3,700,000.00
20,000,000.00
300,000.00
$ 1,300,000.00
19,200,000.00
20,000,000.00
300,000.00
$ (1,100,000.00)
Ending inventory
-0($800 x 2,000)
$ 1,600,000.00
-0-
$ 3,900,000.00
Chapter 5 Variable Costing
5-7
Note that the $20 difference in net income for the three years between full and
variable costing is due to rounding.
c. Under full costing, management could manipulate profit in 2007 by
overproducing (producing more units than really needed in 2007). This
results in fixed manufacturing overhead being buried in ending inventory.
Note that the difference in profit in 2007 between full and variable costing
is equal to the difference in ending inventory under full and variable
costing.
This approach to manipulating earnings could not be repeated year after
year—eventually the inventory build-up would be quite obvious.
P3. a.
Fixed manufacturing overhead
Divided by units produced
Fixed manufacturing overhead per unit
Variable manufacturing costs per unit
Full cost per unit
2006
$ 2,000,000.00
10,000.00
200.00
2,200.00
$
2,400.00
2007
$ 2,000,000.00
6,000.00
333.33
2,200.00
$
2,533.33
$ 24,000,000.00
$ 24,000,000.00
Sales ($3,000 x 8,000 units)
Less cost of goods sold:
($2,400 x 8,000)
($2,400 x 2,000 + $2,533.33 x 6,000)
Gross margin
Less selling and administrative expense
Net income
4,800,000.00
1,000,000.00
$ 3,800,000.00
Ending inventory
($2,400 x 2,000)
$ 4,800,000.00
19,200,000.00
19,999,980.00
4,000,020.00
1,000,000.00
$ 3,000,020.00
$ 6,800,020.00
-0-
b. Company performance is really not worse in 2007—note that the company
had the same cost structure and the same level of sales. The difference is
due to greater production in 2006 which lowered unit cost and buried fixed
manufacturing overhead in inventory.
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Jiambalvo Managerial Accounting
c.
Fixed manufacturing overhead
Variable manufacturing costs per unit
2006
$ 2,000,000.00
$
2,200.00
2007
$ 2,000,000.00
$
2,200.00
$ 24,000,000.00
$ 24,000,000.00
Sales ($3,000 x 8,000 units)
Less cost of goods sold:
($2,200 x 8,000 units)
Contribution margin
Less fixed costs:
Manufacturing
Selling and administrative
Net income
17,600,000.00
6,400,000.00
17,600,000.00
6,400,000.00
2,000,000.00
1,000,000.00
$ 3,400,000.00
2,000,000.00
1,000,000.00
$ 3,400,000.00
Ending inventory
($2,200 x 2,000)
$ 4,400,000.00
$ 6,800,000.00
-0-
Note that the difference in income between full and variable costing over
the two years is due to rounding.
d. Variable costing presents a more realistic view of firm performance in that
income is the same in both years which is consistent with the firm having
the same cost structure and level of sales in both years.
P4. Income computed under full costing is $4,000 higher than income computed
under variable costing. Under variable costing, the entire amount of fixed
manufacturing overhead ($24,000) was treated as a period cost. Under full
costing, $4,000 remains in ending inventory.
Fixed manufacturing overhead
Divided by units produced
Fixed manufacturing overhead per unit
$24,000
1,200
$
20
Amount of fixed manufacturing overhead in ending inventory:
$20 x 200 units = $4,000
Chapter 5 Variable Costing
5-9
P5. a. Contribution margin ÷ sales = contribution margin ratio
$8,100,000 ÷ $18,000,000 = .45.
(Incremental sales x contribution margin ratio) – incremental salaries =
incremental profit
($1,600,000 x .45) - $120,000 = $600,000.
b. The chief accountant is treating income per dollar of sales as the
contribution margin ratio. Income only varies in proportion to sales if all
costs are variable which is clearly not the case for Wilner Glass Company.
P6. a.
Variable Costing
2004
Sales
$ 10,000,000
Less variable cost of goods sold
4,000,000
Contribution margin
6,000,000
Less:
Fixed production costs
6,000,000
Fixed selling and administrative costs
2,000,000
Net income
$ (2,000,000)
2005
$ 12,500,000
5,000,000
7,500,000
2006
$ 15,000,000
6,000,000
9,000,000
6,000,000
2,000,000
$ (500,000)
6,000,000
2,000,000
$ 1,000,000
b. Under full costing, it appears that Ed did a good job since the company hit
the break-even point in its first year and then earned a profit of $500,000 in
its second year. However, variable costing provides a better picture of the
firms profitability under Ed’s guidance. Note that under variable costing,
the company had a $500,000 loss in its second year. Ed was able to show
a profit under full costing by producing more than needed for current
period sales and burying a substantial amount of fixed manufacturing cost
in ending inventory. That’s why Zac could not show a profit under full
costing in 2004. He had to cut production in 2004 to avoid building up
excess inventory. This increased per unit cost. Income statements
prepared under variable costing indicate that Zac’s performance was quite
good. Sales have increased and so has profit.
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Jiambalvo Managerial Accounting
c. The company should not get out of the tractor business. As indicated in
the variable costing income statement, the company is generating a
substantial profit. If the company can continue performing at this level, it
will be quite successful.
P7. a. Fixed manufacturing overhead ÷ Units produced = fixed overhead per unit
$500,000 ÷ 100,000 = $5
$5 x 80,000 units sold = $400,000.
b. With variable costing, the entire amount of fixed manufacturing overhead
($500,000) will be expensed.
c. The amount of fixed manufacturing overhead in ending inventory under
full costing is $100,000:
$5 x 20,000 units = $100,000.
This accounts for the difference between income under full versus variable
costing.
Chapter 5 Variable Costing
P8. a.
Fixed manufacturing overhead
Divided by units produced
Fixed manufacturing overhead per unit
Variable manufacturing costs per unit
($60 + $20 + $5)
Full cost per unit
2006
$ 2,000,000.00
200,000.00
10.00
$
85.00
95.00
Sales ($120 x 170,000 units)
Less cost of goods sold:
($95.00 x 170,000)
Gross margin
Less selling expense
($1,000,000.00 + .10 x $20,400,000)
Less administrative expense
Net income
$ 20,400,000.00
3,040,000.00
800,000.00
$ 410,000.00
Ending inventory
($95 x 30,000)
$ 2,850,000.00
16,150,000.00
4,250,000.00
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Jiambalvo Managerial Accounting
b.
2006
$ 20,400,000.00
Sales ($120 x 170,000 units)
Less variable cost of goods sold:
($85.00 x 170,000)
Less variable selling expense
($.10 x $20,400,000)
Contribution margin
Less fixed costs:
Manufacturing
Selling expense
Administrative expense
Net income
2,000,000.00
1,000,000.00
800,000.00
$ 110,000.00
Ending inventory
($85 x 30,000)
$ 2,550,000.00
14,450,000.00
2,040,000.00
3,910,000.00
c. The amount of fixed manufacturing inventory that is included in ending
inventory under full costing is $300,000 ($10 x 30,000 units). This
accounts for the difference in income under full versus variable costing.