Simple numbers are used in this problem to highlight the concepts covered in the chapter.

Assume that the Perth Woolen Company produces a rug that sells for $20. Perth uses a standard cost system. Total standard variable costs of production are $8 per rug, fixed manufacturing costs are $150,000 per year, and selling and administrative expenses are $30,000 per year, all fixed. Expected production volume is 25,000 rugs per year.

1. For each of the following nine combinations of actual sales and production (in thousands of units) for 20X0, prepare condensed income statements under variable costing and under absorption costing.

Use the following formats:

2. a. In which of the nine combinations is variable-costing income greater than absorption-costing income? In which is it lower? The same?

b. In which of the nine combinations is the production-volume variance unfavorable? Favorable?

c. How much profit is added by selling one more unit under variable costing? Under absorption costing?

d. How much profit is added by producing one more unit under variable costing? Under absorption costing?

e. Suppose sales, rather than production, is the critical factor in determining the success of Perth Woolen Company. Which format, variable costing or absorption costing, provides the better measure of performance?

Transcribed Image Text:

Sales units 15 20 25 20 25 30) 30 35 Production units2020202525 25 30 30 30 Variable Costing Absorption Costing $aa Revenue $ aa Revenue Cost of goods sold Contribution margin Fixed manufacturing costs (bb) Cost of goods sold S cc Gross profit at standard (dd) Favorable unfavorable) Fixed selling and administrative exenses production-volume variance Gross profit at "actual" Selling and administrative expenses Operating income (Y) Operating income