Cost Accounting Chapter 9: Variable and Absorption Costing

The Donaldson company uses an absorption-costing system based on standard costs. total variable manufacturing cost, including direct material cost, is $5 per unit; the standard production rate is 10 units per machine-hour. Total budgeted and actual fixed manufacturing overhead costs are $390,000. Fixed manufacturing overhead is allocated at $6 per machine-hour ($390,000 / 65,000 machine-hours of denominator level). Selling price is $8 per unit. Variable operating (nonmanufacturing) cost, which is driven by units sold, is $2 per unit. Fixed operating (nonmanufacturing) costs are $180,000. Beginning inventory in 2014 is 25,000 units; ending inventory is 55,000 units. Sales in 2014 are 570,000 units. The same standard unit costs persisted throughout 2013 and 2014. For simplicity, assume that there are no price, spending, or efficiency variances.

Requirements:

1. Prepare an income statement for 2014 assuming that the production-volume variance is written off at year-end as an adjustment to cost of goods sold. (Absorption costing)

2. The president has heard about variable costing. She asks you to recast the income statement for 2014 as it would appear under variable costing.

3. Explain the difference in operating income as calculated in requirements 1 and 2. Select answers in parenthasis:

-The difference between absorption and variable costing is due solely to moving (fixed manufacturing costs, fixed operating costs, variable manufacturing costs, or variable manufacturing costs) into inventories as inventories (increase, or decrease) and out of inventories as they (increase, or decrease).

4. Critics have claimed that a widely used accounting system has led to undesirable buildups of inventory levels. (a) Is variable costing or absorption costing more likely to lead to such buildups? Why? (b) What can be done to counteract undesirable inventory buildups? Select answers in parenthasis:

(a) (Absorption, or variable) costing is more likely to lead to buildups of inventory. (Absorption, or variable) costing enables managers to (decrease ending reported inventory costs, decrease reported operating income, increase reported beginning inventory costs, or increase reported operating income) by building up inventory which (increases, or reduces) the amount of (variable, or fixed) manufacturing overhead included in the current periods costs of goods sold.

(b) Select 3 things that can be done to counteract undesirable inventory buildups:

-Change the accounting system to variable costing or throughput costing.

-Ignore financial measures and only focus on non-financial measure when evaluating management.

-Incorporate a carrying charge for carrying inventory.

-Use a longer time period to evaluate performance than a quarter or a year.

-Use a shorter time period to evaluate performance, such as a week or a month.