1) Ch 21 begins with a discussion of the differences between Absorption Costing and Variable Costing. Think back to the various methods we have worked with this semester -- job order costing, process costing, activity-based, and just in time. Which of these are absorption? Which are variable? Both absorption and variable? Neither absorption or variable? Why? (This is a comprehensive midterm question with a lot of gray area in the solution, so be sure to explain why.)

2) In the variable costing income statement, how are the fixed manufacturing costs reported and how are the fixed selling and administrative expenses reported? How is this different from absorption costing income statements? How does this difference impact the usefulness of a variable costing income statement? Be concise!

3) Why is variable costing not used for external reporting?

4) Read the following vignette from Financial and Managerial Accounting by Warren, Reeve. Answer the five questions, A-E. "Management operating with integrity will seek the tangible benefits of reducing inventory, even though there may be an adverse impact on published financial statements."

 

Clarification – The executive refers to a P & L, which is a Profit & Loss Statement, another name for an Income Statement. The "liquidation" referred to is not a liquidation like in a bankruptcy where all of the inventory is sold for pennies on the dollar. This liquidation means that inventory is being sold in a normal business transaction and not replenished in order to reduce the overall level of inventory.

A) Why does the vignette specify "published" financial statements?

B) What are the "tangible benefits of reducing inventory"? Be specific!

C) Describe the Heinz executive's response in terms of the pre-determined overhead rate.

D) In addition to the "hit" from the change in the predetermined overhead rate, what is the source of the other financial "hit" that Heinz is going to take as inventories are reduced?

E) Relate this issue to the assumptions of a CVP Analysis that we studied in Ch 20.