Weeks 3-4 - Chs 7-10 Mastery

1. MP.07.01.ALGO
2. MP.08.01.ALGO
3. MP.09.01.ALGO
4. MP.10.01.ALGO

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1. Mastery Problem: Variable Costing for Management Analysis

   Absorption vs. Variable

   Operating income is one of the most important items reported by a company. Depending on the decision-making needs of management, operating income can be determined using absorption costing or variable costing.

   Select whether the following characteristics are most often associated with absorption costing or variable costing.

   Required under generally accepted accounting principles (GAAP)	Absorption Costing
   Often used for internal use in decision making	Variable Costing
   Cost of goods manufactured includes only variable manufacturing costs	Variable Costing
   Used in reports prepared for external users	Absorption Costing
   Fixed factory overhead costs are not part of cost of goods manufactured	Variable Costing
   Both fixed and variable factory costs are included in cost of goods sold and inventory	Absorption Costing

   Feedback

   Review the differences between absorption and variable costing, and how each type of costing is used in the organization and for management processes.

   Absorption Statement

   Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goods sold.

   Saxon, Inc. Absorption Costing Income Statement For the Year Ended December 31
   Sales		$1,125,000
   Cost of goods sold:
   Cost of goods manufactured	$800,000
   Ending inventory	(200,000)
   Total cost of goods sold		(600,000)
   Gross profit		$525,000
   Selling and administrative expenses		(290,000)
   Operating income		$235,000

   Variable Statement

   Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statement includes a computation of manufacturing margin.

   Saxon, Inc. Variable Costing Income Statement For the Year Ended December 31
   Sales		$1,125,000
   Variable cost of goods sold:
   Variable cost of goods manufactured	$560,000
   Ending inventory	(140,000)
   Total variable cost of goods sold		(420,000)
   Manufacturing margin		$705,000
   Variable selling and administrative expenses		(225,000)
   Contribution margin		$480,000
   Fixed costs:
   Fixed manufacturing costs	$240,000
   Fixed selling and administrative expenses	65,000
   Total fixed costs		(305,000)
   Operating income		$175,000

   Method Comparison

   Review the income statements on the Absorption Statement and Variable Statement, then complete the following table. The companys sales price per unit is $75, and the number of units in ending inventory is 5,000. There was no beginning inventory.

   Item	Amount
   Number of units sold	fill in the blank 4528acfdd042f82_1
   Variable sales and administrative cost per unit	$fill in the blank 4528acfdd042f82_2
   Number of units manufactured	fill in the blank 4528acfdd042f82_3
   Variable cost of goods manufactured per unit	$fill in the blank 4528acfdd042f82_4
   Fixed manufacturing cost per unit	$fill in the blank 4528acfdd042f82_5

   Feedback

   Review the definitions of the items in the table, and think backwards from one of the income statements to get the desired values.

   Manufacturing Decisions

   Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing operating income, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.

   All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.

   The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement and the Variable Statement, he notices that the operating income is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the companys capacity for manufacturing, in the coming year. He reasons that this will boost operating income and satisfy the companys owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow. If the answer is zero, enter "0".

   1. Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.

   Operating Income
   Original Production Level-Absorption	Original Production Level-Variable	Additional 10,000 Units-Absorption	Additional 10,000 Units-Variable
   $fill in the blank de0e51fc2f98fde_1	$fill in the blank de0e51fc2f98fde_2	$fill in the blank de0e51fc2f98fde_3	$fill in the blank de0e51fc2f98fde_4

   2. What is the change in operating income from producing 10,000 additional units under absorption costing?

   $fill in the blank de0e51fc2f98fde_5

   3. What is the change in operating income from producing 10,000 additional units under variable costing?

   $fill in the blank de0e51fc2f98fde_6

   4. What would be your recommendation to the production manager?

   a. Do not produce the extra 10,000 units. The increase in operating income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.

   b. Produce the extra 10,000 units. Operating income will be increased, and the production manager will receive praise for creating higher profits.

   c. Do not produce the extra 10,000 units. Operating income does not change under absorption costing when the additional units are produced.

   d. Produce the extra 10,000 units. It's always a good idea to have extra units on hand and keep the factory operating at capacity, even if all the units are not sold.

   a

   Feedback

   1. Following the examples on the Absorption Statement and Variable Statement panels, recompute operating income under the absorption and variable cost methods, given that the additional units are manufactured. Dont forget that fixed costs will remain the same at any production level within the relevant range.

   2. Review your chart and determine the change in operating income, focusing only on the change in absorption costing amounts.

   3. Review your chart and determine the change in operating income, focusing only on the change in variable costing amounts.

   4. What is the best decision the production manager can make when putting the company's needs ahead of his own?

   Feedback

   Partially correct

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