Accounting Test Bank

CHAPTER 11 ABSORPTION/VARIABLE COSTING AND COST-VOLUME-PROFIT ANALYSIS MULTIPLE CHOICE 1.

Consider the following three product costing alternatives: process costing, job order costing, and standard costing. Which of these can be used in conjunction with absorption costing? a. b. c. d.

job order costing standard costing process costing all of them

ANSWER: 2.

absorption costing. variable costing. direct costing. standard costing.

ANSWER:

a

EASY

Another name for absorption costing is a. b. c. d.

full costing. direct costing. job order costing. fixed costing.

ANSWER: 4.

EASY

In a recent period, Marvel Co. incurred $20,000 of fixed manufacturing overhead and deducted $30,000 of fixed manufacturing overhead. Marvel Co. must be using a. b. c. d.

3.

d

a

EASY

If a firm produces more units than it sells, absorption costing, relative to variable costing, will result in a. b. c. d.

higher income and assets. higher income but lower assets. lower income but higher assets. lower income and assets.

ANSWER:

a

MEDIUM

11–1

11–2

5.

Chapter 11

Under absorption costing, fixed manufacturing overhead could be found in all of the following except the a. b. c. d.

work-in-process account. finished goods inventory account. Cost of Goods Sold. period costs.

ANSWER: 6.

EASY

only on the balance sheet. only on the income statement. on both the balance sheet and income statement. on neither the balance sheet nor income statement.

ANSWER:

c

EASY

Under absorption costing, if sales remain constant from period 1 to period 2, the company will report a larger income in period 2 when a. b. c. d.

period 2 production exceeds period 1 production. period 1 production exceeds period 2 production. variable production costs are larger in period 2 than period 1. fixed production costs are larger in period 2 than period 1.

ANSWER: 8.

d

If a firm uses absorption costing, fixed manufacturing overhead will be included a. b. c. d.

7.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

a

MEDIUM

The FASB requires which of the following to be used in preparation of external financial statements? a. b. c. d.

variable costing standard costing activity-based costing absorption costing

ANSWER:

d

EASY

Chapter 11

9.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

An ending inventory valuation on an absorption costing balance sheet would a. b. c. d.

sometimes be less than the ending inventory valuation under variable costing. always be less than the ending inventory valuation under variable costing. always be the same as the ending inventory valuation under variable costing. always be greater than or equal to the ending inventory valuation under variable costing.

ANSWER: 10.

EASY

treatment of fixed manufacturing overhead. treatment of variable production costs. acceptability for external reporting. arrangement of the income statement.

ANSWER:

b

EASY

Which of the following is not associated with absorption costing? a. b. c. d.

functional format gross margin period costs contribution margin

ANSWER: 12.

d

Absorption costing differs from variable costing in all of the following except a. b. c. d.

11.

11–3

d

EASY

Unabsorbed fixed overhead costs in an absorption costing system are a. b. c. d.

fixed manufacturing costs not allocated to units produced. variable overhead costs not allocated to units produced. excess variable overhead costs. costs that cannot be controlled.

ANSWER:

a

EASY

11–4

13.

Chapter 11

Profit under absorption costing may differ from profit determined under variable costing. How is this difference calculated? a. b. c. d.

Change in the quantity of all units in inventory times the relevant fixed costs per unit. Change in the quantity of all units produced times the relevant fixed costs per unit. Change in the quantity of all units in inventory times the relevant variable cost per unit. Change in the quantity of all units produced times the relevant variable cost per unit.

ANSWER: 14.

a

EASY

What factor, related to manufacturing costs, causes the difference in net earnings computed using absorption costing and net earnings computed using variable costing? a. b. c. d.

Absorption costing considers all costs in the determination of net earnings, whereas variable costing considers fixed costs to be period costs. Absorption costing allocates fixed overhead costs between cost of goods sold and inventories, and variable costing considers all fixed costs to be period costs. Absorption costing “inventories” all direct costs, but variable costing considers direct costs to be period costs. Absorption costing “inventories” all fixed costs for the period in ending finished goods inventory, but variable costing expenses all fixed costs.

ANSWER: 15.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

EASY

The costing system that classifies costs by functional group only is a. b. c. d.

standard costing. job order costing. variable costing. absorption costing.

ANSWER:

d

EASY

Chapter 11

16.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

A functional classification of costs would classify “depreciation on office equipment” as a a. b. c. d.

product cost. general and administrative expense. selling expense. variable cost.

ANSWER: 17.

process costing. job order costing. variable costing. absorption costing.

ANSWER:

c

EASY

Under variable costing, which of the following are costs that can be inventoried? a. b. c. d.

variable selling and administrative expense variable manufacturing overhead fixed manufacturing overhead fixed selling and administrative expense

ANSWER: 19.

EASY

The costing system that classifies costs by both functional group and behavior is a. b. c. d.

18.

b

b

EASY

Consider the following three product costing alternatives: process costing, job order costing, and standard costing. Which of these can be used in conjunction with variable costing? a. b. c. d.

job order costing standard costing process costing all of them

ANSWER:

d

EASY

11–5

11–6

20.

Chapter 11

Another name for variable costing is a. b. c. d.

full costing. direct costing. standard costing. adjustable costing.

ANSWER: 21.

EASY

only on the balance sheet. only on the income statement. on both the balance sheet and income statement. on neither the balance sheet nor income statement.

ANSWER:

b

EASY

Under variable costing, a. b. c. d.

all product costs are variable. all period costs are variable. all product costs are fixed. product costs are both fixed and variable.

ANSWER: 23.

b

If a firm uses variable costing, fixed manufacturing overhead will be included a. b. c. d.

22.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

a

EASY

How will a favorable volume variance affect net income under each of the following methods? a. b. c. d.

Absorption reduce reduce increase increase

ANSWER:

c

Variable no effect increase no effect reduce EASY

Chapter 11

24.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Variable costing considers which of the following to be product costs?

a. b. c. d.

Fixed Mfg. Costs yes yes no no

ANSWER: 25.

Variable Mfg. Costs yes yes yes yes

Variable Selling & Adm. no yes yes no

EASY

costs are classified by their behavior. costs are always lower. it is required for external reporting. it justifies higher product prices.

ANSWER:

a

EASY

The difference between the reported income under absorption and variable costing is attributable to the difference in the a. b. c. d.

income statement formats. treatment of fixed manufacturing overhead. treatment of variable manufacturing overhead. treatment of variable selling, general, and administrative expenses.

ANSWER: 27.

d

Fixed Selling & Adm. no no no no

The variable costing format is often more useful to managers than the absorption costing format because a. b. c. d.

26.

11–7

b

EASY

Which of the following costs will vary directly with the level of production? a. b. c. d.

total manufacturing costs total period costs variable period costs variable product costs

ANSWER:

d

EASY

11–8

28.

Chapter 11

On the variable costing income statement, the difference between the “contribution margin” and “income before income taxes” is equal to a. b. c. d.

the total variable costs. the Cost of Goods Sold. total fixed costs. the gross margin.

ANSWER: 29.

EASY

deducted in the period that they are incurred. inventoried until the related products are sold. treated like period costs. inventoried until the related products have been completed.

ANSWER:

b

EASY

In the application of “variable costing” as a cost-allocation process in manufacturing, a. b. c. d.

variable direct costs are treated as period costs. nonvariable indirect manufacturing costs are treated as product costs. variable indirect manufacturing costs are treated as product costs. nonvariable direct costs are treated as product costs.

ANSWER: 31.

c

For financial reporting to the IRS and other external users, manufacturing overhead costs are a. b. c. d.

30.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

c

EASY

A basic tenet of variable costing is that period costs should be currently expensed. What is the rationale behind this procedure? a. b. c. d.

Period costs are uncontrollable and should not be charged to a specific product. Period costs are generally immaterial in amount and the cost of assigning the amounts to specific products would outweigh the benefits. Allocation of period costs is arbitrary at best and could lead to erroneous decision by management. Because period costs will occur whether production occurs, it is improper to allocate these costs to production and defer a current cost of doing business.

ANSWER:

d

MEDIUM

Chapter 11

32.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Which of the following is a term more descriptive of the type of cost accounting often called “direct costing”? a. b. c. d.

out-of-pocket costing variable costing relevant costing prime costing

ANSWER: 33.

EASY

only direct costs only variable production costs all variable costs all variable and fixed manufacturing costs

ANSWER:

b

EASY

Which of the following must be known about a production process in order to institute a variable costing system? a. b. c. d.

the variable and fixed components of all costs related to production the controllable and non-controllable components of all costs related to production standard production rates and times for all elements of production contribution margin and break-even point for all goods in production

ANSWER: 35.

b

What costs are treated as product costs under variable (direct) costing? a. b. c. d.

34.

11–9

a

EASY

Why is variable costing not in accordance with generally accepted accounting principles? a. b. c. d.

Fixed manufacturing costs are treated as period costs under variable costing. Variable costing procedures are not well known in industry. Net earnings are always overstated when using variable costing procedures. Variable costing ignores the concept of lower of cost or market when valuing inventory.

ANSWER:

a

EASY

11–10

36.

Chapter 11

Which of the following is an argument against the use of direct (variable) costing? a. b. c. d.

Absorption costing overstates the balance sheet value of inventories. Variable factory overhead is a period cost. Fixed manufacturing overhead is difficult to allocate properly. Fixed manufacturing overhead is necessary for the production of a product.

ANSWER: 37.

b. c. d.

EASY

The cost of a unit of product changes because of changes in the number of units manufactured. Profits fluctuate with sales. An idle facility variation is calculated. None of the above.

ANSWER:

b

EASY

An income statement is prepared as an internal report. Under which of the following methods would the term contribution margin appear? a. b. c. d.

Absorption costing no no yes yes

ANSWER: 39.

d

Which of the following statements is true for a firm that uses variable costing? a.

38.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

Variable costing no yes no yes

EASY

In an income statement prepared as an internal report using the variable costing method, fixed manufacturing overhead would a. b. c. d.

not be used. be used in the computation of operating income but not in the computation of the contribution margin. be used in the computation of the contribution margin. be treated the same as variable manufacturing overhead.

ANSWER:

b

EASY

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40.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Variable costing has an advantage over absorption costing for which of the following purposes? a. b. c. d.

analysis of profitability of products, territories, and other segments of a business determining the CVP relationship among the major factors of selling price, sales mix, and sales volume minimizing the effects of inventory changes on net income all of the above

ANSWER: 41.

EASY

selling expenses general and administrative expense product contribution margin total contribution margin

ANSWER:

d

EASY

A firm presently has total sales of $100,000. If its sales rise, its a. b. c. d.

net income based on variable costing will go up more than its net income based on absorption costing. net income based on absorption costing will go up more than its net income based on variable costing. fixed costs will also rise. per unit variable costs will rise.

ANSWER: 43.

d

In the variable costing income statement, which line separates the variable and fixed costs? a. b. c. d.

42.

11–11

a

MEDIUM

CVP analysis requires costs to be categorized as a. b. c. d.

either fixed or variable. fixed, mixed, or variable. product or period. standard or actual.

ANSWER:

a

EASY

11–12

44.

Chapter 11

With respect to fixed costs, CVP analysis assumes total fixed costs a. b. c. d.

per unit remain constant as volume changes. remain constant from one period to the next. vary directly with volume. remain constant across changes in volume.

ANSWER: 45.

EASY

fixed costs decrease. variable costs remain constant. costs decrease. costs remain constant.

ANSWER:

c

EASY

According to CVP analysis, a company could never incur a loss that exceeded its total a. b. c. d.

variable costs. fixed costs. costs. contribution margin.

ANSWER: 47.

d

CVP analysis relies on the assumptions that costs are either strictly fixed or strictly variable. Consistent with these assumptions, as volume decreases total a. b. c. d.

46.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

c

EASY

CVP analysis is based on concepts from a. b. c. d.

standard costing. variable costing. job order costing. process costing.

ANSWER:

b

EASY

Chapter 11

48.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Cost-volume-profit analysis is a technique available to management to understand better the interrelationships of several factors that affect a firm’s profit. As with many such techniques, the accountant oversimplifies the real world by making assumptions. Which of the following is not a major assumption underlying CVP analysis? a. b. c. d.

All costs incurred by a firm can be separated into their fixed and variable components. The product selling price per unit is constant at all volume levels. Operating efficiency and employee productivity are constant at all volume levels. For multi-product situations, the sales mix can vary at all volume levels.

ANSWER: 49.

EASY

contribution margin per unit. fixed cost per unit. total costs per unit. all of the above.

ANSWER:

a

EASY

Which of the following factors is involved in studying cost-volume-profit relationships? a. b. c. d.

product mix variable costs fixed costs all of the above

ANSWER: 51.

d

In CVP analysis, linear functions are assumed for a. b. c. d.

50.

11–13

d

EASY

Cost-volume-profit relationships that are curvilinear may be analyzed linearly by considering only a. b. c. d.

fixed and mixed costs. relevant fixed costs. relevant variable costs. a relevant range of volume.

ANSWER:

d

EASY

11–14

52.

Chapter 11

After the level of volume exceeds the break-even point a. b. c. d.

the contribution margin ratio increases. the total contribution margin exceeds the total fixed costs. total fixed costs per unit will remain constant. the total contribution margin will turn from negative to positive.

ANSWER: 53.

Decrease in fixed cost yes yes yes no

ANSWER:

EASY

b

Increase in direct labor cost yes no no yes

Increase in selling price yes yes no no

EASY

At the break-even point, fixed costs are always a. b. c. d.

less than the contribution margin. equal to the contribution margin. more than the contribution margin. more than the variable cost.

ANSWER: 55.

b

Which of the following will decrease the break-even point?

a. b. c. d.

54.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

EASY

The method of cost accounting that lends itself to break-even analysis is a. b. c. d.

variable. standard. absolute. absorption.

ANSWER:

a

EASY

Chapter 11

56.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Given the following notation, what is the break-even sales level in units? SP = selling price per unit, FC = total fixed cost, VC = variable cost per unit a. b. c. d.

SP/(FC/VC) FC/(VC/SP) VC/(SP – FC) FC/(SP – VC)

ANSWER: 57.

net income fixed costs contribution margin variable costs

ANSWER:

d

MEDIUM

If a firm’s net income does not change as its volume changes, the firm(‘s) a. b. c. d.

must be in the service industry. must have no fixed costs. sales price must equal $0. sales price must equal its variable costs.

ANSWER: 59.

EASY

Consider the equation X = Sales – [(CM/Sales) × (Sales)]. What is X? a. b. c. d.

58.

d

d

MEDIUM

Break-even analysis assumes over the relevant range that a. b. c. d.

total variable costs are linear. fixed costs per unit are constant. total variable costs are nonlinear. total revenue is nonlinear.

ANSWER:

a

EASY

11–15

11–16

60.

Chapter 11

To compute the break-even point in units, which of the following formulas is used? a. b. c. d.

FC/CM per unit FC/CM ratio CM/CM ratio (FC+VC)/CM ratio

ANSWER: 61.

EASY

FC/CM per unit VC/CM FC/CM ratio VC/CM ratio

ANSWER:

c

EASY

The contribution margin ratio always increases when the a. b. c. d.

variable costs as a percentage of net sales increase. variable costs as a percentage of net sales decrease. break-even point increases. break-even point decreases.

ANSWER: 63.

a

A firm’s break-even point in dollars can be found in one calculation using which of the following formulas? a. b. c. d.

62.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

EASY

In a multiple-product firm, the product that has the highest contribution margin per unit will a. b. c. d.

generate more profit for each $1 of sales than the other products. have the highest contribution margin ratio. generate the most profit for each unit sold. have the lowest variable costs per unit.

ANSWER:

c

EASY

Chapter 11

64.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

_____________ focuses only on factors that change from one course of action to another. a. b. c. d.

Incremental analysis Margin of safety Operating leverage A break-even chart

ANSWER: 65.

EASY

was presently operating at a volume that is below the break-even point. present fixed costs were less than its contribution margin. variable costs exceeded its fixed costs. degree of operating leverage is greater than 100.

ANSWER:

a

EASY

The margin of safety is a key concept of CVP analysis. The margin of safety is the a. b. c. d.

contribution margin rate. difference between budgeted contribution margin and actual contribution margin. difference between budgeted contribution margin and break-even contribution margin. difference between budgeted sales and break-even sales.

ANSWER: 67.

a

The margin of safety would be negative if a company(‘s) a. b. c. d.

66.

11–17

d

EASY

Management is considering replacing an existing sales commission compensation plan with a fixed salary plan. If the change is adopted, the company’s a. b. c. d.

break-even point must increase. margin of safety must decrease. operating leverage must increase. profit must increase.

ANSWER:

c

MEDIUM

11–18

68.

Chapter 11

As projected net income increases the a. b. c. d.

degree of operating leverage declines. margin of safety stays constant. break-even point goes down. contribution margin ratio goes up.

ANSWER: 69.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

a

MEDIUM

A managerial preference for a very low degree of operating leverage might indicate that a. b. c. d.

an increase in sales volume is expected. a decrease in sales volume is expected. the firm is very unprofitable. the firm has very high fixed costs.

ANSWER:

b

MEDIUM

Use the following information for questions 70–73. Young Corporation has the following standard costs associated with the manufacture and sale of one of its products: Direct material Direct labor Variable manufacturing overhead Fixed manufacturing overhead Variable selling expenses Fixed SG&A expense

$3.00 per unit 2.50 per unit 1.80 per unit 4.00 per unit (based on an estimate of 50,000 units per year) .25 per unit $75,000 per year

During 2001, its first year of operations, Young manufactured 51,000 units and sold 48,000. The selling price per unit was $25. All costs were equal to standard. 70.

Under absorption costing, the standard production cost per unit for 2001 was a. b. c. d.

$11.30. $7.30. $11.55. $13.05.

ANSWER:

a

EASY

Chapter 11

71.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Under variable costing, the standard production cost per unit for 2001 was a. b. c. d.

$11.30. $7.30. $7.55. $11.55.

ANSWER: 72.

EASY

Based on variable costing, the income before income taxes for the year was a. b. c. d.

$570,600. $560,000. $562,600. $547,500.

ANSWER: 73.

b

c

MEDIUM

The volume variance under absorption costing is a. b. c. d.

$8,000 F. $4,000 F. $4,000 U. $8,000 U.

ANSWER:

b

MEDIUM

11–19

11–20

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 74–76. The following information is available for X Co. for its first year of operations: Sales in units Production in units Manufacturing costs: Direct labor Direct material Variable overhead Fixed overhead Net income (absorption method) Sales price per unit 74.

$30,000 ($7,500) $67,500 can’t be determined from the information given

ANSWER:

b

MEDIUM

What was the total amount of SG&A expense incurred by X Co.? a. b. c. d.

$30,000 $62,500 $6,000 can’t be determined from the information given

ANSWER: 76.

$3 per unit 5 per unit 1 per unit $100,000 $30,000 $40

What would X Co. have reported as its income before income taxes if it had used variable costing? a. b. c. d.

75.

5,000 8,000

b

MEDIUM

Based on variable costing, what would X Co. show as the value of its ending inventory? a. b. c. d.

$120,000 $64,500 $27,000 $24,000

ANSWER:

c

EASY

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–21

Use the following information for questions 77–79. The following information has been extracted from P Co.’s financial records for its first year of operations: Units produced Units sold Variable costs per unit: Direct material Direct labor Manufacturing overhead SG&A Fixed costs: Manufacturing overhead SG&A 77.

$70,000 30,000

$21,000 higher than it would be under variable costing. $70,000 higher than it would be under variable costing. $30,000 higher than it would be under variable costing. higher than it would be under variable costing, but the exact difference cannot be determined from the information given.

ANSWER:

a

MEDIUM

Based on absorption costing, the Cost of Goods Manufactured for P Co.’s first year would be a. b. c. d.

$200,000. $270,000. $300,000. $210,000.

ANSWER: 79.

$8 9 3 4

Based on absorption costing, P Co.’s income in its first year of operations will be a. b. c. d.

78.

10,000 7,000

b

MEDIUM

Based on absorption costing, what amount of period costs will P Co. deduct? a. b. c. d.

$70,000 $79,000 $30,000 $58,000

ANSWER:

d

MEDIUM

11–22

80.

Chapter 11

For its most recent fiscal year, a firm reported that its contribution margin was equal to 40 percent of sales and that its net income amounted to 10 percent of sales. If its fixed costs for the year were $60,000, how much were sales? a. b. c. d.

$150,000 $200,000 $600,000 can’t be determined from the information given

ANSWER: 81.

b

MEDIUM

At its present level of operations, a small manufacturing firm has total variable costs equal to 75 percent of sales and total fixed costs equal to 15 percent of sales. Based on variable costing, if sales change by $1.00, income will change by a. b. c. d.

$0.25. $0.10. $0.75. can’t be determined from the information given.

ANSWER: 82.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

a

EASY

You obtain the following information regarding fixed production costs from a manufacturing firm for fiscal year 2001: Fixed costs in the beginning inventory Fixed costs incurred this period

$ 16,000 100,000

Which of the following statements is not true: a. b. c. d.

The maximum amount of fixed production costs that this firm could deduct using absorption costs in 2001 is $116,000. The maximum difference between this firm’s 2001 income based on absorption costing and its income based on variable costing is $16,000. Using variable costing, this firm will deduct no more than $16,000 for fixed production costs. If this firm produced substantially more units than it sold in 2001, variable costing will probably yield a lower income than absorption costing.

ANSWER:

c

MEDIUM

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–23

Use the following information for questions 83–86. Simple Corp. produces a single product. The following cost structure applied to its first year of operations, 2001: Variable costs: SG&A $2 per unit Production $4 per unit Fixed costs (total cost incurred for the year): SG&A $14,000 Production $20,000 83.

Assume for this question only that during 2001 Simple Corp. manufactured 5,000 units and sold 3,800. There was no beginning or ending work-in-process inventory. How much larger or smaller would Simple Corp.’s income be if it uses absorption rather than variable costing? a. b. c. d.

The absorption costing income would be $6,000 larger. The absorption costing income would be $6,000 smaller. The absorption costing income would be $4,800 larger. The absorption costing income would be $4,000 smaller.

ANSWER: 84.

MEDIUM

Assume for this question only that Simple Corp. manufactured and sold 5,000 units in 2001. At this level of activity it had an income of $30,000 using variable costing. What was the sales price per unit? a. b. c. d.

$16.00 $18.80 $12.80 $14.80

ANSWER: 85.

c

b

MEDIUM

Assume for this question only that Simple Corp. produced 5,000 units and sold 4,500 units in 2001. If Simple uses absorption costing, it would deduct period costs of a. b. c. d.

$24,000. $34,000. $27,000. $23,000.

ANSWER:

d

MEDIUM

11–24

86.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Assume for this question only that Simple Corp. manufactured 5,000 units and sold 4,000 in 2001. If Simple employs a costing system based on variable costs, the company would end 2001 with a finished goods inventory of a. b. c. d.

$4,000. $8,000. $6,000. $5,000.

ANSWER:

a

MEDIUM

Use the following information for questions 87–89. The following information was extracted from the first year absorption-based accounting records of Confused Co. Total fixed costs incurred Total variable costs incurred Total period costs incurred Total variable period costs incurred Units produced Units sold Unit sales price 87.

What is Cost of Goods Sold for Confused Co.’s first year? a. b. c. d.

$80,000 $90,000 $48,000 can’t be determined from the information given

ANSWER: 88.

$100,000 50,000 70,000 30,000 20,000 12,000 $12

c

DIFFICULT

If Confused Co. had used variable costing in its first year of operations, how much income (loss) before income taxes would it have reported? a. b. c. d.

($6,000) $54,000 $26,000 $2,000

ANSWER:

d

DIFFICULT

Chapter 11

89.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Based on variable costing, if Confused had sold 12,001 units instead of 12,000, its income before income taxes would have been a. b. c. d.

$9.50 higher. $11.00 higher. $8.50 higher. $8.33 higher.

ANSWER: 90.

11–25

c

MEDIUM

Z Corp. incurred the following costs in 2001 (its first year of operations) based on production of 10,000 units: Direct material Direct labor Variable product costs Fixed product costs (in total)

$5 per unit $3 per unit $2 per unit $100,000

When Z Corp. prepared its 2001 financial statements, its Cost of Goods Sold was listed at $100,000. Based on this information, which of the following statements must be true: a. b. c. d.

Z Corp. sold all 10,000 units that it produced. Z Corp. sold 5,000 units. Z Corp. had a very profitable year. From the information given, one cannot tell whether Z Corp.’s financial statements were prepared based on variable or absorption costing.

ANSWER:

b

MEDIUM

11–26

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 91–93. Three new companies (X, Y, and Z) began operations on January 1, 2001. Consider the following operating costs that were incurred by these companies during the complete calendar year 2001: Production in units Sales price per unit Fixed production costs Variable production costs Variable SG&A Fixed SG&A 91.

Company Z 10,000 $10 $30,000 $10,000 $30,000 $10,000

Company X Company Y Company Z All of the companies will report the same income.

ANSWER:

d

MEDIUM

Based on sales of 7,000 units, which company will report the greater income before income taxes for 2001 under variable costing? a. b. c. d.

Company X Company Y Company Z All of the companies will report the same income.

ANSWER: 93.

Company Y 10,000 $10 $20,000 $20,000 $20,000 $20,000

Based on sales of 7,000 units, which company will report the greater income before income taxes for 2001 under absorption costing? a. b. c. d.

92.

Company X 10,000 $10 $10,000 $30,000 $10,000 $30,000

a

MEDIUM

Based on sales of 10,000 units, which company will report the greater income before income taxes for 2001 under variable costing? a. b. c. d.

Company X Company Y Company Z All of the companies will report the same income before income taxes.

ANSWER:

d

MEDIUM

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–27

Use the following information for questions 94–96. JV Co. produces a single product that sells for $7.00 per unit. Standard capacity is 100,000 units per year; 100,000 units were produced and 80,000 units were sold during the year. Manufacturing costs and selling and administrative expenses are presented below. There were no variances from the standard variable costs. Any under- or overapplied overhead is written off directly at year-end as an adjustment to cost of goods sold. Direct material Direct labor Manufacturing overhead Selling & Admin.

Fixed costs $0 0 150,000 80,000

Variable costs $1.50 per unit produced 1.00 per unit produced 0.50 per unit produced 0.50 per unit sold

JV had no inventory at the beginning of the year. 94.

In presenting inventory on the balance sheet at December 31, the unit cost under absorption costing is a. b. c. d.

$2.50. $3.00. $3.50. $4.50.

ANSWER: 95.

MEDIUM

What is the net income under variable costing? a. b. c. d.

$50,000 $80,000 $90,000 $120,000

ANSWER: 96.

d

a

MEDIUM

What is the net income under absorption costing? a. b. c. d.

$50,000 $80,000 $90,000 $120,000

ANSWER:

b

MEDIUM

11–28

97.

Chapter 11

A firm has fixed costs of $200,000 and variable costs per unit of $6. It plans on selling 40,000 units in the coming year. To realize a profit of $20,000, the firm must have a sales price per unit of at least a. b. c. d.

$11.00. $11.50. $10.00. $10.50.

ANSWER: 98.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

MEDIUM

A firm has fixed costs of $200,000 and variable costs per unit of $6. It plans on selling 40,000 units in the coming year. If the firm pays income taxes on its income at a rate of 40 percent, what sales price must the firm use to obtain an after-tax profit of $24,000 on the 40,000 units? a. b. c. d.

$11.60 $11.36 $12.00 $12.50

ANSWER:

c

DIFFICULT

Use the following information for questions 99–102. Below is an income statement for Bender Co. for 2001: Sales Variable costs Contribution margin Fixed costs Profit before taxes 99.

$400,000 (125,000 ) $275,000 (200,000) $ 75,000

What is Bender’s degree of operating leverage? a. b. c. d.

3.67 5.33 1.45 2.67

ANSWER:

a

MEDIUM

Chapter 11

100.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Based on the cost and revenue structure on the income statement, what was Bender’s break-even point for 2001 in dollars? a. b. c. d.

$200,000 $325,000 $300,000 $290,909

ANSWER: 101.

d

MEDIUM

What was Bender’s margin of safety for 2001? a. b. c. d.

$200,000 $75,000 $100,000 $109,091

ANSWER: 102.

11–29

d

EASY

Assuming that the fixed costs are expected to remain at $200,000 for 2002 and the sales price per unit and variable costs per unit are also expected to remain constant, how much profit before taxes will be produced if the company anticipates 2002 sales rising to 130 percent of the 2001 level? a. b. c. d.

$97,500 $195,000 $157,500 A prediction cannot be made from the information given.

ANSWER:

c

MEDIUM

11–30

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 103 and 104. Timberline produces and sells a single product. Information on its costs for 2001 follow: Variable costs: SG&A Production Fixed costs: SG&A Production 103.

$15.00 $11.40 $9.60 $10.00

ANSWER:

a

MEDIUM

In 2002, Timberline estimates that it will produce and sell 4,000 units. The variable costs per unit and the total fixed costs are expected to be the same as in 2001. However, it anticipates a sales price of $16 per unit. What is Timberline’s projected margin of safety in 2002? a. b. c. d.

$7,000 $20,800 $18,400 $13,000

ANSWER: 105.

$12,000 per year $15,000 per year

Assume Timberline produced and sold 5,000 units in 2001. At this level of activity, it produced a profit of $18,000. What was Timberline’s sales price per unit? a. b. c. d.

104.

$2 per unit $4 per unit

b

MEDIUM

Story Manufacturing incurs annual fixed costs of $250,000 in producing and selling “Tales.” Estimated unit sales for 2001 are 125,000. An after-tax income of $75,000 is desired by management. The company projects its income tax rate at 40 percent. What is the maximum amount that Story can expend for variable costs per unit and still meet its profit objective if the sales price per unit is estimated at $6? a. b. c. d.

$3.37 $3.59 $3.00 $3.70

ANSWER:

c

MEDIUM

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–31

Use the following information for questions 106 and 107. The following information relates to financial projections of Big Co. for 2001: Projected sales Projected variable costs Projected fixed costs Projected unit sales price 106.

How many units would Big Co. need to sell in 2001 to earn a profit before taxes of $10,000? a. b. c. d.

25,714 10,000 8,571 12,000

ANSWER: 107.

d

MEDIUM

If Big Co. achieves its projections in 2001, what will be its degree of operating leverage? a. b. c. d.

6.00 1.20 1.68 2.40

ANSWER: 108.

60,000 units $2.00 per unit $50,000 per year $7.00

b

MEDIUM

Signal Co. manufactures a single product. For 2001, the company had sales of $90,000, variable costs of $50,000, and fixed costs of $30,000. Signal expects its cost structure and sales price per unit to remain the same in 2002, however total sales are expected to jump by 20 percent. If the 2002 projections are realized, net income in 2002 should exceed net income in 2001 by a. b. c. d.

100 percent. 80 percent. 20 percent. 50 percent.

ANSWER:

b

MEDIUM

11–32

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 109–111. Diversified Corp. manufactures and sells two products: X and Y. The operating results of the company for 2001 follow: Product X 2,000 $10 7

Sales in units Sales price per unit Variable costs per unit

Product Y 3,000 $5 3

In addition, the company incurred total fixed costs in the amount of $9,000. 109.

How many total units would the company have needed to sell to breakeven in 2001? a. b. c. d.

3,750 750 3,600 1,800

ANSWER: 110.

MEDIUM

If the company would have sold a total of 6,000 units in 2001, consistent with CVP assumptions how many of those units would you expect to be Product Y? a. b. c. d.

3,000 4,000 3,600 3,500

ANSWER: 111.

a

c

MEDIUM

How many units would the company have needed to sell in 2001 to produce a profit of $12,000? a. b. c. d.

8,750 20,000 10,000 8,400

ANSWER:

a

MEDIUM

Chapter 11

112.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–33

Below is an income statement for Jewell Co. for 2002: Sales Variable costs Contribution margin Fixed costs Profit before taxes

$ 300,000 (150,000 ) $ 150,000 (100,000 ) $ 50,000

What was the company’s margin of safety in 2002? a. b. c. d.

$50,000 $100,000 $150,000 $25,000

ANSWER: 113.

b

MEDIUM

Below is an income statement for Jewell Co. for 2002: Sales Variable costs Contribution margin Fixed costs Profit before taxes

$300,000 (150,000) $150,000 (100,000) $ 50,000

If the unit sales price for Jewell’s sole product was $10, how many units would it have needed to sell in 2002 to produce a profit of $40,000? a. b. c. d.

27,500 29,000 28,000 can’t be determined from the information given

ANSWER: 114.

c

MEDIUM

A firm estimates that it will sell 100,000 units of its sole product in the coming period. It projects the sales price at $40 per unit, the CM ratio at 60 percent, and profit at $500,000. What is the firm budgeting for fixed costs in the coming period? a. b. c. d.

$1,600,000 $2,400,000 $1,100,000 $1,900,000

ANSWER:

d

MEDIUM

11–34

115.

Chapter 11

Hat Co. manufactures a western-style hat that sells for $10 per unit. This is its sole product and it has projected the break-even point at 50,000 units in the coming period. If fixed costs are projected at $100,000, what is the projected contribution margin ratio? a. b. c. d.

80 percent 20 percent 40 percent 60 percent

ANSWER: 116.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

MEDIUM

Brando Co. manufactures little boxes of “bad attitudes.” Each box sells for $15. The firm’s projected costs for 2002 are listed below: Variable costs per unit: Production SG&A Fixed costs: Production SG&A Estimated volume

$5 1 $40,000 60,000 20,000 units

What is Brando’s projected margin of safety for 2002? a. b. c. d.

$133,333 $150,000 $80,000 $100,000

ANSWER:

a

MEDIUM

Chapter 11

117.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–35

Brando Co. manufactures little boxes of “bad attitudes.” Each box sells for $15. The firm’s projected costs for 2002 are listed below: Variable costs per unit: Production SG&A Fixed costs: Production SG&A Estimated volume

$5 1 $40,000 60,000 20,000 units

What is Brando’s projected degree of operating leverage for 2002? a. b. c. d.

2.25 1.80 3.75 1.67

ANSWER:

a

MEDIUM

Use the following information for questions 118–120. Below are income statements that apply to three companies: A, B, and C: Company A $100 (10) $90 (30) $ 60

Sales Variable costs Contribution margin Fixed costs Profit before taxes 118.

Company B $100 (20) $80 (20) $ 60

Company C $100 (30) $70 (10 ) $ 60

Within the relevant range, if sales go up by $1 for each firm, which firm will experience the greatest increase in profit? a. b. c. d.

Company A Company B Company C can’t be determined from the information given

ANSWER:

a

EASY

11–36

119.

Chapter 11

Within the relevant range, if sales go up by one unit for each firm, which firm will experience the greatest increase in net income? a. b. c. d.

Company A Company B Company C can’t be determined from the information given

ANSWER: 120.

EASY

Company A Company B Company C They all have the same margin of safety.

ANSWER:

c

MEDIUM

Alan is interested in entering the catfish farming business. He estimates if he enters this business, his fixed costs would be $50,000 per year and his variable costs would equal 30 percent of sales. If each catfish sells for $2, how many catfish would Alan need to sell to generate a profit that is equal to 10 percent of sales? a. b. c. d.

40,000 41,667 35,000 No level of sales can generate a 10 percent net return on sales.

ANSWER: 122.

d

At sales of $100, which firm has the highest margin of safety? a. b. c. d.

121.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

b

DIFFICULT

The following information pertains to Nova Co.’s cost-volume-profit relationships: Break-even point in units sold Variable costs per unit Total fixed costs

1,000 $500 $150,000

How much will be contributed to profit before taxes by the 1,001st unit sold? a. b. c. d.

$650 $500 $150 $0

ANSWER:

c

MEDIUM

Chapter 11

123.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–37

Information concerning Label Corporation’s Product A follows: Sales Variable costs Fixed costs

$300,000 240,000 40,000

Assuming that Label increased sales of Product A by 20 percent, what should the profit from Product A be? a. b. c. d.

$20,000 $24,000 $32,000 $80,000

ANSWER: 124.

c

MEDIUM

Lindsay Company reported the following results from sales of 5,000 units of Product A for June: Sales Variable costs Fixed costs Operating income

$200,000 (120,000) (60,000 ) $ 20,000

Assume that Lindsay increases the selling price of Product A by 10 percent in July. How many units of Product A would have to be sold in July to generate an operating income of $20,000? a. b. c. d.

4,000 4,300 4,500 5,000

ANSWER:

a

MEDIUM

11–38

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

THE FOLLOWING MULTIPLE CHOICE RELATE TO MATERIAL COVERED IN THE APPENDIX OF THE CHAPTER. 125.

On a break-even chart, the break-even point is located at the point where the total a. b. c. d.

revenue line crosses the total fixed cost line. revenue line crosses the total contribution margin line. fixed cost line intersects the total variable cost line. revenue line crosses the total cost line.

ANSWER: 126.

rate at which profit changes as volume changes. rate at which the contribution margin changes as volume changes. ratio of increase of total fixed costs. total costs per unit.

ANSWER:

b

MEDIUM

In a CVP graph, the area between the total cost line and the total revenue line represents total a. b. c. d.

contribution margin. variable costs. fixed costs. profit.

ANSWER: 128.

EASY

In a CVP graph, the slope of the total revenue line indicates the a. b. c. d.

127.

d

d

EASY

In a CVP graph, the area between the total cost line and the total fixed cost line yields the a. b. c. d.

fixed costs per unit. total variable costs. profit. contribution margin.

ANSWER:

b

EASY

Chapter 11

129.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

If SAB Company’s fixed costs were to increase, the effect on a profit-volume graph would be that the a. b. c. d.

contribution margin line would shift upward parallel to the present line. contribution margin line would shift downward parallel to the present line. slope of the contribution margin line would be more pronounced (steeper). slope of the contribution margin line would be less pronounced (flatter).

ANSWER: 130.

b

MEDIUM

If SAB Company’s variable costs per unit were to increase but its unit selling price stays constant, the effect on a profit-volume graph would be that the a. b. c. d.

contribution margin line would shift upward parallel to the present line. contribution margin line would shift downward parallel to the present line. slope of the contribution margin line would be pronounced (steeper). slope of the contribution margin line would be less pronounced (flatter).

ANSWER: 131.

11–39

d

EASY

The most useful information derived from a cost-volume-profit chart is the a. b. c. d.

amount of sales revenue needed to cover enterprise variable costs. amount of sales revenue needed to cover enterprise fixed costs. relationship among revenues, variable costs, and fixed costs at various levels of activity. volume or output level at which the enterprise breaks even.

ANSWER:

c

EASY

SHORT ANSWER/PROBLEMS 1.

Why do managers frequently prefer variable costing to absorption costing for internal use? ANSWER: Managers may prefer variable costing because it classifies costs both by their function and their behavior. When costs are classified by behavior, managers can more accurately predict how total costs will change when volume changes. With more accurate information, managers can make better production and pricing decisions. MEDIUM

11–40

2.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Why is variable costing not used extensively in external reporting? ANSWER: Variable costing is not used extensively outside of the firm because absorption costing is required by GAAP and the IRS. MEDIUM

3.

How can a company produce both variable and absorption costing information from a single accounting system? ANSWER: Firms only have one accounting information system. This system will be based on either variable or absorption costing. If the system needs to provide information in both the variable and absorption formats, the system’s accounting information can be converted from one format to the other. The conversion requires an adjustment to the product inventory accounts and the amount of product costs charged against the period’s income. The conversion is typically easier if standard costing is employed. MEDIUM

4.

What are the major differences between variable and absorption costing? ANSWER: The major difference between variable costing and absorption costing is in the way each defines product cost. While absorption costing includes fixed manufacturing overhead as a product cost, variable costing treats it as a cost of the period. A secondary difference between the two methods is the format of the income statement. Absorption costing utilizes the traditional income statement format that categorizes costs by their function only. Variable costing uses an income statement format that categorizes costs by both their function and behavior. MEDIUM

5.

Why is absorption costing not used for CVP analysis? ANSWER: Absorption costing is not used in break-even analysis because it presents a classification of costs by function rather than by behavior. Without a behavioral classification of costs, it is impossible to predict how total costs change as volume changes. MEDIUM

Chapter 11

6.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–41

How do changes in volume affect the break-even point? ANSWER: Within the relevant range, the break-even point does not change. This is due to the linearity assumptions that apply to total revenues, fixed costs, and variable costs. MEDIUM

7.

What major assumption do multiproduct firms need to make in using CVP analysis that single-product firms need not make? ANSWER: The assumption that must be imposed is a constant sales mix. A multiproduct firm assumes that (within the relevant range) the sales mix is constant. This permits CVP analysis to be performed using a unit of the constant sales mix. MEDIUM

8.

What important information is conveyed by the margin of safety calculation in CVP analysis? ANSWER: The break-even point in CVP analysis is critical because it divides profitable levels of operation from unprofitable levels of operation. The margin of safety gives managers an idea of the extent to which sales can fall before operations will become unprofitable. MEDIUM

11–42

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 9–11. Limpin Co. manufactures and sells walking canes. The following income statement applies to 2001, its first year of operations: Sales (800 units @ $15) Cost of Goods Sold Gross Margin Selling, general, and administrative expenses Operating income

$12,000 (8,000) $ 4,000 (3,000 ) $ 1,000

Other information: 1. The company produced 1,000 units during the year. 2. Variable SG&A expenses are $1 per cane. 3. Variable production costs are $7 per cane. 4. There was no ending work-in-process inventory. 9.

How much fixed manufacturing overhead did the Limpin Co. incur in 2001? ANSWER: The Cost of Goods Sold is based on sales of 800 units and is recorded at $8,000. This $8,000 is comprised of $5,600 of variable product costs ($7 × 800). Therefore, $2,400 of the Cost of Goods Sold is fixed. Given that the firm sold 80 percent of its output (800/1,000), $2,400 must be 80 percent of the total fixed manufacturing overhead incurred. This sets the total fixed manufacturing overhead costs incurred at $3,000. MEDIUM

10.

What were the total variable costs incurred in 2001? ANSWER: The total variable product costs would be $5,600/.80 = $7,000. The total variable SG&A would be $1 × 800 =$800. Total variable costs incurred are $7,000 + $800 = $7,800. MEDIUM

11.

If the Limpin Co. adopted variable costing, the ending finished goods inventory for 2001 would be carried at what value? ANSWER: EASY

The answer is 200 units × $7 = $1,400.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–43

Use the following information for questions 12–14. The Crown Co. manufactures toasters. The company hired a cost accountant in its first year of operations, 2001, to explain to management how its costs behaved. After studying various documents and industry data, the cost accountant announced that the total SG&A expenses that the firm can expect to incur in any period is captured by the equation: Y = $50,000 + $10X, where Y is the total SG&A expense incurred and X is the number of units sold. Also, the accountant announced that the total product costs incurred in any period could be captured by the formula Y = $100,000 + $6X, where Y is the total manufacturing cost incurred and X is the number of units produced. In 2001, the firm produced 10,000 units and sold 9,000 of them at $35 each. 12.

According to the accountant’s equations, what would be the total of all costs incurred by the firm in 2001? ANSWER: Total production costs are based on the number of units produced and would be: (10,000 × $6) + $100,000 = $160,000. Total period costs would be based on the number of units sold and would be: (9,000 × $10) + $50,000 = $140,000. The total of all costs would be $160,000 + $140,000 = $300,000. MEDIUM

13.

If the firm’s costs conformed exactly to the accountant’s equations, how much income before income taxes would be reported for 2001 if the firm uses absorption costing? ANSWER: Sales ($35 × 9,000) Cost of Goods Sold: Beg. fin. goods inventory Cost of Goods Manufactured Goods available Ending inventory Cost of Goods Sold Gross margin Less period costs Income before income taxes MEDIUM

$315,000 $

0 160,000 $160,000 (16,000) (144,000 ) $171,000 (140,000 ) $ 31,000

11–44

14.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

If the firm’s costs conformed exactly to the accountant’s equations, how much income before income taxes would be reported for 2001 if the firm uses variable costing? ANSWER: Sales Less variable costs: Product costs ($6 × 9,000) Period costs ($10 × 9,000) Contribution margin Less fixed costs: Product costs Period costs Income before income taxes

$315,000 $54,000 90,000 $100,000 50,000

(144,000 ) $171,000 (150,000) $ 21,000

MEDIUM 15.

Stanley Corp. produces a single product. The following is a cost structure applied to its first year of operations, 2001: Sales price Variable costs: SG&A Production Fixed costs (total cost incurred for the year): SG&A Production

$15 per unit $2 per unit $4 per unit $14,000 $20,000

During 2001, Stanley Corp. manufactured 5,000 units and sold 3,800. There was no beginning or ending work-in-process inventory. a. b. c.

How much income before income taxes would be reported if Stanley uses absorption costing? How much income before income taxes would be reported if variable costing was used? Show why the two costing methods give different income amounts.

Chapter 11

ANSWER: a.

b.

c.

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Income under absorption costing is: Sales $15 × 3,800 = COGS 3,800 × ($4 + $20,000/5,000) GM Oper. Exp. VSE $2 × 3,800 = FSE Absorption income before income taxes

$57,000 30,400 $26,600 $ 7,600 14,000

Income under variable costing: CMU = SP – VProd.Cost – VSGA = $15 – $4 – $2 = $9 ×Vol. sold 3,800 CM Less: FC – Production SG&A Variable costing income before income taxes Reason for difference in income: Fixed costs expensed under absorp. costing COGS 3,800 × $20,000/5,000 units Fixed SG&A Total Fixed costs expensed under variable costing Fixed SG&A Fixed Production Total FC Difference in FC expensed under two methods This is also the difference in income amounts.

MEDIUM

11–45

(21,600) $ 5,000

$34,200 (20,000) (14,000 ) $ 200

$15,200 14,000 $29,200 $14,000 20,000 $34,000 $ 4,800

11–46

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 16 and 17. Information relating to the 2001 operations of McNickle Corp. follows: Sales Variable costs Contribution margin Fixed costs Profit before taxes 16.

$120,000 (36,000 ) $ 84,000 (70,000 ) $ 14,000

McNickle’s break-even point for 2001 was 1,000 units. Compute McNickle’s sales price per unit. ANSWER:

The break-even point is found by dividing the fixed costs by the CM ratio.

The CM ratio is: $84,000/$120,000 = 70%. Breakeven would then be: $70,000/.70 = $100,000. Since we also know that the break-even point is defined as 1,000 units, it must follow that the unit sales price is $100,000/1,000 = $100. MEDIUM 17.

Compute McNickle’s degree of operating leverage for 2001. ANSWER: The degree of operating leverage is computed as the contribution margin divided by profit before taxes: $84,000/$14,000 = 6. MEDIUM

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–47

Use the following information for questions 18 and 19. Dos Co. manufactures and sells 2 products: A and B. The projected information on these two products for 2002 is: Sales in units Sales price per unit Variable costs per unit

Product A 4,000 $12 8

Product B 1,000 $8 4

Total fixed costs for the company are projected at $10,000. 18.

Compute Dos Co.’s projected break-even point for 2002 in total units. ANSWER: The company anticipates a sales mix consisting of 4 units of Product A and 1 unit of Product B. The total contribution margin for one unit of sales mix would be $20. This consists of $16 of contribution margin from the 4 units of Product A and $4 of contribution margin from 1 unit of Product B. The overall company breakeven is found by dividing total fixed costs by the contribution margin on one unit of sales mix: $10,000/$20 = 500 units. The 500 units of sales mix contain 500 × 5 units of product for a total of 2,500. Of the 2,500 total units, 2,000 are units of Product A and 500 are units of Product B. MEDIUM

19.

How many units would the company need to sell to produce an income before income taxes equal to 15 percent of sales? ANSWER: Again, using a unit of sales mix as the unit of analysis, one unit of sales mix sells for $56. Since the contribution margin is $20 on one unit of sales mix, the CM ratio on one unit of sales mix is $20/$56 = .3571. This implies that variable costs as a percentage of sales are equal to 1 – .3571 = .6429. Income before income taxes equal to 15 percent of sales can be found by solving a formula of the following type: Sales – VC – FC = Income before income taxes In this particular case, we solve the following formula: Sales – (.6429 × Sales) – $10,000 = (.15 × Sales) Solving for Sales, we get $48,286. We can find out how many units of sales mix are required to generate sales of $48,286 by dividing $48,286 by $56 = 863. These 863 units of sales mix each contain 5 units of product, so the correct answer would be 863 × 5 = 4,315 units of product, 3,452 of Product A and 863 of Product B. MEDIUM

11–48

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Use the following information for questions 20 and 21. P Corp. predicts it will produce and sell 40,000 units of its sole product in 2001. At that level of volume, it projects a sales price of $30 per unit, a contribution margin ratio of 40 percent, and fixed costs of $5 per unit. 20.

What is the company’s projected breakeven for 2001 in dollars and units? ANSWER: Given the CM ratio of 40 percent, and the Sales price per unit of $30, the CM per unit must be $30 × .40 = $12. The total fixed costs would be projected at $5 × 40,000 = $200,000. Breakeven would be: $200,000/$12 = 16,667 units. This would also equate to $500,000 of sales. MEDIUM

21.

What would the company’s projected profit be if it produced and sold 30,000 units? ANSWER: Projected profit would be: Sales (30,000 × $30) Variable costs (30,000 × $18) Contribution margin Fixed costs Profit MEDIUM

$900,000 (540,000 ) $360,000 (200,000 ) $160,000

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–49

Questions 22 and 23 are based on the following data pertaining to two types of products manufactured by Korn Corp.:

Product Y Product Z

Per unit Sales price Variable costs $120 $ 70 $500 $200

Fixed costs total $300,000 annually. The expected mix in units is 60 percent for Product Y and 40 percent for Product Z. 22.

How much is Korn’s break-even point sales in units? ANSWER: BEP units = FC/(unit SP – unit VC) or unit CM(UMC) For multiple products, use the weighted CM with weights based on units of sales weights. BEP = FC / [60% ($120 – $70) + 40% ($500 – $200)] = $300,000/ ($30/u + $120/u) = 2,000 units MEDIUM

23.

What are Korn’s break-even point sales in dollars? ANSWER: BEP dollars = FC/CMR For multiple products, use weighted CMR with weights based on sales dollars as weights or sales mix. Sales mix is 60 percent and 40 percent in units or in dollars. Weighted average CMR = WACM/WASale WACMR = [60% ($120 – $70) + 40% ($500 – $200)] ÷ (60% × $120) + (40% × $500) WACMR = [$30 + $120] ÷ [$72 + $200] = .551 BEP sales = 2,000 × $272 = $544,000 MEDIUM

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24.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

“This makes no sense at all,” said Bill Sharp, president of Essex Company. “We sold the same number of units this year as we did last year, yet our profits have more than doubled. Who made the goof—the computer or the people who operate it?” The statements to which Mr. Sharp was referring are shown here (absorption costing basis): Sales (20,000 units each year) Less cost of good sold Gross margin Less selling and administrative expenses Income before income taxes

2001 $700,000 460,000 $240,000 200,000 $ 40,000

2002 $700,000 400,000 $300,000 200,000 $100,000

The company was organized on January 1, 2001, so the previous statements show the results of its first two years of operation. In the first year, the company produced and sold 20,000 units; in the second year, the company again sold 20,000 units, but it increased production in order to have a stock of units on hand, as shown here: Production in units Sales in units Variable production cost per unit Fixed overhead costs (total)

2001 20,000 20,000 $8 $300,000

2002 25,000 20,000 $8 $300,000

Fixed overhead costs are applied to units of product on a basis of each year’s production. (The company produces and sells a single product.) Variable selling and administrative expenses are $1 per unit sold. Required: 1. Compute the cost of single unit of product for each year under: a. absorption costing. b. variable costing. 2.

What is the value of ending inventory in 2002 under: a. full cost? b. variable cost?

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

ANSWER: 1.

2.

a

Variable man. Fixed man.

2001 $ 8 15 $23

b.

Variable man.

a.

5,000 × $23 = $115,000

b.

5,000 × 20 = 100,000

MEDIUM

2001 $8

2002 $ 8 12 $20

2002 $8

2001

$300,000 = $15 20,000

2002

$300,000 = $12 25,000

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25.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

The following data have been taken from the records of a company: Production in units during 2001 Units sold during 2001 Selling price per unit Standard variable costs per unit: Material and labor Indirect manufacturing costs Selling & administrative expenses Fixed costs budgeted for year: Indirect manufacturing costs Selling & administrative expenses

200,000 190,000 $15.00 $8.00 2.00 1.00

$11.00

$400,000 300,000

$700,000

Required: 1. Determine the income (loss) before income taxes for the year 2001 under (a) absorption costing and (b) variable costing.

2.

What is the value of ending inventory under (a) absorption costing and (b) variable costing?

3.

Reconcile the difference in the two incomes.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

ANSWER: 1. (a.) Sales – COG S (190,000 × 12) – SLA Income before income taxes

$2,850,000 2,280,000 $ 570,000 490,000 $ 80,000

2. (a.)

$12 × 10,000 = $120,000

(b.)

$10 × 10,000 = $100,000

(b.) Sales $2,850,000 – VC (190,000 × 11) 2,090,000 CM $ 760,000 – FC 700,000 Income before income taxes $ 60,000 PRODUCT COST ABSORPTION VARIABLE VAR FIX

3.

 NI = (200,000 – 190,000) × $2 = $20,000

MEDIUM

11–53

$10 2 $12

$10 (400,000) (200,000)

___ $10

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26.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Actual costs for Sonic, Inc. for the past year were as follows: Direct material (2 pounds @ $5) Direct labor (3 hours @ $10) Variable selling and administrative Fixed selling and administrative

$10 per unit $30 per unit $2 per unit $80,000

During the year, 10,000 units were produced and 9,000 units were sold. There were no beginning inventories. Thirty thousand direct labor hours were worked during the year. Actual overhead for the year totaled $252,000 of which $140,000 was fixed. Selling price = $100/unit. Budgeted fixed overhead was $150,000 and the expected activity level was 30,000 direct labor hours. Variable overhead was budgeted at 3 direct labor hours per unit and $4 per direct labor hour. The company uses a normal costing system and overhead variances are closed to cost of goods sold. Required: a. Determine the unit cost using variable costing. b.

Determine the unit cost using absorption costing.

c.

Using variable costing, determine the contribution margin, and variable costing income.

d.

Using absorption costing, determine the gross margin, and absorption costing income.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–55

ANSWER: a.

b.

c.

DM DL 30 V-FOH (3 × $4)

$10

DM DL V-FOH F-FOH (3 × $5)

$10 30 12 15 $67

12 $52

$150,000 = $5 30,000

Sell Price $100 – VAR Cost 54 ($52 + $2) CM $ 46 × 9,000 units = – FC = Income before income taxes (STD) + favorable VAR-FOH SPD VAR Income before income taxes (actual)

$414,000 (230,000) $184,000 8,000 $192,000

Variable FOH spending variance = $112,000 – (30,000 × $4) = $8,000 F d.

SP $100 – COGS 67 GM $ 33 × 9,000 units = – S&A EXP (9,000 × $2) + $80,000 Income before income taxes (STD) + Favorable variance Income before income taxes actual

MEDIUM

$297,000 (98,000) $199,000 8,000 $207,000

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27.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Sports Innovators has developed a new design to produce hurdles that are used in track and field competition. The company’s hurdle design is innovative in that the hurdle yields when hit by a runner and its height is extraordinarily easy to adjust. Management estimates expected annual capacity to be 90,000 units; overhead is applied using expected annual capacity. The company’s cost accountant predicts the following 2001 activities and related costs: Standard unit variable manufacturing costs Variable unit selling expense Fixed manufacturing overhead Fixed selling and administrative expenses Selling price per unit Units of sales Units of production Units in beginning inventory

$12 $5 $480,000 $136,000 $35 80,000 85,000 10,000

Other than any possible under- or overapplied fixed overhead, management expects no variances from the previous manufacturing costs. Under- or overapplied fixed overhead is to be written off to Cost of Goods Sold. Required: 1. Determine the amount of under- or overapplied fixed overhead using (a) variable costing and (b) absorption costing. 2.

Prepare projected income statements using (a) variable costing and (b) absorption costing.

3.

Reconcile the incomes derived in part 2.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

ANSWER: 1.

2.

3.

a.

$0

b.

(90,000 – 85,000) × $5.33 = $26,650 U

a.

Sales (80,000 × $35) = – VC (80,000 × $17) = CM – FC Income before income taxes

$2,800,000 (1,360,000 ) $1,440,000 (616,000) $ 824,000

b.

Sales (80,000 × $35) – COGS ($17.33 × 80,000) GM $1,413,600 – S&A Income before income (STD) – VOL VAR Income before income taxes

$2,800,000 (1,386,400)

5,000 × $5.33 = $26,650.

MEDIUM

(536,000) $ 877,600 (26,650) $ 850,950

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28.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

On December 30, 2001, a bomb blast destroyed the bulk of the accounting records of the Horne Division, a small one-product manufacturing division that uses standard costs and flexible budgets. All variances are written off as additions to (or deductions from) income; none are pro-rated to inventories. In addition, the chief accountant mysteriously disappeared. You have the task of reconstructing the records for the year 2001. The general manager has said that the accountant has been experimenting with both absorption costing and variable costing. The records are a mess, but you have gathered the following data for 2001: a. b. c. d. e. f. g. h. i. j. k. l. m. n. o.

Cash on hand, December 31, 2001 Sales Actual fixed indirect manufacturing costs Accounts receivable, December 31, 2001 Standard variable manufacturing costs per unit Variances from standard of all variable manufacturing costs Operating income, absorption-costing basis Accounts payable, December 31, 2001 Gross profit, absorption costing at standard (before deducting variances) Total liabilities Unfavorable budget variance, fixed manufacturing costs Notes receivable from chief accountant Contribution margin, at standard (before deducting variances) Direct-material purchases, at standard prices Actual selling and administrative costs (all fixed)

$10 $128,000 21,000 20,000 1 $5,000 U $14,400 18,000 22,400 100,000 1,000 U 4,000 48,000 50,000 6,000

These do not necessarily have to be solved in any particular order. Ignore income taxes. Required: 1. Operating income on a variable-costing basis. 2. Number of units sold. 3. Number of units produced. 4. Number of units used as the denominator to obtain fixed indirect cost application rate per unit on absorption-costing basis. 5. Did inventory (in units) increase or decrease? Explain. 6. By now much in dollars did the inventory level change (a) under absorption costing, (b) under variable costing? 7. Variable manufacturing cost of goods sold, at standard prices. 8. Manufacturing cost of goods sold at standard prices, absorption costing.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

11–59

ANSWER: 1.

CM – FC Operating Income (STD) – unfavorable variances Operating Income (actual)

$48,000 (26,000 ) $22,000 (6,000) $16,000

Actual fix mfg – unfavorable VAR fix cost @STD

2.

Sales – CM = VC

$128,000 (48,000 ) $ 80,000/$1 UNIT = 80,000 units sold

3.

Sales – GM COGS

$128,000 (22,400) $105,600/80,000 = $1.32

Difference in OI = (P – S) × fix mfg/unit $(1,600) = (P – 80,000) × $.32 P = 75,000 4.

OI – absorption cost = $22,400 – $6,000 = variances – other VAR VOL VAR

$16,400 (14,400) $ 2,000 6,000 $ 4,000

OI STD OI ACT UNF UNF FAV

$4,000 F = (75,000 – X) × $.32 X = 62,500 units produced 5.

Inventory decreased. OI absorption is less than OI variable.

6.

Absorption cost 5,000 units × $1.32 = $6,600 Variable cost 5,000 units × $1 = $5,000

7.

80,000 units × $1 = $80,000

8.

80,000 × $1.32 = $105,600

DIFFICULT

$21,000 (1,000 ) $20,000

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29.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

Smith Company produces and sells two products: A and B in the ratio of 3A to 5B. Selling prices for A and B are, respectively, $1,200 and $240; respective variable costs are $480 and $160. The company’s fixed costs are $1,800,000 per year. Compute the volume of sales in units of each product needed to: Required: a. breakeven. b.

earn $800,000 of income before income taxes.

c.

earn $800,000 of income after income taxes, assuming a 30 percent tax rate.

d.

earn 12 percent on sales revenue in before-tax income.

e.

earn 12 percent on sales revenue in after-tax income, assuming a 30 percent tax rate.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

ANSWER: A

SP – VC CM

$1,200 (480 ) $ 720

B

SP – VC CM

$240 (160 ) $ 80

Weighted CM = (3 × $720) + (5 × $80) = $2,560 a.

$1,800,000 = 703.125 $2,560

A = 704 × 3 = 2,112 units B = 704 × 5 = 3,520

b.

$1,800,000 + $800,000 = 1015.625 $2,560

A = 1,016 × 3 = 3,048 units B = 1,016 × 5 = 5,080

c.

$800,000/1 – .3 = $1,142,857 $1,800,000 + $1,142,857 = 1,149.55 $2,560

d.

SP = (3 × $1,200) + (5 × $240) = $4,800 X = $1,800,000 + $.12X = $4,354,839 $2,560/$4,800 A = ($4,354,839 × .75)/$1200 = 2,722 units B = ($4,354,839 × .25/$240 = 4,537

e.

X = $1,800,000 + $.12X 1 – .3 = $4,973,684 $2,560/$4,800 A = ($4,973,684 × .75)/$1,200 = 3,109 units B = ($4,973,684 × .25/$240 = 5,181

MEDIUM

A = 1,150 × 3 = 3,450 units B = 1,150 × 5 = 5,750

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30.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

The Jones Company makes three products. Data follow: Selling price Variable costs

Product A $10 7

Product B $20 12

Product C $40 16

Total annual fixed costs are $840,000. The firm’s experience has been that about 20 percent of dollar sales come from product A, 60 percent from B, and 20 percent from C. Required: a. Compute break-even in sales dollars.

b.

Determine the number of units to be sold at the break-even point.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

ANSWER: a.

SP – VC = CM CMR

A $10 (7 ) $ 3 30%

B $20 (12 ) $ 8 40%

C $40 (16 ) $24 60%

CMR = (.2 × 30%) + (.6 × 40%) + (.2 × 60%) = 42% BE = $840,000/.42 = $2,000,000 b.

A ($2,000,000 × .20)/$10 = 40,000 units B ($2,000,000 × .60)/$20 = 60,000 units C ($2,000,000 × .20)/$40 = 10,000 units

MEDIUM

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31.

Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit Analysis

The Fred Company sells two products, A and B, with contribution margin ratios of 40 and 30 percent and selling prices of $5 and $2.50 a unit. Fixed costs amount to $72,000 a month. Monthly sales average 30,000 units of product A and 40,000 units of product B.

Required: a. Assuming that three units of product A are sold for every four units of product B, calculate the dollar sales volume necessary to breakeven. b. As part of its cost accounting routine, Fred Company assigns $36,000 in fixed costs to each product each month. Calculate the break-even dollar sales volume for each product. c. Fred Company is considering spending an additional $9,700 a month on advertising, giving more emphasis to product A and less emphasis to product B. If its analysis is correct, sales of product A will increase to 40,000 units a month, but sales of product B will fall to 32,000 units a month. Recalculate the break-even sales volume, in dollars, at this new product mix. Should the proposal to spend the additional $9,700 a month be accepted? ANSWER: a.

CM = (3 × $2) + (4 × $.75) = $9 SP = (3 × $5) = (4 × $2.50) = $25 BE = $72,000 = $400,000 $9/$25

b.

A = $36,000 = $90,000 .4

B = $36,000 = $120,000 .3

c.

CM = (5 × $2) + (4 × $.75) = $13 SP = (5 × $5) + (4 × $2.50) = $35 BE = $72,000 + $9,700 = $219,962 $13/35 OLD NEW CM A = 30,000 × $2 = $60,000 B = 40,000 × $.75 = 30,000 $90,000 – FC (72,000 ) OI $18,000

CM A = 40,000 × $2 = $ 80,000 B = 32,000 × $.75 = 24,000 $104,000 – FC (81,700 ) OI $ 22,300

At current sales levels increase advertising. MEDIUM