Answer Key KinneyAISE03IM

CHAPTER 3 Predetermined Overhead Rated, Flexible Budgets, and Absorption/Variable Costing Questions to be identified and used as allocation bases.

1. Although both variable and mixed costs change in total with activity measure changes, the difference is that variable costs change in direct proportion to such activity changes and mixed costs do not. Since a mixed cost has both a fixed and variable component, the cost per unit at different activity levels is not constant as it is with a variable cost.

Separation of variable and fixed costs allows managers to make decisions that rely on knowledge of cost behavior. For example, some decisions require that a manager identify costs that will change if a particular decision alternative (such as whether to manufacture and sell additional units) is implemented. Total variable cost responds differently from total fixed cost to managerial actions. Use of a total overhead rate does not easily allow managers to determine the impact of such differences.

2. No, these are not always the best points of observation. First, the points must be within the relevant range of activity. Second, to be useful, the points must be reflective of the entire data set of observation points. If the high and low points do not meet these two conditions, alternative points should be selected.

5. The regression method has the major advantage of using all points in the data set to determine the fixed and variable cost elements of the mixed costs. This is in contrast to the high-low method, which uses only two points in the data set.

3. There are several reasons for using predetermined overhead rates. First, the company does not need to wait to assign overhead costs to products or services until the end of the period when actual costs are known. Second, such rates eliminate overhead cost fluctuations that have nothing to do with volume levels. Third, predetermined overhead rates provide a means to control distortions in product costs caused by changes in volume between or among periods, and the resulting product/service cost changes caused by differences in fixed cost per period.

6. The two differences between absorption and variable costing lie in the treatment of fixed factory overhead and the presentation of costs/expenses on the income statement. Absorption costing treats fixed factory overhead as a product cost and allocates it to the units produced during the period; variable costing treats fixed overhead as a period expense and charges the full amount incurred to the income of the period. Absorption costing presents costs on the income statement in functional categories without regard to cost behavior; variable costing presents costs on the income statement first as product or period, secondly by cost behavior (variable or fixed), and possibly by functional categories.

4. Departmental overhead rates are superior to plant-wide overhead rates in that overhead application bases can be identified that more accurately reflect the causes of costs in each department. In effect, use of departmental rates permit more cost drivers

The underlying cause of the difference between absorption and variable costing is found in the definition of an asset. Asset cost should include all costs necessary to 31

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get an item into place, position, and ready for sale or use. Absorption costing considers fixed overhead to be inventoriable (part of asset cost) because products could not be made without the basic manufacturing capacity represented by fixed overhead cost. Variable costing proponents, however, believe that fixed overhead is not inventoriable because it is incurred regardless of whether production occurs or not. The “correct” answer cannot be determined because both positions have logical and rational arguments to support them. 7. Functionally classifying a cost refers to classification based on the reason the cost was incurred (production, selling, or administrative) by category (wages, salaries, utilities, etc.). Behaviorally classifying a cost refers to classification based on the reaction that the cost has to a change in underlying activity (such as production or sales volume) and, thus, as variable or fixed. A company is concerned about behavioral classification because (as long as the company is operating in the relevant range of activity) variable costs will change in a direct relationship with changes in some underlying activity measure, but fixed costs will remain constant. If variable and fixed costs are combined and shown merely as functional categories, management will not be able to see how each functional category of cost will change with changes in activity. 8. Absorption costing is required for external reporting. The rationale is that fixed manufacturing overhead is a product cost and, thus, it should be added to variable production cost and assigned to inventory. The total cost per unit will be shown as an expense only in the period in which the related products are sold. 9. Use of monetary, quantitative information varies greatly between external and internal users. External users emphasize profitability potential; internal users emphasize information that helps make

sales, production, and capital expenditure decisions. Both absorption and variable costing have a place in decision making. Accountants and decision makers need to understand the applications and limitations of the two techniques within the context of past, present, and future cost information needs. No matter which type of costing a firm uses, the firm’s total revenue must cover all costs – both variable and fixed – and also generate a satisfactory profit if a firm is to survive in the long run. The methods of cost accumulation and cost presentation used for reporting are determined by what is acceptable to those parties for whom the reports are intended. External reporting is guided by the characteristics of reliability, uniformity, and consistency. Internal reporting is guided by flexibility in helping managers with planning, controlling, decision making and performance evaluations. 10. When production exceeds volume, absorption costing income will be higher than variable costing income because some of the fixed factory overhead incurred during the period will be deferred into inventory rather than appearing on the income statement. Since no fixed overhead is inventoried under variable costing, there will be a larger expense on the income statement under variable costing than under absorption costing. When production is less than sales volume, some of the fixed overhead deferred in previous periods will be charged against income as part of cost of goods sold under absorption costing in addition to all of the current period fixed overhead. Thus, there will be a higher income statement charge under absorption costing than under variable costing (which will only expense the current period fixed overhead). Therefore, under this circumstance, absorption costing income will be less than variable costing income.

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Exercises 11.

a. Jan: $360,000 x 1.80 = $648,000 Feb: $330,000 x 1.80 = $594,000 Mar: $340,000 x 1.80 = $612,000 b. Jan : Actual – Applied = $640,000 - $648,000 = $ 8,000 overapplied Feb: Actual – Applied = $570,400 - $594,000 = $23,600 overapplied Mar: Actual – Applied = $614,700 - $612,000 = $ 2,700 underapplied

12.

a. Expected overhead = ($42,900 x 12) + ($5 x 156,000) = $514,800 + $780,000 = $1,294,800 Predetermined overhead rate = $1,294,800 ÷ 156,000 = $8.30 per DL hour Overhead per unit = $8.30 x 3 hours per unit = $24.90 b. Manufacturing Overhead Various Accounts Work in Process Inventory (12,780 x $8.30) Manufacturing Overhead

128,550 128,550 106,074 106,074

c. 12,780 DL hours ÷ 3 = 4,260 units should have been produced 13.

a. Applied VOH = 4,420 x $8 = $35,360 b. Applied FOH = 4,420 x $21.86 = $96,921 c. VOH: Actual VOH – Applied VOH = $32,980 - $35,360 = $2,380 overapplied FOH: Actual FOH – Applied FOH = $123,700 - $96,921 = $26,779 underapplied

14.

a.

(1)

At any level, the variable cost is $4 per machine hour. Since two hours are needed to make one unit, the variable rate is $8 per unit. At production of 5,490 units, the fixed rate is $120,000 ÷ 5,490 or $21.86 per unit.

(2)

At any level, the variable cost is $4 per machine hour. At production of 5,490 units, the fixed rate is $120,000 ÷ (5,490 x 2) = $120,000 ÷ 10,980 MHs = $10.93 per machine hour.

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b.

(1)

Combined rate = $8 + $21.86 = $29.86 per unit.

(2)

Combined rate = $4 + $10.93 = $14.93 per unit.

c. At actual production of 5,600 units and applying OH on units of production: VOH (5,600 x $8) FOH

15.

Expected = Actual Applied $ 44,800 (5,600 x $ 8) = $ 44,800 120,000 (5,600 x$21.86) = 122,416

Under/Overapp. $ 0 2,416 overapp.

a. A fixed overhead cost of $28 per unit is obtained by dividing total fixed overhead cost ($1,400,000) by the total number of units actually produced (50,000). A fixed overhead cost of $17.50 is obtained by dividing the $1,400,000 by the actual capacity of 80,000 units. The price bid by Taylor Tool should include a fixed overhead cost of $28 per unit, which reflects the actual level of activity unless Taylor Tool has another contract to produce the additional 30,000 units. A fixed overhead cost of $17.50 is more likely to cause Taylor Tool to obtain the contract because the amount will lower the per unit cost of the bid ($20 DM & DL + $4 VOH + $17.50 FOH = $41.50 x 1.5 = $62.25). b. The cost per unit was $52 ($20 + $4 + $28). Therefore, the invoice price per unit should be $78.00 ($52 x 1.5), and the total invoice price should be $78.00 x 50,000 units or $3,900,000. c. No, since production totaled 80,000 units, the fixed overhead cost per unit is $17.50. Thus, the price to Manantuka should be reduced to $3,112,500 ($62.25 x 50,000). Additionally, since the margin is most likely less than 50 percent on products sold to other buyers, Taylor Tool should charge a reasonable price on the government contract. d. Without the additional contract, Taylor should not have bid $62.25 per unit. However, if the government was willing to pay “full cost” (regardless of how that amount was defined) it was ethical to bill $3,900,000 since the company was merely applying a fixed overhead rate that approximated actual fixed overhead. The fact that Taylor Tool was able to secure another contract should not affect the company’s ability to recover all costs from Manantuka. If management is aware of the existence of other contracts before the bill is presented, the price could be adjusted or, if future production levels are significant, Taylor could consider rebating a portion of Manantuka’s contract cost.

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e. Taylor Tool should consider the following: • • • • •

relationship between the bid price and the final contract price ability of companies to manipulate bid prices, especially in costplus contracts effect on other companies’ abilities to compete for the contract future sales to the same customer effects on profits and stock prices if the contract were settled at $62.25 per unit versus $78.00 per unit

The ethical dilemma is overcome if Taylor Tool has no other customer and no prospect of other customers to purchase the goods that would have been produced by the excess capacity. In such a case, the $28 overhead rate is totally ascribable to the Manantuka contract. 16.

a. VOH rate (can be calculated at either level): $435,000 ÷ 100,000 MHs = $4.35 per MH or $652,500 ÷ 150,000 MHs = $4.35 per MH b. FOH rate: $405,000 ÷ 180,000 = $2.25 per MH c. Expected capacity = 2/3 x 180,000 = 120,000 MHs FOH rate: $405,000 ÷ 120,000 = $3.375 per MH d. At 115,000 MHs: Total VOH applied = 115,000 x $4.35 = $500,250 Total FOH applied (practical capacity rate): 115,000 x $2.25 = $258,750 Total FOH applied (expected capacity rate): 115,000 x $3.375 = $338,125

17.

Total OH applied (practical) ($500,250 + $258,750) Actual OH Underapplied OH

$759,000 (900,000) $141,000

Total OH applied (expected) ($500,250 + $338,125) Actual OH Underapplied OH

$838,375 (900,000) $ 61,625

a. Given the relationship within the account balances, it appears that overhead is applied based on direct labor cost. Thus, using the information in the WIP account, the rate is $60,000 ÷ $30,000 or 200% of direct labor cost. b. The amount should be prorated because it is very large relative to the balances in Work in Process Inventory, Finished Goods Inventory and Cost of Goods Sold.

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c. Work in Process Inventory : $50,000 x ($120,000 ÷ $570,000) = $10,526 Finished Goods Inventory: $50,000 x ($160,000 ÷ $570,000) = 14,035 Cost of Goods Sold: $50,000 x ($290,000 ÷ $570,000) = 25,439 Total $50,000 d. Work in Process Inventory: $50,000 x ($ 60,000 ÷ $240,000) = $12,500 Finished Goods Inventory: $50,000 x ($ 60,000 ÷ $240,000) = 12,500 Cost of Goods Sold: $50,000 x ($120,000 ÷ $240,000) = 25,000 Total $50,000 e. A debit balance in the manufacturing overhead account can be the result of several causes including: (1) paying higher prices than budgeted for the resources comprising actual overhead, (2) using more overhead resources than attached to inventory for actual output, (3) producing at less capacity than the planned level of activity upon which the predetermined overhead rate was based, or (4) a combination of the prior three causes. 18.

a. Manufacturing Overhead Cost of Goods Sold

66,000

b. Manufacturing overhead Work in Process Inventory Finished Goods Inventory Cost of Goods Sold

66,000

66,000

21,120 5,280 39,600

WIP $ 768,000 768,000 ÷ 2,400,000 = 32% .32 x $66,000 = $21,120 FG 192,000 192,000 ÷ 2,400,000 = 8% .08 x $66,000 = 5,280 CGS 1,440,000 1,440,000 ÷ 2,400,000 = 60% .60 x $66,000 = 39,600 Total $ 2,400,000 c. The method in part (b) would be more appropriate in this instance because of the magnitude of the amount of overapplied overhead. It is 5.5 percent of the total balances in all of the accounts containing overhead, so to close it directly to cost of goods sold would cause a distortion of the costs remaining in inventory. 19.

x 200 325 400 410 525 680 820 900 4,260

y $ 250 220 240 245 310 395 420 450 $2,430

xy $ 30,000 71,500 96,000 100,450 162,750 268,600 344,400 405,000 $1,478,700

x2 40,000 105,625 160,000 168,100 275,625 462,400 672,400 810,000 2,694,150

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x = 4,260 ÷ 8 = 532.50 y = $2,430 ÷ 8 = $303.75 b=

∑ xy − n( x)( y) = $1,478,700 − 8(532.50)($303.75) = $184,725 = $0.43 2,694,150 − 8(532.50)(532.50) 425,700 ∑ x − n( x ) 2

2

a = y − b x = $303.75 − $0.43(532.50) = $74.78

y = $74.78 + $0.43 MH 20.

a.

x 100 87 80 70 105 115 120 677

y $ 175 162 154 142 185 200 202 $1,220

xy $ 17,500 14,094 12,320 9,940 19,425 23,000 24,240 $120,519

x2 10,000 7,569 6,400 4,900 11,025 13,225 14,400 67,519

x = 677 ÷ 7 = 96.71

y = $1,220 ÷ 7 = $174.29 b=

∑ xy − n( x)( y) ∑ x − n( x ) 2

2

=

$120,519 − 7(96.71)($174.29) 67,519 − 7(96.71)(96.71)

=

$2,529.90 2,049.23

= $1.23

a = y − b x = $174.29 − 1.23(96.71) = $53.34 y = $53.34 + 1.23 (# of shipments) b. y = $53.34(4) + $1.23(340) = $631.56 21.

a. High activity Low activity Differences

MHs 9,000 3,000 6,000

Total Cost = Variable Cost + Fixed Cost $ 440 $(810) $1,250 980 (270) 1,250 $(540)

Variable rate = $(540) ÷ 6,000 MHs = $(0.09) per MH High activity variable cost = 9,000 x $(0.09) = $(810) Low activity variable cost = 3,000 x $(0.09) = $(270) Fixed cost at low activity = $980 – $(270) = $1,250 Total maintenance cost = $1,250 - $0.09 MH This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.

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b. The variable cost component is negative which implies that, as the number of machine hours increase, the amount of maintenance costs declines. Such a relationship is implausible. One explanation that would account for the perceived inverse relationship would be that Humble Houses performs the maintenance chores when there is idle time available. As business activity increases, less and less time is available to perform maintenance activities. c. For a cost prediction formula to work effectively, it is not required for there to be a positive relationship between the activity measure and the cost pool. Thus, the formula developed in part (a) might function effectively. However, one cannot interpret the parameters of the model (-$0.09, $1,250) as variable and fixed costs, respectively. 22.

a. High activity Low activity Differences

MHs 34,000 31,000 3,000

Total Cost = Variable Cost + Fixed Cost $ 6,100 $2,720 $3,380 5,860 2,480 3,380 $ 240

Variable rate = $240 ÷ 3,000 MHs = $0.08 per MH High activity variable cost = 34,000 x $0.08 = $2,720 Low activity variable cost = 31,000 x $0.08 = $2,480 Fixed cost at high activity = $6,100 - $2,720 = $3,380 Fixed cost at low activity = $5,860 - $2,480 = $3,380 Budget formula:

TC = FC + VC(X) TC = $3,380 + $0.08 MH

b. TC = $3,380 + $0.08(33,715) = $3,380 + $2,697 = $6,077 23.

a. ($300,200 + $99,800) ÷ (5,000 + 20,000) = $400,000 ÷ 25,000 = $16.00 DLH b. ($300,200 + $99,800) ÷ (38,000 + 2,000) = $400,000 ÷ 40,000 = $10.00 MH c. Assembly: $300,200 ÷ 38,000 = $7.90 MH Finishing: $99,000 ÷ 20,000 = $4.99 DLH d. Overhead assigned using answer from part (a): 1 x $16.00 = $16.00 Overhead assigned using answer from part (b): 5 x $10.00 = $50.00 Overhead assigned using answer from part (c): (5 x $7.90) + (1 x $4.99) = $39.50 + $4.99 = $44.49

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39

a.

250 Variable costs: Supplies @ $3.00 per DLH Direct labor @ $7.00 per DLH Utilities @$5.40 per DLH Fixed costs: Direct labor Utilities Rent Advertising Total cost

b. Cost per DLH

300

350

400

$ 750 $ 900 1,750 2,100 1,350 1,620

$ 1,050 2,450 1,890

$ 1,200 2,800 2,160

500 500 350 350 450 450 75 75 $ 5,225 $ 5,995

500 350 450 75 $ 6,765

500 350 450 75 $ 7,535

$ 20.90 $ 19.98

$ 19.33

$ 18.84

c. $19.33 x 1.4 = $27.06 $27.06 x 1.25 hours per groom = $33.83 or $34 per groom 25.

a. High activity Low activity Differences

MHs 3,800 2,500 1,300

Total Cost = Variable Cost + Fixed Cost $1,160 $760 $400 900 500 400 $ 260

Variable rate = $260 ÷ 1,300 MHs = $0.20 per MH Cost formula: y = $400 + $0.20 MH b. Variable utilities cost @ $0.20 per MH Fixed utilities cost Expected total utilities cost 26.

2,000 $400 400 $800

3,000 $ 600 400 $1,000

5,000 $1,000 400 $1,400

a. If the purpose is to control costs, the comparison is inappropriate. Actual costs should be compared with flexible budget costs at the same level of output as that of the actual cost – in this case 17,550 units (not 16,000 units). A flexible budget formula allows the determination of costs at any level of activity. b. Variable rate (b) (at any point) = $4 (for example, $80,000 ÷ 20,000 units) Fixed amount (a) (given) = $32,000 The flexible budget for the 17,550 unit level is: Variable (17,550 x $4) $ 70,200 Fixed 32,000 Total $102,200

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A comparison with the budget follows: Variable Fixed Total

Budget $ 70,200 32,000 $102,200

Actual $ 69,000 32,800 $101,800

Variances $1,200 F 800 U $ 400 F

The company did well controlling variable costs, but fixed costs were $800 over the budgeted amount. 27.

a. Income – variable costing $ 94,000 Deduct increase in CGS [FOH out of inventory ($7 x 4,800)] (33,600) Income – absorption costing $ 60,400 b. Income – variable costing Add decrease in CGS [FOH inventoried ($7 x 1,000) Income – absorption costing

28.

a. Ingredients Labor Variable overhead Total variable cost Divided by units Variable cost per unit Total variable cost Fixed overhead Total cost Divided by units Absorption cost per unit

$ 94,000 7,000 $ 101,000

$239,200 114,400 187,200 $540,800 ÷104,000 $5.20 $540,800 93,600 $634,400 ÷104,000 $6.10

b. Variable cost of goods sold = 98,000 x $5.20 = $509,600 c. Absorption cost of goods sold = 98,000 x $6.10 = $597,800 d. Ending inventory (variable costing) = 6,000 x $5.20 = $31,200 Ending inventory (absorption costing) = 6,000 x $6.10 = $36,600 e. Fixed overhead charged to expense (variable costing) = $93,600 Fixed overhead charged to expense (absorption costing) = $88,200

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41

The variance between variable and absorption net income is caused by the difference in treatment of fixed manufacturing overhead. Fixed overhead expensed: Variable costing Absorption costing [$500,000 x (46,000 ÷ 50,000) Net income difference

$500,000 460,000 $ 40,000

The company’s net income would have been $40,000 higher under absorption costing. 30.

a. (18,000 – 16,560) x $8.00 = 1,440 x $8.50 = $11,520 b. (18,000 – 16,560) x ($8.00 - $1.50) = 1,440 x $6.50 = $9,360 c. Absorption costing would have produced the higher net income because it would have required $2,160 (1,440 x $1.50) of fixed manufacturing overhead to be inventoried rather than to be charged against income.

31.

a. Budgeted fixed overhead = $0.42 x 100,000 = $42,000 b. Actual (and budgeted) fixed overhead Applied fixed overhead (90,000 x $0.42) Underapplied fixed overhead (absorption)

$42,000 37,800 $ 4,200

There is no underapplied or overapplied fixed overhead under variable costing because fixed overhead is not applied to units of product. c. Direct material Direct labor Variable overhead Cost per unit (variable) Fixed overhead Cost per unit (absorption)

$1.80 1.00 0.15 $2.95 0.42 $3.37

d. Absorption cost of goods sold (97,500 x $3.37) Plus underapplied overhead (10,000 x $0.42) Adjusted cost of goods sold Selling and administrative costs: Variable (97,500 x $0.28) $27,300 Fixed 75,000 Total expense (absorption)

$328,575 4,200 $332,775

102,300 $435,075

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Variable cost of goods sold (97,500 x $2.95) Variable selling expenses (97,500 x $0.28) Fixed overhead Fixed selling and administrative expenses Total expense (variable)

$287,625 27,300 42,000 75,000 $431,925

e. Income is higher under variable costing because the sales level is greater than the production level. It will be higher by the fixed overhead per unit ($0.42) times the change in inventory (7,500 unit decline) or $3,150. 32.

The debate surrounding the use of variable costing versus absorption costing for valuing inventory hinges on whether the incurrence of fixed overhead creates an asset. A cost incurred to create an asset, as opposed to a cost that is an expense of the period, must be capitalized and should not be charged against revenues (expensed) until its related benefit is recognized in income. Since inventory is an asset, any costs that are incurred to create that asset, including fixed overhead, should be considered for capitalization. This is the argument for use of absorption costing. However, proponents of variable costing argue that the incurrence of fixed overhead relates more to the capacity to produce than to production. Accordingly, these people argue that fixed overhead is not directly related to production sufficiently to be considered an inventoriable cost.

33.

a. 1.

SLUGGER SPORTSWEAR Income Statement (Absorption Costing Basis) For the Month Ended April 30, 2006 Sales ($7,200,000 ÷ $72 = 100,000 units sold) Cost of goods sold ($51 x 100,000) Production volume variance ($15 x 42,500)* Gross margin Fixed selling & administrative expenses Income before taxes

*

$7,200,000 (5,100,000) (637,500) $1,462,500 (1,200,000) $ 262,500

Total production (100,000 units sold + 7,500 units inventoried) 107,500 Expected production (150,000) Units creating volume variance 42,500

2. Differences in incomes = $150,000 - $262,500 = $(112,500) This amount is equal to the increase in inventory of 7,500 units x $15 per unit fixed overhead deferred in ending inventory under absorption costing.

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b. The vice-president of marketing should find the variable costing approach to income determination desirable for many reasons, including the following:

• • •

34.

Variable costing income varies with units sold, not units produced. Fixed manufacturing overhead costs are charged against revenue in the period in which they are incurred; consequently, manufacturing cost per unit does not change with a change in production level. The contribution margin offers a useful tool for marketing decisions that consider changes in relationships among costs, volume levels, and profit figures. (CMA adapted)

a. 1. Total DLHs = 27,000 + 3,000 = 30,000 OH rate per DLH = $969,020 ÷ 30,000 DLHs = $32.30 per DLH 2. Total MHs = 2,100 + 65,800 = 67,900 OH rate per MH = $969,020 ÷ 67,900 MHs = $14.27 per MH b. Cutting: $383,400 ÷ 27,000 DLHs = $14.20 per DLH Assembly: $585,620 ÷ 65,800 MHs = $8.90 per MH c.

RW22SKI Direct material $ 34.85 Direct labor – Cutting (6 x $14.00; 4.8 x $14.00) 84.00 Direct labor – Assembly (.03 x $6.50; .05 x $6.50) .20 Total cost other than overhead $119.05 (1) Overhead (plant-wide rate using DLHs) (6.03 x $32.30; 4.85 x $32.30) 194.77 Total cost $313.82 Total cost other than overhead (2) Overhead (plant-wide rate using MHs) (5.96 x $14.27; 9.45 x $14.27) Total cost Total cost other than overhead (3) Cutting Department overhead (6 x $14.20; 4.8 x $14.20) Assembly Department overhead (5.9 x $8.90; 9.3 x $8.90) Total cost

SD45ROW $ 19.57 67.20 .33 $ 87.10 156.66 $243.76

$119.05

$ 87.10

85.05 $204.10

134.85 $221.95

$119.05

$ 87.10

85.20

68.16

52.51 $256.76

82.77 $238.03

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d. Given that a competitor sells the similar product for $270, management would probably conclude that production of RW22SKI was not feasible if the cost determined from a plant-wide overhead rate based on DLHs was used; competing on price would create a “loss” per unit. Using the cost determined from a plant-wide rate based on MHs might cause management to undercut the competitor’s price substantially, believing that a significant profit margin could be made. Using the cost determined from departmental rates (which is the most accurate of the three costs) would allow management to meet the competition’s price but would provide a small 5 percent profit margin. Possibly management needs to determine if the product could be produced more efficiently. 35.

a.

Normal 56,000 Variable costs: Indirect material $ 112,000 Indirect labor 56,000 Factory utilities 1,120 Factory maintenance 9,520 Material handling 3,360 Machine depreciation 1,680 Total variable costs $ 183,680 Fixed costs: Factory utilities $ 3,000 Factory maintenance 10,000 Material handling 8,000 Building rent 40,000 Supervisors’ salaries 72,000 Factory insurance 6,000 Total fixed costs $ 139,000

b. Variable OH rate per unit Fixed OH rate per unit

$3.28 2.48

Exp. 72,000

Prac. 95,000

Theor. 100,000

$ 144,000 72,000 1,440 12,240 4,320 2,160 $ 236,160

$ 190,000 95,000 1,900 16,150 5,700 2,850 $ 311,600

$200,000 100,000 2,000 17,000 6,000 3,000 $328,000

$

$

$

3,000 10,000 8,000 40,000 72,000 6,000 $ 139,000

3,000 10,000 8,000 40,000 72,000 6,000 $139,000

$3.28 1.93

c. 1. Variable Manufacturing Overhead Raw Materials (Supplies) Inventory

$3.28 1.46

3,000 10,000 8,000 40,000 72,000 6,000 $139,000 $3.28 1.39

140,000 140,000

To record indirect material at $2.00 per unit produced

Variable Manufacturing Overhead Wages Payable (or Cash)

70,000 70,000

To record indirect labor at $1.00 per unit produced

Variable Manufacturing Overhead Fixed Manufacturing Overhead Utilities Payable (or Cash)

1,400 3,000 4,400

To record factory utilities This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.

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Variable Manufacturing Overhead Fixed Manufacturing Overhead Cash (or Supplies)

11,900 10,000 21,900

To record factory maintenance

Variable Manufacturing Overhead Fixed Manufacturing Overhead Cash

4,200 8,000 12,200

To record material handling charges

Variable Manufacturing Overhead Accumulated Depreciation

2,100 2,100

To record depreciation at $0.03 per unit produced

Fixed Manufacturing Overhead Cash

40,000 40,000

To record building rent

Fixed Manufacturing Overhead Salaries Payable (or Cash)

72,000 72,000

To record supervisors’ salaries

Fixed Manufacturing Overhead Cash (or Prepaid Ins. or Ins. Payable)

6,000 6,000

To record factory insurance

Work in Process Inventory Variable Manufacturing Overhead Fixed Manufacturing Overhead

364,700 229,600 135,100

To apply variable and fixed manufacturing overhead to WIP

2. Actual fixed overhead Applied fixed overhead (70,000 x $1.93) Underapplied fixed overhead d.

36.

$139,000 135,100 $ 3,900

Use of expected capacity would create costs that would be more closely related to actual production costs. However, use of practical capacity would help indicate to management the costs of unused capacity.

a. Total overhead = $635,340 + $324,000 = $959,340 Total MHs = 72,000 + 9,300 = 81,300 OH rate per MH = $959,340 ÷ 81,300 MH = $11.80 MH Applied overhead = $11.80 x 8.15 = $96.17

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b. Fabrication: $635,340 ÷ 72,000 MH = $8.82 per MH x 8 Finishing: $324,000 ÷ 48,000 DLH = $6.75 per DLH x 2 Total OH applied per unit using departmental rates

$70.56 13.50 $84.06

c. Because each department has such a difference in the type of work being performed (machine intensive vs. labor intensive), plant-wide rates will not most accurately attach overhead costs. 37.

a.

Activity in MHs

Production overhead costs: Variable Fixed Total

Low 2,500

3,000

High 3,500

$ 10,125 95,400 $105,525

$ 12,150 95,400 $107,550

$ 14,175 95,400 $109,575

Activity in DLHs Installation overhead costs: Variable Fixed Total

$ 85,500 73,800 $159,300

b. Number of pools: 8 Production (25 MH per pool) Variable (8 x 25 x $4.05) Fixed (monthly amount) Total production overhead Installation (60 DLH per pool) Variable (8 x 60 x $14.25) Fixed (monthly amount) Total installation Total c. Number of pools: 120 Production (25 MH per pool) Variable (120 x 25 x $4.05) Fixed Installation (60 DLH per pool) Variable (120 x 60 x $14.25) Fixed Total overhead Budgeted capacity Overhead cost per pool

$ 99,750 73,800 $173,550

$

$114,000 73,800 $187,800

810 7,950 $

8,760

$ 6,840 6,150 12,990 $ 21,750

$ 12,150 95,400 $102,600 73,800

$107,550

176,400 $283,950 ÷120 $2,366.25

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Chapter 3

38.

47

a. Variable indirect labor Variable indirect materials Variable utilities Variable portion of other mixed costs Total variable OH costs

$120,000 20,000 80,000 120,000 $340,000

Total variable OH costs ÷ number of MHs = Variable OH rate per MH $340,000 ÷ 100,000 MHs = $3.40 per MH Fixed machinery depreciation Fixed machinery lease payments Fixed machinery insurance Fixed salaries Fixed utilities Total fixed overhead OH costs

$ 77,000 13,000 16,000 75,000 12,000 $ 193,000

Total fixed OH costs ÷ number of MHs = Fixed OH rate per MH $193,000 ÷ 100,000 MHs = $1.93 per MH b. Variable Manufacturing Overhead Various accounts

273,600 273,600

To record actual VOH costs

Fixed Manufacturing Overhead Various accounts

185,680 185,680

To record actual FOH costs

Work in Process Inventory (103,000 MHs x $3.40) Variable Manufacturing Overhead

350,200 350,200

To apply VOH to production

Work in Process Inventory (103,000 MHs x $1.93) Fixed Manufacturing Overhead

198,790 198,790

To apply FOH to production

c. Actual VOH Applied VOH Overapplied VOH

$273,600 350,200 $ 76,600

Actual FOH Applied FOH Overapplied FOH

d. Fixed Manufacturing Overhead Cost of Goods Sold

$185,680 198,790 $ 13,110

13,110 13,110

To close FOH at year-end

e.

Balance Proportion WIP $ 234,000 $234,000 ÷ $1,560,000 FG 390,000 390,000 ÷ $1,560,000 CGS 936,000 936,000 ÷ $1,560,000 Total $1,560,000

% 0.15 0.25 0.60 1.00

Overapp. OH Adj. $76,600 $11,490 $76,600 19,150 $76,600 45,960 $76,600

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Variable Manufacturing Overhead Work in Process Inventory Finished Goods Inventory Cost of Goods Sold 39.

76,600 11,490 19,150 45,960

a. Indirect material: variable; at either level, $3.20 per animal day Indirect labor: mixed; $4,000 + $6.00 per animal day at 6,000 days $40,000 at (4,000) days (28,000) 2,000 $12,000 $12,000 ÷ 2,000 = $6 per animal day Total cost Variable ($6 x 6,000 animal days) Fixed

$40,000 36,000 $ 4,000

Maintenance: mixed; $2,000 + $0.80 per animal day at 6,000 days $ 6,800 at (4,000) days (5,200) 2,000 $ 1,600 $1,600 ÷ 2,000 = $0.80 per animal day Total cost Variable ($0.80 x 6,000 animal days) Fixed

$ 6,800 (4,800) $ 2,000

Utilities: variable; at either level, $1.00 per animal day All other: mixed; $1,200 + $1.60 per animal day at 6,000 days $10,800 at (4,000) days (7,600) 2,000 $ 3,200 $3,200 ÷ 2,000 = $1.60 per animal day Total cost Variable ($1.60 x 6,000 animal days) Fixed

$10,800 (9,600) $ 1,200

Total fixed cost = $4,000 + $2,000 + $1,200 = $7,200 Total variable cost = $3.20 + $6.00 + $0.80 + $1.00 + $1.60 = $12.60 Total OH cost formula: $7,200 + $12.60 per animal day b. $7,200 ÷ ($13.40 - $12.60) = 9,000 animal days c. $13.40 x 9,000 = $120,600

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Chapter 3

49

d. VOH rate remains constant at FOH rate ($7200 ÷ 12,000) Total OH rate at 12,000 animal days

$12.60 0.60 $13.20*

*

This rate assumes that 12,000 days is still within the relevant range of activity and, therefore, no variable costs will change per unit and no fixed costs will change in total.

40.

D-Tect Income Statements (Absorption) For the Years Ended December 31, 2006 and 2007 2006 (20,000 units) Sales (units × $200) $4,000,000 CGS (units × $130) $2,600,000 Underapplied FOH 0 (2,600,000) Gross Profit $1,400,000 S&A: Variable (units × $20)$ 400,000 Fixed 180,000 (580,000) Income before taxes $ 820,000

2007 (24,000 units) $4,800,000 $3,120,000 90,000 (3,210,000) $1,590,000 $ 480,000 180,000

(660,000) $ 930,000

D-Tect Income Statements (Variable) For the Years Ended December 31, 2006 and 2007 2006 (20,000 units) $4,000,000 (2,000,000) $2,000,000 (400,000) $1,600,000

Sales (units × $200) CGS (units × $100) Product CM Variable SG&A(units × $20) Total CM Fixed costs Factory $750,000 S&A 180,000 (930,000) Income before taxes $ 670,000

2007 (24,000 units) $4,800,000 (2,400,000) $2,400,000 (480,000) $1,920,000 $750,000 180,000

2006 $820,000 670,000 $150,000

2007 $930,000 990,000 $(60,000)

Difference is equal to inventory change + 5,000 Times FOH application rate × $30 Difference in income $150,000

- 2,000 × $30 $(60,000)

Net income (absorption) Net income (variable) Difference in income

(930,000) $ 990,000

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50

41. a.

Salado Corp. Income Statement (Absorption) For the Year Ended December 31, 2006 Sales Cost of goods sold – Variable Fixed overhead [($1,505,000 ÷ 1,750) x 1,500] Gross profit Variable selling & administrative Fixed selling & administrative Net income

$3,750,000 $1,950,000 1,290,000 $ 270,000 190,000

(3,240,000) $ 510,000 (460,000) $ 50,000

b. The difference in the amounts is equal to the fixed overhead of ($1,505,000 ÷ 1,750 units) or $860 per unit times the 250 units produced but not sold during the year. This $215,000 is contained in ending inventory under absorption costing, whereas it appears as part of total fixed overhead expense on the variable costing income statement. c. It is not only ethical, it is required for the statements to be in conformity with generally accepted accounting principles. d. 1.

Salado Corp. Income Statement (Variable) For the Year Ended December 31, 2007 Sales (1,850 x $2,500) Variable cost of goods sold (1,850 × $1,300) Product contribution margin Variable selling & administrative ($180 × 1,850) Contribution margin Fixed overhead $1,505,000 Fixed selling & administrative 190,000 Net income

2.

$4,625,000 (2,405,000) $2,220,000 (333,000) $1,887,000 (1,695,000) $ 192,000

Salado Corp. Income Statement (Absorption) For the Year Ended December 31, 2007 Sales $4,625,000 Cost of goods sold - Variable $2,405,000 Fixed overhead [($1,505,000 ÷ 1,750) x 1,850] 1,591,000 (3,996,000) Gross profit $ 629,000 Variable selling & administrative $ 333,000 Fixed selling & administrative 190,000 (523,000) Net income $ 106,000

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3. Net income under variable costing Net income under absorption costing Difference in net incomes

$192,000 (106,000) $ 86,000

The difference in the net incomes is equal to the incremental decrease in the ending balances of the inventory accounts when compared to the beginning balances. Another way to look at this more easily is to multiply the 100 units sold in excess of the 1,750 units produced by the fixed overhead application rate of $860 per unit. 42. a.

x 10 14 22 28 40 62 100 90 80 446

y $ 16,000 18,400 24,000 28,400 37,000 56,000 68,000 60,000 48,000 $355,800

xy $ 160,000 257,600 528,000 795,200 1,480,000 3,472,000 6,800,000 5,400,000 3,840,000 $22,732,800

x2 100 196 484 784 1,600 3,844 10,000 8,100 6,400 31,508

x = 446 ÷ 9 = 49.56 y = $355,800 ÷ 9 = $39,533.33

b=

∑ xy − n( x )( y ) = $22,732,800 − 9(49.56)($39,533.33) = $5,099,353.49 = $542.35 31,508 − 9( 49.56)( 49.56) 9,402.26 ∑ x − n( x ) 2

2

a = y − b x = $39,533.33 − $542.35( 49.56) = $12,654.46 y = $12,654.46 + $542.35(# of charters) b.

x $ 12,000 18,000 26,000 36,000 60,000 82,000 120,000 100,000 96,000 $550,000

y $ 16,000 18,400 24,000 28,400 37,000 56,000 68,000 60,000 48,000 $355,800

xy $ 192,000,000 331,200,000 624,000,000 1,022,400,000 2,220,000,000 4,592,000,000 8,160,000,000 6,000,000,000 4,608,000,000 $27,749,600,000

x2 144,000,000 324,000,000 676,000,000 1,296,000,000 3,600,000,000 6,724,000,000 14,400,000,000 10,000,000,000 9,216,000,000 46,380,000,000

x = $550,000 ÷ 9 = $61,111.11 y = $355,800 ÷ 9 = $39,533.33

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52

b=

∑ xy − n( x )( y ) = $27,749,600,000 − 9(61,111.11)($39,533.33) = $6,006,268,895.33 = $0.47 46,380,000,000 − 9(61,111.11)(61.111.11) 12,768,890,111.11 ∑ x − n( x ) 2

2

a = y − b x = $39,533.33 − $0.47(61,111.11) = $10,811.11 y = $10,811.11 + $0.47(gross receipts) 43. a.

MHs High activity 2,700 Low activity (1,400) Differences 1,300

Total Cost = Variable Cost + Fixed Cost $13,160 $8,640 $4,520 (9,000) 4,480 4,520 $ 4,160

Variable rate = $4,160 ÷ 1,300 MHs = $3.20 per MH High activity variable cost = 2,700 × $3.20 = $8,640 Low activity variable cost = 1,400 × $3.20 = $4,480 Fixed cost at low activity = $9,000 – $4,480 = $4,520 Total maintenance cost = $4,520 + $3.20MH b.

x 1,400 1,900 2,000 2,500 2,200 2,700 1,700 2,300 16,700

y $ 9,000 10,719 10,900 13,000 11,578 13,154 9,525 11,670 $89,546

xy $ 12,600,000 20,366,100 21,800,000 32,500,000 25,471,600 35,515,800 16,192,500 26,841,000 $191,287,000

x2 1,960,000 3,610,000 4,000,000 6,250,000 4,840,000 7,290,000 2,890,000 5,290,000 36,130,000

x = 16,700 ÷ 8 = 2,087.50

y = $89,546 ÷ 8 = $11,193.25 b=

∑ xy − n( x )( y ) = $191,287,000 − 8(2,087.50)($11,193.25) = $4,359,725 = $3.44 36,130,000 − 8( 2,087.50)( 2,087.50) 1,268,750 ∑ x − n( x ) 2

2

a = y − b x = $11,193.25 − $3.44( 2,087.50) = $4,012.25 y = $4,012.25 + $3.44MH c. Part (b) computations provide the better answer. The least squares regression approach takes into consideration all of the available data and employs a mathematical algorithm to minimize the variance around the fitted regression line.

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Chapter 3

44. a.

53

Riveting Manufacturing Income Statement (Variable) For the Year Ended December 31, 2007 Sales Variable Cost of Goods Sold: Work in Process 1/1/07 Finished goods 1/1/07 Manufacturing costs incurred Total costs available Work in process 12/31/07 Finished goods 12/31/07 Product Contribution Margin Variable Selling Expenses Contribution Margin Fixed Expenses Factory overhead Selling Administrative Operating Income

$1,015,000 46,400 $ 16,950 650,600 $713,950 (61,900) (13,180)

$ 42,300 44,250 75,000

(638,870) $ 376,130 (50,750) $ 325,380

(161,550) $ 163,830

Supporting calculations Variable finished goods inventory at 1/1/07: Absorption finished goods inventory Less fixed overhead (1,050 hours × $1 per hour) Variable finished goods inventory

$18,000 (1,050) $16,950

Variable work in process inventory at 1/1/07: Absorption work in process inventory Less fixed overhead (1,600 hours × $1 per hour) Variable work in process

$48,000 (1,600) $46,400

Variable manufacturing costs incurred during 2007: Direct material Direct labor (23,000 hours × $6 per hour) Variable overhead (23,000 hours × $6.20 per hour) Variable manufacturing costs

$370,000 138,000 142,600 $650,600

The direct labor rate is ($150,000 ÷ 25,000 hours) or $6.00 per hour. The variable overhead rate is ($155,000 ÷ 25,000 hours) or $6.20 per hour. Variable work in process inventory at 12/31/07: Absorption work in process inventory Less fixed overhead (2,100 hours × $1) Variable work in process inventory

$64,000 (2,100) $61,900

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54

Variable finished goods inventory at 12/31/07: Absorption finished goods inventory Less fixed overhead (820 hours × $1) Variable finished goods inventory

$14,000 (820) $13,180

Variable selling expenses = Sales × 5% = $1,015,000 × 5% = $50,750 Fixed selling expenses: Total selling expenses Less variable selling expenses Fixed selling expenses

$95,000 (50,750) $44,250

b. The difference in the operating income of $270 is caused by the different treatment of fixed manufacturing overhead. Under absorption costing, fixed overhead costs are assigned to inventory and are not expensed until the goods are sold. Under variable costing, these costs are treated as expenses in the period incurred. Since the direct labor hours in the work in process and finished goods inventories had a net increase of 270 hours, the absorption costing operating profit is higher because the fixed factory overhead associated with the increased labor hours in inventory is not expensed when absorption costing is used.

Work in process Finished goods Total

1/1/07 Inventories 1,600 1,050 2,650

12/31/07 Inventories 2,100 820 2,920

Differences 500 (230) 270

The increase in hours (270) times the fixed overhead rate ($1 per hour) equals the difference in operating incomes ($270). 45. a.

Royals Fashions Company Income Statement (Variable) For the Year Ended December 31, 2007 Sales (40,000 × $20) Variable cost of goods sold (40,000 x $7.50) Contribution margin Fixed costs: Production Selling & administrative Income before taxes

$800,000 (300,000) $500,000 $117,000 125,000

(242,000) $258,000

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Chapter 3

b.

55

Royals Fashions Company Income Statement (Absorption) For the Year Ended December 31, 2007 Sales (40,000 × $20) Cost of goods sold (40,000 x $9.45) Underapplied fixed overhead* Gross margin Less selling and administrative costs Income before taxes

$800,000 $378,000 23,400

(401,400) $398,600 (125,000) $273,600

Number of units in ending FG inventory = 4,000 + 48,000 – 40,000 = 12,000 FOH: $117,000 ÷ 60,000 = $1.95 per unit Underapplied FOH = $1.95 x (60,000 – 48,000) = $1.95 x 12,000 = $23,400 c. Inventory increased from 4,000 to 12,000 units or by 8,000 units. Each added unit absorbs $1.95 in allocated fixed overhead or a total of $15,600. The presumption in the problem is that the books are maintained on a variable costing basis. Assuming only the current year needs to be adjusted (the beginning inventory of 2007 was charged with the appropriate fixed overhead), then the entry would be: Inventory (8,000 x $1.95) Cost of Goods Sold (40,000 x $1.95) Underapplied Overhead Fixed Factory Overhead

15,600 78,000 23,400 117,000

d. Advantages: • The fixed costs are reported at incurred values (and not applied), thus increasing the likelihood of better control of those costs. • Profits are directly influenced by changes in sales volume (and not influenced by building inventory). • The impact of fixed costs on profits is emphasized. • Product line, territory, etc., marginal contribution is emphasized and more readily ascertainable. Disadvantages: • Total costs may be overlooked when considering problems. • Distinction between fixed and variable cost is arbitrary for many costs. • Emphasis on variable cost may cause managers to ignore fixed costs. e. Advantages: • Statements would readily reflect the direct impact of sales volume on profits. • The consequences of fixed costs would be more obvious. • Inventory swings would not influence profits. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.

56

Chapter 3

Disadvantages: • Costs are not matched with revenues. • The difficulty in separating fixed and variable costs might cause statements to be misleading. • Statements would confuse investors used to absorption costing statements. • Confidential information (on the nature of costs) could be disclosed to competitors. (CMA adapted)

This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.