Variable Costing & Segment Reporting

Responsibility Accounting and Transfer Pricing (C. Variable Costing & Segmented Reporting) C. VARIABLE COSTING AND SEGMENTED REPORTING THEORIES: Direct costing 1. A basic tenet of direct costing is that period costs should be currently expensed. What is the rationale behind this procedure? A. Period costs are uncontrollable and should not be charged to a specific product. B. Period costs are generally immaterial in amount and the cost of assigning the amounts to specific products would outweigh the benefits. C. Allocation of period costs is arbitrary at best and could lead to erroneous decisions by management. D. Because period costs will occur whether or not production occurs, it is improper to allocate these costs to production and defer current costs of doing business. 2.

In a variable costing system, product cost includes A. direct materials, direct labor, variable overhead B. direct materials, direct labor, fixed overhead C. direct labor, variable overhead, fixed overhead D. direct materials, variable overhead, fixed overhead

3.

Which of the following must be known about production process in order to institute a direct costing system? A. The variable and fixed components of all costs related to production. B. The controllable and noncontrollable components of all costs related to production. C. Standard production rates and times for all elements of production. D. Contribution margin and breakeven point for all goods in production.

4.

Under the direct costing concept, unit product cost would most likely be increased by A. A decrease in the remaining useful life of factory machinery depreciated on the units-of-production method. B. A decrease in the number of units produced. C. An increase in the remaining useful life of factory machinery depreciated on the sum-of-the-years’-digits method. D. An increase in the commission paid to salesmen for each unit sold.

5.

Which of the following statements is true for a firm that uses variable (direct) costing? A. The cost of a unit of product changes because of changes in the number of units manufactured. B. Profits fluctuate with sales C. An idle facility variation is calculated D. Product costs include “direct” (variable) administrative costs.

6.

Which of the following is an argument against the use of direct (variable) costing? A. Absorption costing overstates the balance sheet value of inventories. B. Variable factory overhead is a period cost. C. Fixed factory overhead is difficult to allocate properly. D. Fixed factory overhead is necessary for the production of a product.

7.

Advocates of variable costing for internal reporting purposes do not rely on which of the following points? A. The matching concept B. Price-volume relationships C. Absorption costing does not include selling and administrative expenses as part of inventoriable cost D. Production influences income under absorption costing

8.

Which costing method is not acceptable to the SFAS external reporting? A. absorption costing C. full costing B. variable costing D. all of these are acceptable

9.

Variable costing can be used for A. external reporting B. internal reporting C. either external reporting or internal reporting D. neither external reporting nor internal reporting

10.

Which of the following is not true of variable costing? A. Profits may increase though sales decrease. B. Profits fluctuate with sales. C. The cost of the product consists of all variable production costs. D. The income statement under variable costing does not include overhead volume variance.

Contribution margin format income statement 11. When variable costing is used, the income statement is usually prepared using A. a contribution margin format C. a functional format B. an operational format D. all of these Absorption costing 12. Absorption costing of inventories, as required by GAAP, has been criticized for encouraging managers to increase year-end inventories in order to boost reported profits. Which of the following techniques is the most effective at resolving this problem? A. Senior management control of inventory levels B. Adoption of just-in-time (JIT) production system C. Reward managers based upon the residual income approach D. Use variable costing to determine income for bonus purposes 13.

When absorption costing is used, all of the following costs are considered product costs except A. direct labor C. variable selling and administrative costs B. variable overhead D. fixed overhead

14.

Unabsorbed fixed overhead costs in an absorption costing system are A. Fixed factory costs not allocated to units produced. B. Variable overhead costs not allocated to units produced. C. Excess variable overhead costs. D. Costs that should be controlled.

Responsibility Accounting and Transfer Pricing (C. Variable Costing & Segmented Reporting) Variable costing vs. Absorption costing 15. What is the primary difference between variable and absorption costing? A. inclusion of fixed selling expenses in product costs B. inclusion of variable factory overhead in period costs C. inclusion of variable selling expenses in product costs D. inclusion of fixed factory overhead in product costs 16.

Which of the following statements is true? A. Absorption costing net income exceeds variable costing net income when units produced and sold are equal. B. Variable costing net income exceeds absorption costing net income when units produced exceed units sold. C. Variable costing net income exceeds absorption costing net income when units produced equal units sold. D. Absorption costing net income exceeds variable costing net income when units produced are greater than units sold.

17.

Net earnings determined using full absorption costing can be reconciled to net earnings determined using direct costing by computing the difference between A. Inventoried fixed costs in the beginning and ending inventories and any deferred over- or underapplied fixed factory overhead. B. Inventoried discretionary costs in the beginning and ending inventories. C. Gross margin (absorption costing method) and contribution margin (direct costing method). D. Sales as recorded under the direct costing method and sales as recorded under the absorption costing method.

18.

Net profit under absorption costing may differ from net profit determined under direct costing. How is this difference calculated? A. Change in the quantity of all units in inventory times the relevant fixed costs per unit. B. Change in the quantity of all units produced times the relevant fixed costs per unit. C. Change in the quantity of all units in inventory times the relevant variable cost per unit. D. Change in the quantity of all units produced times the relevant variable cost per unit.

Sensitivity analysis 19. The level of production affects income under which of the following methods? A. absorption costing C. variable costing B. both absorption and variable costing D. neither absorption nor variable costing 20.

Variable-costing income will usually exceed absorption costing income when A. sales exceed production C. production exceeds sales B. production and sales are equal D. none of these

21.

Variable costing net income is A. higher than absorption net income when more units are sold than produced B. lower than absorption net income when more units are produced than sold C. the same as absorption net income when all units produced are sold D. all of the above

22.

A manufacturing company prepares income statements using both absorption and variable costing methods. At the end of a period actual sales revenues, total gross profit, and total contribution margin approximated budgeted figures, whereas net income was substantially greater than the budgeted amount. There were no beginning or ending inventories. There most likely explanation of the net income increase is that, compared to budget, actual A. Manufacturing fixed costs had increased. B. Selling and administrative fixed expenses had decreased. C. Sales prices and variable costs had increased proportionately. D. Sales prices had declined proportionately less than variable costs.

23.

When variable costing is used, fixed manufacturing overhead is recognized as an expense when the A. cost is incurred C. product is sold B. product is completed D. product is inventoried

Segment reporting 24. A segment is any part of an organization about which a manager seeks A. cost data C. quantitative data B. revenue data D. any of the above 25.

Which of the following could be considered a segment? A. division B. sales territory

26.

The guideline(s) used in assigning costs to a segment include(s) whether A. costs are fixed C. costs are directly traceable B. costs are variable D. all of the above

27.

Segment margin is equal to A. sales less variable costs B. sales less variable costs and direct fixed costs C. sales less variable costs and indirect fixed costs D. sales less cost of goods sold

28.

Revenue less variable costs and direct fixed costs equals A. contribution margin B. segment margin

29.

Indicate which of the following costs would be avoided if a segment is eliminated. 1. variable manufacturing costs 2. direct fixed costs 3. common fixed costs 4. variable selling costs 5. direct fixed selling costs 6. common fixed selling costs A. 2, 3, 5, 6 C. 2, 3, 4, 5 B. 1, 2, 4, 5 D. 1, 4, 5, 6

C. D.

C. D.

product line all of these

income before taxes income after taxes

Responsibility Accounting and Transfer Pricing (C. Variable Costing & Segmented Reporting) 30.

Which of the following costs would continue to be incurred even if a segment is eliminated? A. direct fixed expenses B. common fixed costs C. variable cost of goods sold D. variable selling and administrative expenses

Cost allocation policy 31. Which of the following is a good reason for allocating indirect costs to operating departments? A. The company could lose money if the operating departments do not pay for the services they use. B. To remind managers of the need to cover indirect costs. C. To encourage managers to use more services. D. To determine the true costs of operating departments. 32.

The cost allocation policy most likely to encourage use of a service is based on A. budgeted total costs of the service department B. actual total costs of the service department C. budgeted variable costs for the service department D. actual variable costs for the service department

33.

The term “dual rates” refers to A. allocating costs to several operating departments B. allocating fixed costs based on capacity requirements and variable costs based on use C. allocating both actual costs and budgeted costs D. using the budgeted rate to allocate some costs, the actual rate to allocate others

34.

The WORST method of allocating service department costs is to allocate A. total actual costs based on actual use of the service B. total budgeted costs based on long-term expected use of the service C. total budgeted cost based on actual use of the service D. none of the above, because all the above are equally undesirable

PROBLEMS: Variable costing Ending inventory i. The following information pertains to Sharapova Corporation: Beginning inventory Ending inventory Direct labor per unit Direct materials per unit Variable overhead per unit Fixed overhead per unit Variable selling costs per unit Fixed selling costs per unit What is the value of ending inventory using the variable costing method? A. P155,000 C. P100,000 B. P125,000 D. P195,000

0 units 5,000 units P10 8 2 5 6 8

Absorption costing Gross margin ii. A company manufactures a single product for its customers by contracting in advance of production. Therefore, the company only produces units that will be sold by the end of each period. During the last period, the following sales were made and costs incurred: Sales P40,000 Direct materials 9,050 Direct labor 6,000 Rent (9/10 factory, 1/10 office) 3,000 Depreciation on factory equipment 2,000 Supervision (2/3 factory, 1/3 office) 1,500 Salespeople’s salaries 1,300 Insurance (2/3 factory, 1/3 office) 1,200 Office supplies 750 Advertising 700 Depreciation on office equipment 500 Interest on loan 300 Based on the above data, the gross margin percentage for the last period (rounded to nearest percent) was A. 41% C. 46% B. 44% D. 49% Variable costing vs. Absorption costing Unit costs iii. During May, Roy Co. produced 10,000 units of Product X. Costs incurred by Roy during May were as follows Direct materials Direct labor Variable manufacturing overhead Variable selling and general Fixed manufacturing overhead Fixed selling and general Total What are the unit costs under absorption and variable costing methods, respectively? A. P5.10; P3.80 C. P4.40; P3.50 B. P3.80 P5.10 D. P3.50: P4.40 Difference in income iv. Consider the following: Sales price, per unit Standard absorption cost rate Standard variable cost rate Variable selling expense rate Fixed selling and administrative expenses

P10,000 20,000 5,000 3,000 9,000 4,000 P51,000

P18 per unit P12 per unit P8 per unit P2 per unit P40,000

Responsibility Accounting and Transfer Pricing (C. Variable Costing & Segmented Reporting) Fixed manufacturing overhead

P60,000

Last period, 13,000 units were produced. In the current period, 15,000 units were produced. In each period, 13,000 units were sold. What is the difference in reported income under absorption and variable costing for the current period? A. The variable-costing income exceeded absorption-costing income by P4,000. B. The absorption-costing income exceeded variable-costing income by P8,000. C. The variable-costing income exceeded absorption-costing income by P6,000. D. Net income will not be different between the two methods. v.

The Blue Company has failed to reach its planned activity level during its first two years of operation. The following table shows the relationship between units produced, sales, and normal activity for these years and the projected relationship for Year 3. All prices and costs have remained the same for the last two years and are expected to do so in Year 3. Income has been positive in both Year 1 and Year 2. Units Produced Sales Planned Activity Year 1 90,000 90,000 100,000 Year 2 95,000 95,000 100,000 Year 3 90,000 90,000 100,000 Because Blue Company uses an absorption costing system, one would predict gross margin for Year 3 to be A. Greater than Year 1. C. Equal to Year 1. B. Greater than Year 2. D. Equal to Year 2.

Reconciliation Income under absorption costing vi. A company had income of P50,000 using direct costing for a given period. Beginning and ending inventories for that period were 13,000 units and 18,000 units, respectively. Ignoring income taxes, if the fixed overhead application rate were P2.00 per unit, what would the income have been using absorption costing? A. P40,000 B. P50,000 C. P60,000 D. Cannot be determined from the information given. Income under variable costing vii. Luna Company had income of P65,000 using absorption costing for a given period. Beginning and ending inventories for that pe riod were 13,000 units and 18,000 respectively. Ignoring income taxes, if the fixed overhead application rate were P2.50 per unit, what would the income have been using variable costing? A. P 77,500 C. P 52,500 B. P 60,000 D. P 20,000 Unit contribution margin viii. The following information was extracted from the first year of absorption-based accounting records of Soulmate Co. Total fixed costs incurred P100,000 Total variable costs incurred 50,000 Total period costs incurred 70,000 Total variable period costs incurred 30,000 Units produced 20,000 Units sold 12,000 Unit sales Price P 12 Based on variable costing, if Soulmate Co. had sold 12,001 units instead of 12,000, its income before taxes would have been A. P 9.50 higher C. P11.00 higher B. P 8.50 higher D. P 8.33 higher ix.

At its present level of operations, a small manufacturing firm has total variable costs equal to 75% of sales and total fixed costs equal to 15% of sales. Based on variable costing, if sales change by P1.00, income will change by A. P 0.25 C. P 0.75 B. P 0.12 D. P 0.10

Segmented Income Statement Effect of dropping a department x. Zambales Mining Co. mines three products. Gold Ore sells for P1,000,000 per ton, variable costs are P600,000 per ton, and fi xed mining costs are P5,000,000. The segment margin for 2005 was P(1,000,000). The management of Zambales Mining was considering dropping the mining of Gold Ore. Only one-half of the fixed expenses are direct and would be eliminated if the segment was dropped. If Gold Ore were dropped, net income for Zamba les Mining would A. Increase by P1,000,000 C. Decrease by P1,000,000 B. Increase by P1,500,00 D. Decrease by P1,500,000 xi.

Aging Company plans to discontinue a segment with a P32,000 segment margin. Common expenses allocated to the segment amounted to P45,000, of which P20,000 cannot be eliminated if the segment were closed. The effect of closing down the segment on Aging Company’s before tax profit would be A. P12,000 decrease C. P 7,000 decrease B. P12,000 increase D. P 7,000 increase

Use this data to respond to questions 16 through 17. Omid Publishing Company has three divisions: A, B, and C. The revenues of these divisions are P29,000, 48,000, and 63,000 respectively. Variable costs of these divisions amount to 57%, 59%, and 64% of the given revenues. The divisions' short-term controllable fixed costs are P4,200, 5,200, and 6,200 respectively. The divisions' long-term controllable fixed costs amount to P3,800, 4,900, and 5,700 in the order given. The company's uncontrollable costs amount to P7,150, and income tax is at 20% of operating income. xii.

Long-term controllable margin for division A amounts to A. P4,470 B. P8,270

C. D.

P12,470 P16,470

xiii.

Short-term controllable margin for division B amounts to A. P9,580 B. P14,480

C. D.

P19,680 P23,580

Comprehensive Questions 10 through 13 are based on the following annual flexible budget which has been prepared for use in making decisions relating to Product X. Budgeted units 100,000 150,000 200,000 Sales Volume P800,000 P1,200,000 P1,600,000 Manufacturing costs: Variable P300,000 P 450,000 P 600,000

Responsibility Accounting and Transfer Pricing (C. Variable Costing & Segmented Reporting) Fixed Selling expenses: Variable Fixed Income (or loss)

200,000 P500,000

200,000 P 650,000

200,000 P 800,000

P200,000 160,000 P360,000 (P60,000)

P 300,000 160,000 P 460,000 P 90,000

P 400,000 160,000 P 560,000 P 240,000

The 200,000-unit budget has been adopted and will be used for allocating fixed manufacturing costs to units of Product X. At the end of the first six months the following information is available: Units Production completed 120,000 Sales 60,000 All fixed costs are budgeted and incurred uniformly throughout the year and all costs incurred coincide with the budget. Over- and underapplied fixed manufacturing costs are deferred until year-end. Annual sales have the following seasonal pattern: Portion of Annual Sales First quarter 10% Second quarter 20% Third quarter 30% Fourth quarter 40% 100% xiv.

The amount of fixed factory costs applied to product during the first six months under absorption costing would be A. Overapplied by P20,000. C. Underapplied by P40,000. B. Equal to the fixed costs incurred. D. Underapplied by P80,000

xv.

Reported net income (or loss) for the first six months under absorption costing would be A. P160,000 C. P 80,000 B. P 40,000 D. P (40,000)

xvi.

Reported net income (or loss) for the firs six months under direct costing would be A. P144,000. C. P 72,000 B. P0 D. P(36,000)

xvii. Assuming that 90,000 units of Product X were sold during the first six months and that this is to be used as a basis, the revised budget estimate for the total number of units to be sold during this year would be A. 360,000. C. 240,000 B. 200,000. D. 300,000

i.

ii.

iii.

Answer: C Direct materials Direct labor Variable overhead Total unit cost- variable costing Value of ending inventory (5,000 x P20) Answer: C Sales Cost of goods sold Direct materials Direct labor Rent (0.9 x P3,000) Depreciation Supervision (2/3 x P1,500) Insurance (2/3 x P1,200) Gross margin Gross margin percentage (P18,400 ÷ P40,000)

P 8 10 2 P20 P100,000 P40,000 P9,050 6,050 2,700 2,000 1,000 800

(21,600) P18,400 46%

Answer: C Direct materials Direct labor Variable overhead Total variable product cost Variable unit cost (P35,000 ÷ 10,000) Add Fixed overhead per unit (P9,000 ÷ 10,000) Absorption unit cost

P10,000 20,000 5,000 P35,00 P3.50 0.90 P4.40

iv.

Answer: B Fixed overhead rate per unit: P12 – P8 P4 Difference in income: 2,000 x P4 P8,000 During the current year, the company’s production equaled the budgeted. The inventory increased. Therefore, absorption costing income is higher than the variable costing income.

v.

Answer: C The production and unit sales during year 3 matched with year 1.

vi.

Answer: C The income under absorption costing is higher by P10,000 because the amount of fixed overhead that related to unsold units was deferred and was included as cost of finished goods inventory. The variable costing income statement immediately wrote the entire fixed overhead that was incurred during the year as period cost. Fixed overhead deferred as product cost: 5,000 x P2 P10,000 Absorption income (P50,000 + P10,000) P60,000

Responsibility Accounting and Transfer Pricing (C. Variable Costing & Segmented Reporting)

vii. Answer: C Absorption income Less Fixed Overhead in decrease in inventory

(18,000 – 15,000) x 2.50

Income, Variable costing viii. Answer: B CMR per unit = Selling Price – Unit variable cost P8.50 = P12.00 – P3.50 Variable Cost Per unit Product: (50,000 – 30,000) / 20,000 = Selling & Adm. (variable period costs) Total variable cost/unit * Total variable costs – variable period cost (selling & adm.) = variable product cost.

65,000 12,500 52,500

30,000/12,000

P1.00 2.50 P3.50

ix.

Answer: A 1.00 - (1.00 x .75) = P0.25

x.

Answer: A The only relevant information to compute the effect of dropping the mining of gold ore is the negative segment margin. If th e product line is dropped, the company can avoid the negative margin of P1 million.

xi.

Answer: C Avoidable common expenses Segment margin lost Decrease in profit

P 25,000 32,000 P( 7,000)

xii. Answer: A Revenues Variable cost (P29,000 x 0.57) Contribution margin Less Short-term controllable fixed cost Short-term controllable margin Long-term controllable fixed cost Long-term controllable margin

P29,000 16,530 12,470 4,200 8,270 3,800 P 4,470

xiii. Answer: B Revenues Variable cost (P48,000 x 0.59) Contribution margin Short-term controllable fixed cost Short-term controllable margin – Div B

P48,000 28,320 19,680 5,200 P14,480

xiv. Answer: A Budgeted actual fixed overhead (0.5 x P200,000) Applied fixed overhead (120,000 x P1.00) Overapplied fixed overhead (favorable volume variance) xv.

P100,000 120,000 P 20,000

Answer: B Sales (60,000 x P8) Cost of goods sold (60,000 x P4) Gross profit Selling and other expenses (60,000 x 2) + P80,000 Absorption profit

xvi. Answer: B Total contribution margin (60,000 x P3) Less: Fixed manufacturing OH Fixed selling and other expenses Variable costing profit CM per unit (P1.6M – P0.6M – P0.4M) ÷ 200,000)

P480,000 240,000 240,000 200.000 P 40,000 P180,000 P100,000 80,000

180,000 NIL P3.00

xvii. Answer: D The sales pattern indicated that sales for the first semester was 30%. The assumption was that the pattern was still valid. Therefore the assumed 90,000 units would be 30 percent of expected annual sales. (90,000 ÷ 0.3) = 300,000 units