Financial and Managerial Accounting Study Set 1

Business

Quiz 21 :

Variable Costing for Management Analysis

Quiz 21 :

Variable Costing for Management Analysis

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Ethics and professional conduct in business The Southwest Division of Texcaliber Inc. uses absorption costing for profit reporting. The general manager of the Southwest Division is concerned about meeting the income objectives of the division. At the beginning of the reporting period, the division had an adequate supply of inventory. The general manager has decided to increase production of goods in the plant in order to allocate fixed manufacturing cost over a greater number of units. Unfortunately, the increased production cannot be sold and will increase the inventory. However, the impact on earnings will be positive because the lower cost per unit will be matched against sales. The general manager has come to Aston Melon, the controller, to determine exactly how much additional production is required in order to increase net income enough to meet the division's profit objectives. Aston analyzes the data and determines that the inventory will need to be increased by 30% in order to absorb enough fixed costs and meet the income objective. Aston reports this information to the division manager. Discuss whether Aston is acting in an ethical manner.
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Comment the Ethical manner of Aston:
S Division of TI uses absorption costing for reporting income statement figures. The general manager of the division is under pressure to meet income targets. He is planning to increase production even though there are no corresponding customer orders.
Aston, the controller of production, is acting with integrity by reporting the information to the division manager. As a controller, he has overall jurisdiction over the operations.
However, he may not have the powers to question the general manager's actions of increasing production solely for meeting the division's profit targets.
By reporting the matter to the division manager, Aston is indirectly questioning the decision of the general manager.
It is the responsibility of the divisional manager to present a true picture of the division's performance. Condoning the general manager's actions would show a lack of integrity for the following reasons:
• The division is resorting to a deliberate increase in production without corresponding customer demand in order to show increased earnings. The result is that fixed costs are allocated over a larger inventory base. This effectively decreases the unit cost of production decreases for the same sales level and artificially boosts net income for the period. The fixed costs become part of unsold inventory and thus get transferred to the balance sheet.
• The true state of profitability and net income is glossed over and hidden behind artificial reporting. The income information in such financial reports can be misleading to senior management.
• Since there is an avenue available to cover up lackluster performance, there is no incentive to improve performance and profitability. Senior management, believing that the division's performance is good, will not intervene to improve things.
• Increasing production without corresponding sales (production exceeds sales) provides short-term benefits. When inventory gets used later, the costs must be allocated to the period's sales, reducing profits for the subsequent reporting period. Therefore the general manager's action will adversely affect future period net income.
• The objective of financial reporting is to present a true picture of the company's affairs to users. The general manager has utilized a loophole in absorption costing under GAAP, which permits transfer of fixed costs to inventory. This is tantamount to misrepresentation.

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What types of costs are customarily included in the cost of manufactured products under (a) the absorption costing concept and (b) the variable costing concept?
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a. Absorption Costing:
Under Absorption Costing, the cost of manufactured goods includes:
1. Direct materials costs
2. Direct labor costs
3. Factory overhead costs consisting of (i) variable and (ii) fixed factory overheads.
b. Variable Costing:
Under Variable Costing, only variable costs are included for determining the cost of goods manufactured. Fixed costs relating to factory overheads are treated as a period expense. The costs included are:
1. Direct materials costs
2. Direct labor costs
3. Variable factory overheads
The cost of goods manufactured will be higher when Absorption Costing is adopted, as it includes fixed factory overheads also.

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Inventory valuation under absorption costing and variable costing At the end of the first year of operations, 6,400 units remained in the finished goods inventory. The unit manufacturing costs during the year were as follows: img Determine the cost of the finished goods inventory reported on the balance sheet under (a) the absorption costing concept and (b) the variable costing concept.
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a. Absorption costing:
Under the absorption costing approach all the costs incurred for manufacturing a product will be allocated to the costs. The cost incurred for manufacturing will consist of direct material, direct labor, variable overhead and fixed overheads. The absorption costing includes both fixed and variable overheads.
Calculate Valuation of Closing Inventory as per Absorption Costing:
Under absorption costing the fixed manufacturing costs are treated as manufacturing costs and are added to direct material, direct labor and other direct expenses to arrive at costs of goods sold.
Consider the below table:
img Therefore from the above calculations, it is clear that the value of Inventory calculated using absorption costing is $876,800
b. Variable costing:
• Under variable costing, all the variable costs are treated as product costs. All the fixed costs are treated as period costs. Therefore, all the costs related to the manufacturing of products, that will vary will the production such as direct material, direct labor and variable manufacturing overhead are treated as product costs.
• Further, costs such as selling and administration expenses which are fixed in nature, are treated as period costs, as these expenses are incurred throughout the period irrespective of production.
Calculate Valuation of Closing Inventory as per Variable Costing:
Under variable costing concept, fixed manufacturing costs are not included while calculating the cost of goods sold. Hence to calculate the contribution margin, variable costing uses the below formula:
img Consider Below Table:
img Therefore from the above calculations, it is clear that the value of Inventory calculated using Variable costing is $780,800.

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Variable costing Light Company has the following information for January: img Determine (a) the manufacturing margin, (b) the contribution margin, and (c) income from operations for Light Company for the month of January. Marley Company has the following information for March: img Determine (a) the manufacturing margin, (b) the contribution margin, and (c) income from operations for Marley Company for the month of March.
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Absorption and variable costing income statements During the first month of operations ended May 31016, Frost Point Fridge Company manufactured 40,000 mini refrigerators, of which 36,000 were sold. Operating data for the month are summarized as follows: img Instructions 1. Prepare an income statement based on the absorption costing concept. 2. Prepare an income statement based on the variable costing concept. 3. Explain the reason for the difference in the amount of income from operations reported in (1) and (2).
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Absorption and variable costing income statements During the first month of operations ended July 31, 2016, YoSan Inc. manufactured 2,400 flat panel televisions, of which 2,000 were sold. Operating data for the month are summarized as follows: img Instructions 1. Prepare an income statement based on the absorption costing concept. 2. Prepare an income statement based on the variable costing concept. 3. Explain the reason for the difference in the amount of income from operations reported in (1) and (2).
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Inventories under absorption costing BendOR, Inc. manufactures control panels for the electronics industry and has just completed its first year of operations. The following discussion took place between the controller, Gordon Merrick, and the company president, Matt McCray: Matt: I've been looking over our first year's performance by quarters. Our earnings have been increasing each quarter, even though our sales have been flat and our prices and costs have not changed. Why is this? Gordon: Our actual sales have stayed even throughout the year, but we've been increasing the utilization of our factory every quarter. By keeping our factory utilization high, we will keep our costs down by allocating the fixed plant costs over a greater number of units. Naturally, this causes our cost per unit to be lower than it would be otherwise. Matt: Yes, but what good is this if we have been unable to sell everything that we make? Our inventory is also increasing. Gordon: This is true. However, our unit costs are lower because of the additional production. When these lower costs are matched against sales, it has a positive impact on our earnings. Matt: Are you saying that we are able to create additional earnings merely by building inventory? Can this be true? Gordon: Well, I've never thought about it quite that way... but I guess so. Gordon: Well, I've never thought about it quite that way... but I guess so. Matt: And another thing. What will happen if we begin to reduce our production in order to liquidate the inventory? Don't tell me our earnings will go down even though our production effort drops! Gordon: Well... Matt: There must be a better way. I'd like our quarterly income statements to reflect what's really going on. I don't want our income reports to reward building inventory and penalize reducing inventory. Gordon: I'm not sure what I can do-we have to follow generally accepted accounting principles. 1. Why does reporting income under generally accepted accounting principles "reward" building inventory and "penalize" reducing inventory? 2. What advice would you give to Gordon in responding to Matt's concern about the present method of profit reporting?
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Which type of manufacturing cost (direct materials, direct labor, variable factory overhead, fixed factory overhead) is included in the cost of goods manufactured under the absorption costing concept but is excluded from the cost of goods manufactured under the variable costing concept?
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Income statements under absorption costing and variable costing Frigid Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1, 2016, and operated at 100% of capacity during the first month. The following data summarize the results for July: img a. Prepare an income statement according to the absorption costing concept. b. Prepare an income statement according to the variable costing concept. c. What is the reason for the difference in the amount of income from operations reported in (a) and (b)?
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Variable costing-production exceeds sales Fixed manufacturing costs are $60 per unit, and variable manufacturing costs are $150 per unit. Production was 453,000 units, while sales were 426,000 units. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations. Fixed manufacturing costs are $44 per unit, and variable manufacturing costs are $100 per unit. Production was 67,200 units, while sales were 50,400 units. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations.
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Income statements under absorption costing and variable costing The demand for solvent, one of numerous products manufactured by Mac n' Cheese Industries Inc., has dropped sharply because of recent competition from a similar product. The company's chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on June 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed. The controller has been asked by the president of the company for advice on whether to continue production during May or to suspend the manufacture of solvent until June 1. The controller has assembled the following pertinent data: img The production costs and selling and administrative expenses, based on production of 4,000 units in April, are as follows: img Sales for May are expected to drop about 20% below those of the preceding month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with solvent. The inventory of solvent at the beginning and end of May is expected to be inconsequential. Instructions 1. Prepare an estimated income statement in absorption costing form for May for solvent, assuming that production continues during the month. Round amounts to two decimals. 2. Prepare an estimated income statement in variable costing form for May for solvent, assuming that production continues during the month. Round amounts to two decimals. 3. What would be the estimated loss in income from operations if the solvent production were temporarily suspended for May? 4. What advice should the controller give to management?
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Income statements under absorption costing and variable costing The demand for aloe vera hand lotion, one of numerous products manufactured by Smooth Skin Care Products Inc., has dropped sharply because of recent competition from a similar product. The company's chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on December 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed. The controller has been asked by the president of the company for advice on whether to continue production during November or to suspend the manufacture of aloe vera hand lotion until December 1. The controller has assembled the following pertinent data: img The production costs and selling and administrative expenses, based on production of 400,000 units in October, are as follows: img Sales for November are expected to drop about 20% below those of the preceding month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with aloe vera hand lotion. The inventory of aloe vera hand lotion at the beginning and end of November is expected to be inconsequential. Instructions 1. Prepare an estimated income statement in absorption costing form for November for aloe vera hand lotion, assuming that production continues during the month. 2. Prepare an estimated income statement in variable costing form for November for aloe vera hand lotion, assuming that production continues during the month. 3. What would be the estimated loss in income from operations if the aloe vera hand lotion production were temporarily suspended for November? 4. What advice should the controller give to management?
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Segmented contribution margin analysis Bon Jager Inc. manufactures and sells devices used in cardiovascular surgery. The company has two salespersons, Dean and Martin. A contribution margin by salesperson report was prepared as follows: img Interpret the report, and provide recommendations to the two salespersons for improving profitability.
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Which of the following costs would be included in the cost of a manufactured product according to the variable costing concept: (a) rent on factory building, (b) direct materials, (c) property taxes on factory building, (d) electricity purchased to operate factory equipment, (e) salary of factory supervisor, (f) depreciation on factory building, (g) direct labor?
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Income statements under absorption costing and variable costing Bionic Cotton Inc. manufactures and sells high-quality sporting goods equipment under its highly recognizable Cool Cat logo. The company began operations on January 1, 2016, and operated at 100% of capacity (90,000 units) during the first month, creating an ending inventory of 8,000 units. During February, the company produced 82,000 garments during the month but sold 90,000 units at $100 per unit. The February manufacturing costs and selling and administrative expenses were as follows: img a. Prepare an income statement according to the absorption costing concept for February. b. Prepare an income statement according to the variable costing concept for February. c. What is the reason for the difference in the amount of income from operations reported in (a) and (b)?
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Variable costing-sales exceed production The beginning inventory is 11,600 units. All of the units that were manufactured during the period and 11,600 units of the beginning inventory were sold. The beginning inventory fixed manufacturing costs are $32 per unit, and variable manufacturing costs are $72 per unit. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations. The beginning inventory is 52,800 units. All of the units that were manufactured during the period and 52,800 units of the beginning inventory were sold. The beginning inventory fixed manufacturing costs are $14.70 per unit, and variable manufacturing costs are $30 per unit. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations.
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Absorption and variable costing income statements for two months and analysis During the first month of operations ended March 31, 2016, Hip and Conscious Clothing Company produced 55,500 designer cowboy hats, of which 51,450 were sold. Operating data for the month are summarized as follows: img During April, Hip and Conscious Clothing produced 47,400 designer cowboy hats and sold 51,450 cowboy hats. Operating data for April are summarized as follows: img Instructions 1. Using the absorption costing concept, prepare income statements for (a) March and (b) April. 2. Using the variable costing concept, prepare income statements for (a) March and (b) April. 3. a. Explain the reason for the differences in the amount of income from operations in (1) and (2) for March. ?b. Explain the reason for the differences in the amount of income from operations in (1) and (2) for April. 4. Based on your answers to (1) and (2), did Hip and Conscious Clothing Company operate more profitably in March or in April? Explain.
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Absorption and variable costing income statements for two months and analysis During the first month of operations ended July 31, 2016, Head Gear Inc. manufactured 6,400 hats, of which 5,200 were sold. Operating data for the month are summarized as follows: img During August Head Gear Inc. manufactured 4,000 hats and sold 5,200 hats. Operating data for August are summarized as follows: img Instructions 1. Using the absorption costing concept, prepare income statements for (a) July and (b) August. 2. Using the variable costing concept, prepare income statements for (a) July and (b) August. 3. a. Explain the reason for the differences in the amount of income from operations in (1) and (2) for July. b. Explain the reason for the differences in the amount of income from operations in (1) and (2) for August. 4. Based on your answers to (1) and (2), did Head Gear Inc. operate more profitably in July or in August? Explain.
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Margin analysis Jellnick Equipment Inc. manufactures and sells kitchen cooking products throughout the state. The company employs four salespersons. The following contribution margin by salesperson analysis was prepared: img 1. Calculate the manufacturing margin as a percent of sales and the contribution margin ratio for each salesperson. 2. Explain the results of the analysis.
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In the variable costing income statement, how are the fixed manufacturing costs reported, and how are the fixed selling and administrative expenses reported?
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