ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
a) Concept Questions
9-1 No. Differences in operating income between variable costing and absorption costing are due
to accounting for fixed manufacturing costs. Under variable costing only variable manufacturing costs
are included as inventoriable costs. Under absorption costing both variable and fixed manufacturing
costs are included as inventoriable costs. Fixed marketing and distribution costs are not accounted for
differently under variable costing and absorption costing.
9-3 No. The difference between absorption costing and variable costs is due to accounting for fixed
manufacturing costs. As service or merchandising companies have no fixed manufacturing costs, these
companies do not make choices between absorption costing and variable costing.
9-7 Under absorption costing, heavy reductions of inventory during the accounting period might
combine with low production and a large production volume variance. This combination could result
in lower operating income even if the unit sales level rises.
9-9 Examples of dysfunctional decisions managers may make to increase reported operating
income are:
a. Plant managers may switch production to those orders that absorb the highest amount of
fixed manufacturing overhead, irrespective of the demand by customers.
b. Plant managers may accept a particular order to increase production even though another
plant in the same company is better suited to handle that order.
c. Plant managers may defer maintenance beyond the current period to free up more time for
production.
9-10 Approaches used to reduce the negative aspects associated with using absorption costing
include:
a. Change the accounting system:
• Adopt either variable or throughput costing, both of which reduce the incentives of
managers to produce for inventory.
• Adopt an inventory holding charge for managers who tie up funds in inventory.
b. Extend the time period used to evaluate performance. By evaluating performance over a
longer time period (say, 3 to 5 years), the incentive to take short-run actions that reduce
long-term income is lessened.
c. Include nonfinancial as well as financial variables in the measures used to evaluate
performance.
9-13 No. It depends on how a company handles the production-volume variance in the end-of-period
financial statements. For example, if the adjusted allocation-rate approach is used, each denominator-
level capacity concept will give the same financial statement numbers at year-end.
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ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
9-15 No. The costs of having too much capacity/too little capacity involve revenue opportunities
potentially forgone as well as costs of money tied up in plant assets.
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ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
(b) Tutorial exercises and problems
9-23 Variable and absorption costing, explaining operating-income differences.
1. Key inputs for income statement computations are:
January February March
Beginning inventory 0 100 100
Production 1,400 1,375 1,430
Goods available for sale 1,400 1,475 1,530
Units sold 1,300 1,375 1,455
Ending inventory 100 100 75
The budgeted fixed manufacturing cost per unit and budgeted total manufacturing cost per unit
under absorption costing are:
January February March
(a) Budgeted fixed manufacturing costs $490,000 $490,000 $490,000
(b) Budgeted production 1,400 1,400 1,400
(c) = (a) ÷ (b) Budgeted fixed manufacturing cost per unit $350 $350 $350
(d) Budgeted variable manufacturing cost per unit $950 $950 $950
(e) = (c) + (d) Budgeted total manufacturing cost per unit $1,300 $1,300 $1,300
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ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
(a) Variable Costing (periodic format)
January 2017 February 2017 March 2017
a
Revenues $4,550,000 $4,812,500 $5,092,500
Less: Cost of goods sold
Beginning Inventoryb 0 95,000 95,000
Variable manufacturing costsc 1,330,000 1,306,250 1,358,500
Deduct: Ending Inventoryd (95,000) (95,000) (71,250)
Variable cost of goods sold (1,235,000) (1,306,250) (1,382,250)
Variable operating costse (942,500) (996,875) (1,054,875)
Contribution margin 2,372,500 2,509,375 2,655,375
Less:
Fixed manufacturing costs (490,000) (490,000) (490,000)
Fixed operating costs (120,000) (120,000) (120,000)
Operating income $1,762,500 $1,899,375 $2,045,375
a
$3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b
$950 x 0, $950 x 100, $950 x $100
c
$950 x 1,400, $950 x 1,375, $950 x 1430
d
$950 x 100, $950 x 100, $950 x 75
e
$725 × 1,300; $725 × 1,375; $725 × 1,455
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ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
(a) Variable Costing (perpetual format)
January 2017 February 2017 March 2017
a
Revenues $4,550,000 $4,812,500 $5,092,500
Less: Cost of goods sold b (1,235,000) (1,306,250) (1,382,250)
Variable operating costs c (942,500) (996,875) (1,054,875)
Contribution margin 2,372,500 2,509,375 2,655,375
Less:
Fixed manufacturing costs (490,000) (490,000) (490,000)
Fixed operating costs (120,000) (120,000) (120,000)
Operating income $1,762,500 $1,899,375 $2,045,375
a
$3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b
$950 × 1,300; $950 × 1,375; $950 × 1,455
c
$725 × 1,300; $725 × 1,375; $725 × 1,455
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ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
(b) Absorption Costing (periodic format)
January 2017 February 2017 March 2017
a
Revenues $4,550,000 $4,812,500 $5,092,500
Cost of goods sold
Beginning inventoryb $ 0 $ 130,000 $ 130,000
c
Variable manufacturing costs 1,330,000 1,306,250 1,358,500
Allocated fixed manufacturing
costsd 490,000 481,250 500,500
Cost of goods available for sale 1,820,000 1,917,500 1,989,000
Deduct ending inventorye (130,000) (130,000) (97,500)
f
Adjustment for prod. vol. var. 0 8,750 U (10,500) F
Cost of goods sold 1,690,000 1,796,250 1,881,000
Gross margin 2,860,000 3,016,250 3,211,500
Operating costs
Variable operating costsg 942,500 996,875 1,054,875
Fixed operating costs 120,000 120,000 120,000
Total operating costs 1,062,500 1,116,875 1,174,875
Operating income $1,797,500 $1,899,375 $2,036,625
a
$3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b
$0× 0; $1,300 × 100; $1,300 × 100
c
$950 × 1,400; $950 × 1,375; $950 × 1,430
d
$350 × 1,400; $350 × 1,375; $350 × 1,430
e
$1,300 × 100; $1,300 × 100; $1,300 × 75
f
$490,000 – $490,000; $490,000 – $481,250; $490,000 – $500,500
g
$725 × 1,300; $725 × 1,375; $725 × 1,455
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ACCT3104 Advanced Management Accounting Tutorial 2 - Solutions
(b) Absorption Costing (perpetual format)
January February March 2017
2017 2017
Revenuesa $4,550,000 $4,812,500 $5,092,500
Cost of Goods Sold:
Cost of Goods Sold before Adjustment for (1,690,000) (1,787,500) (1,891,500)
Variancesb
Add Adjustment for Production Volume Variancec 0 (8,750)U 10,500F
Cost of Goods Sold (1,690,000) (1,796,250) (1,881,000)
Gross Margin 2,860,000 3,016,250 (3,211,500)
Operating Costs:
Variable operating costsd (942,500) (996,875) (1,054,875)
Fixed operating costs (120,000) (120,000) (120,000)
Total operating costs (1,062,500) (1,116,875) (1,174,875)
Operating Income $1,797,500 $1,899,375 $2,036,625
a
$3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b
$1300 × 1,300; $1300 × 1,375; $1300 × 1,455
c
$350 x (1,400 – 1,400); $350 x (1,375 -1,400); $350 x (1,430 – 1,400)
d
$725 × 1,300; $725 × 1,375; $725 × 1,455
Fixed manufacturing Fixed manufacturing
2. Absorption-costing – Variable costing = costs in – costs in
operating income operating income
ending inventory beginning inventory
January: $1,797,500 – $1,762,500 = ($350 × 100) – $0
$35,000 = $35,000
February: $1,899,375 – $1,899,375 = ($350 × 100) – ($350 × 100)
$0 = $0
March: $2,036,625 – $2,045,375 = ($350 × 75) – ($350 × 100)
– $8,750 = – $8,750
The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories
increase (as in January) and out of inventories as they decrease (as in March).
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ACCT3104 Management Accounting Tutorial 2 - Solutions
9-24 Throughput costing (continuation of 9-23).
1.
January February March
Revenuesa $4,550,000 $4,812,500 $5,092,500
Direct material cost of goods
sold
Beginning inventoryb $ 0 $55,000 $ 55,000
Direct materials in goods
manufacturedc 770,000 756,250 786,500
Cost of goods available for
sale 770,000 811,250 841,500
Deduct ending inventoryd (55,000) (55,000) (41,250)
Total direct material
cost of goods sold 715,000 756,250 800,250
Throughput margin 3,835,000 4,056,250 4,292,250
Other costs
Manufacturinge 1,050,000 1,040,000 1,062,000
Operatingf 1,062,500 1,116,875 1,174,875
Total other costs 2,112,500 2,156,875 2,236,875
Operating income $1,722,500 $1,899,375 $2,055,375
a
$3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b
$0 × 0; $550 × 100; $550 × 100
c
$550 × 1,400; $550 × 1,375; $550 × 1,430
d
$550 × 100; $550 × 100; $550 ×75
e
($400 × 1,400) + $490,000; ($400 × 1,375) + $490,000; ($400 × 1,430) + $490,000
f
($725 × 1,300) + $120,000; ($725 × 1,375) + $120,000; ($725 × 1,455) + $120,000
2. Operating income under:
January February March
Variable costing $1,762,500 $1,899,375 $2,045,375
Absorption costing 1,797,500 1,899,375 2,036,625
Throughput costing 1,722,500 1,899,375 2,055,375
Throughput costing puts greater emphasis on sales as the source of operating income than does
absorption or variable costing. Accordingly, income under throughput costing is highest in
periods where the number of units sold is relatively large (as in March) and lower in periods of
weaker sales (as in January).
3. Throughput costing puts a penalty on producing without a corresponding sale in the same
period. Costs other than direct materials that are variable with respect to production are
expensed when incurred, whereas under variable costing they would be capitalized as an
inventoriable cost.
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ACCT3104 Management Accounting Tutorial 2 - Solutions
9-39 Denominator-level choices, changes in inventory levels, effect on operating
income.
1.
Normal
Theoretical Practical Capacity
Capacity Capacity Utilization
Denominator level in units 275,000 265,000 233,200
Budgeted fixed manuf. costs $2,915,000 $2,915,000 $2,915,000
Budgeted fixed manuf. cost allocated per unit $ 10.60 $ 11.00 $ 12.50
Production in units 235,000 235,000 235,000
Allocated fixed manuf. costs (production in units
× budgeted fixed manuf. cost allocated per unit) $2,491,000 $2,585,000 $2,937,500
Production volume variance (budgeted fixed
manuf. costs – allocated fixed manuf. costs)a $ 424,000 U $ 330,000 U $ 22,500 F
a
PVV is unfavorable if budgeted fixed manuf. costs are greater than allocated fixed costs
2.
Normal
Theoretical Practical Capacity
Capacity Capacity Utilization
Units produced 235,000 235,000 235,000
Budgeted fixed mfg. cost allocated per unit $10.60 $11.00 $12.50
Budgeted var. mfg. cost per unit $ 8.00 $ 8.00 $ 8.00
Budgeted cost per unit of inventory or
production $18.60 $19.00 $20.50
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ACCT3104 Management Accounting Tutorial 2 - Solutions
ABSORPTION-COSTING BASED INCOME STATEMENTS
Revenues ($39 selling price per unit × units sold) $9,750,000 $9,750,000 $9,750,000
Cost of goods sold
Beginning inventory (35,000 units × budgeted
cost per unit of inventory) 651,000 665,000 717,500
Variable manufacturing costs
(235,000 units × $8 per unit) 1,880,000 1,880,000 1,880,000
Allocated fixed manufacturing overhead
(235,000 units × budgeted fixed mfg. cost
allocated per unit) 2,491,000 2,585,000 2,937,000
Cost of goods available for sale 5,022,000 5,130,000 5,535,000
Deduct ending inventory (20,000b units ×
budgeted cost per unit of inventory) (372,000) (380,000) (410,000)
Adjustment for production-volume variance 424,000 U 330,000 U (22,500) F
Total cost of goods sold 5,074,000 5,080,000 5,102,500
Gross margin 4,676,000 4,670,000 4,647,500
Operating costs 200,000 200,000 200,000
Operating income $4,476,000 $4,470,000 $4,447,500
b
Ending inventory = Beginning inventory + production – sales = 35,000 + 235,000 – 250,000
= 20,000 units
20,000 × $18.60; 20,000 × $19.00; 20,000 ×$20.50
3. Donaldson’s 2017 beginning inventory was 35,000 units; its ending inventory was
20,000 units. So, during 2017, there was a drop of 15,000 units in inventory levels (matching
the 15,000 more units sold than produced). The smaller the denominator level, the larger is the
budgeted fixed cost allocated to each unit of production, and when those units are sold (all the
current production is sold, and then some), the larger is the cost of each unit sold, and the
smaller is the operating income. Normal capacity utilization is the smallest capacity of the
three; hence, in this year, when production was less than sales, the absorption-costing based
operating income is the smallest when normal capacity utilization is used as the denominator
level.
4. Reconciliation
Theoretical Capacity Operating Income - Practical Capacity Operating Income $6,000
Decrease in inventory level during 2017 15,000
Fixed mfg cost allocated per unit under practical capacity — fixed mfg.
cost allocated per unit under theoretical capacity ($11 – $10.60) $0.40
Additional allocated fixed cost included in COGS under practical capacity =
15,000 units × $0.40 per unit = $6,000
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ACCT3104 Management Accounting Tutorial 2 - Solutions
More fixed manufacturing costs are included in inventory under practical capacity, so when
inventory level decreases (as it did in 2017), more fixed manufacturing costs are included in
COGS under practical capacity than under theoretical capacity, resulting in a lower operating
income.
9-42 Absorption costing and production-volume variance—alternative capacity bases.
1. Inventoriable cost per unit = Variable production cost + Fixed manufacturing
overhead/Capacity
Fixed Mfg. Variable Inventoriable
Capacity Capacity Fixed Mfg. Overhead Production Cost Per
Type Level Overhead Rate Cost Unit
Theoretical 1,000,000 $1,200,000 $1.20 $3.00 $4.20
Practical 600,000 $1,200,000 $2.00 $3.00 $5.00
Normal 300,000 $1,200,000 $4.00 $3.00 $7.00
Master Budget 250,000 $1,200,000 $4.80 $3.00 $7.80
2. Kappa’s actual production level is 350,000 CFLs. We can compute the production-
volume variance as:
PVV = Budgeted Fixed Mfg. Overhead – (Fixed Mfg. OH Rate × Actual Production Level)
Fixed Mfg.
Overhead
Fixed Mfg. Rate × Production-
Capacity Capacity Fixed Mfg. Overhead Actual volume
Type Level Overhead Rate Production Variance
Theoretical 1,000,000 $1,200,000 $1.20 $ 420,000 $780,000 U
Practical 600,000 $1,200,000 $2.00 $ 700,000 $500,000 U
Normal 300,000 $1,200,000 $4.00 $1,400,000 $200,000 F
Master 250,000 $1,200,000 $4.80 $1,680,000 $480,000 F
3. Operating Income for Kappa given production of 350,000 CFLs and sales of 275,000
CFLs @ $10:
Theoretical Practical Normal Master
Budget
a
Revenue $2,750,000 $2,750,000 $2,750,000 $2,750,000
Less: COGS b 1,155,000 1,375,000 1,925,000 2,145,000
Production-
volume variance 780,000 U 500,000 U (200,000) F (480,000) F
Gross margin 815,000 875,000 1,025,000 1,085,000
c
Variable selling 68,750 68,750 68,750 68,750
Fixed selling 250,000 250,000 250,000 250,000
Operating income $ 496,250 $ 556,250 $ 706,250 $ 766,250
a
275,000 × 10; b275,000 ×4.20, ×5.00, ×7.00, ×7.80; c275,000 × 0.25
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ACCT3104 Management Accounting Tutorial 2 - Solutions
(c) Additional exercises
9-21 Variable and absorption costing, explaining operating-income differences.
1. Key inputs for income statement computations are
April May
Beginning inventory 0 150
Production 500 400
Goods available for sale 500 550
Units sold 350 520
Ending inventory 150 30
The budgeted fixed cost per unit and budgeted total manufacturing cost per unit under
absorption costing are
April May
(a) Budgeted fixed manufacturing costs $2,000,000 $2,000,000
(b) Budgeted production 500 500
(c)=(a)÷(b) Budgeted fixed manufacturing cost per unit $4,000 $4,000
(d) Budgeted variable manufacturing cost per unit $10,000 $10,000
(e)=(c)+(d) Budgeted total manufacturing cost per unit $14,000 $14,000
(a) Variable costing
April 2017 May 2017
a
Revenues $8,400,000 $12,480,000
Variable costs
Beginning inventory $ 0 $1,500,000
Variable manufacturing costsb 5,000,000 4,000,000
Cost of goods available for sale 5,000,000 5,500,000
Deduct ending inventoryc (1,500,000) (300,000)
Variable cost of goods sold 3,500,000 5,200,000
d
Variable operating costs 1,050,000 1,560,000
Total variable costs 4,550,000 6,760,000
Contribution margin 3,850,000 5,720,000
Fixed costs
Fixed manufacturing costs 2,000,000 2,000,000
Fixed operating costs 600,000 600,000
Total fixed costs 2,600,000 2,600,000
Operating income $1,250,000 $3,120,000
a $24,000 × 350; $24,000 × 520 c $10,000 × 150; $10,000 × 30
b $10,000 × 500; $10,000 × 400 d $3,000 × 350; $3,000 × 520
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ACCT3104 Management Accounting Tutorial 2 - Solutions
(b) Absorption costing
April 2017 May 2017
Revenues a
$8,400,000 $12,480,000
Cost of goods sold
Beginning inventory $ 0 $2,100,000
Variable manufacturing costsb 5,000,000 4,000,000
Allocated fixed manufacturing costsc 2,000,000 1,600,000
Cost of goods available for sale 7,000,000 7,700,000
Deduct ending inventoryd (2,100,000) (420,000)
Adjustment for prod.-vol. variancee 0 400,000 U
Cost of goods sold 4,900,000 7,680,000
Gross margin 3,500,000 4,800,000
Operating costs
Variable operating costsf 1,050,000 1,560,000
Fixed operating costs 600,000 600,000
Total operating costs 1,650,000 2,160,000
Operating income $1,850,000 $ 2,640,000
a
$24,000 × 350; $24,000 × 520 d
$14,000 × 150; $14,000 × 30
b
$10,000 × 500; $10,000 × 400 e
$2,000,000 – $2,000,000; $2,000,000 – $1,600,000
c
$4,000 × 500; $4,000 × 400 f
$3,000 × 350; $3,000 × 520
2.
Absorption-costing Variable-costing Fixed manufacturing costs Fixed manufacturing costs
– = –
operating income operating income in ending inventory in beginning inventory
April:
$1,850,000 – $1,250,000 = ($4,000 × 150) – ($0)
$600,000 = $600,000
May:
$2,640,000 – $3,120,000 = ($4,000 × 30) – ($4,000 × 150)
– $480,000 = $120,000 – $600,000
– $480,000 = – $480,000
The difference between absorption and variable costing is due solely to moving fixed
manufacturing costs into inventories as inventories increase (as in April) and out of inventories
as they decrease (as in May).
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ACCT3104 Management Accounting Tutorial 2 - Solutions
9-22 Throughput costing (continuation of 9-21).
1. April 2017 May 2017
a
Revenues $8,400,000 $12,480,000
Direct material cost of goods sold
Beginning inventory
Direct materials in goods $ 0 $1,005,000
b
manufactured 3,350,000 2,680,000
Cost of goods available for sale 3,350,000 3,685,000
c
Deduct ending inventory (1,005,000) (201,000)
Total direct material cost of goods sold 2,345,000 3,484,000
Throughput margin 6,055,000 8,996,000
Other costs
Manufacturing costs 3,650,000d 3,320,000e
Other operating costs 1,650,000f 2,160,000g
Total other costs 5,300,000 5,480,000
Operating income $ 755,000 $ 3,516,000
a
$24,000 × 350; $24,000 × 520 e
($3,300 × 400) + $2,000,000
b
$6,700 × 500; $6,700 × 400 f
($3,000 × 350) + $600,000
c
$6,700 × 150; $6,700 × 30 g
($3,000 × 520) + $600,000
d
($3,300 × 500) + $2,000,000
2. Operating income under:
April May
Variable costing $1,250,000 $3,120,000
Absorption costing 1,850,000 2,640,000
Throughput costing 755,000 3,516,000
In April, throughput costing has the lowest operating income, whereas in May throughput
costing has the highest operating income. Throughput costing puts greater emphasis on sales
as the source of operating income than does either absorption or variable costing.
3. Throughput costing puts a penalty on production without a corresponding sale in the
same period. Costs other than direct materials that are variable with respect to production are
expensed in the period of incurrence, whereas under variable costing they would be capitalized.
As a result, throughput costing provides less incentive to produce for inventory than either
variable costing or absorption costing.
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ACCT3104 Management Accounting Tutorial 2 - Solutions
9-41 Downward demand spiral.
1. Fixed manufacturing overhead rate = $576,000/24,000 units = $24 per unit
Manufacturing cost per unit:
$20 direct materials + $35 direct mfg. labor + $9 var. mfg. OH + $24 fixed mfg. OH = $88
Selling price: $88 × 130% = $114.40
2. Fixed manufacturing overhead rate = $576,000/18,000 units = $32 per unit
Manufacturing cost per unit:
$20 direct materials + $35 direct mfg. labor + $9 var. mfg. OH + $32 fixed mfg. OH = $96
Selling price: $96 × 130% = $124.80
By using budgeted units produced, and not practical capacity, as the denominator
level, Gostkowski is burdening its products with the cost of unused capacity. Apparently, the
competitor has not done this, and because of its higher selling price, Gostkowski’s sales
decline. Consequently, 2018 budgeted quantities are even lower, which increases the unit cost
and selling price. This phenomenon is known as the downward demand spiral, and it causes
Gostkowski to continually inflate its selling price, which in turn leads to progressively lower
sales.
3. Fixed manufacturing overhead rate = $576,000/48,000 units = $12 per unit
Manufacturing cost per unit:
$20 direct materials + $35 direct mfg. labor + $9 var. mfg. OH + $12 fixed mfg. OH = $76
Selling price: $76 × 130% = $98.80
If Gostkowski had used practical capacity as its denominator level of activity, its initial selling
price of $98.60 would have been virtually in line with the $98.40 selling price of Gostkowski’s
competitor, and it would likely have resulted in higher sales. Using practical capacity will result
in a higher unfavorable production-volume variance, which will most likely be written off to
cost of goods sold and reduce operating income. However, as sales and production increase in
future years and the company “grows into” its capacity, the amount of unused capacity will be
lower, resulting in future cost savings.
15
