Author Question: Comparison of variable costing and absorption costing. Gammaro Company uses standard costing. Tim ... (Read 640 times)

WhattoUnderstand · **on:** Jul 6, 2018

Comparison of variable costing and absorption costing.

Gammaro Company uses standard costing. Tim Sweeney, the new president of Gammaro Company, is presented with the following data for 2014:

Required:
1. At what percentage of denominator level was the plant operating during 2014?
2. How much fixed manufacturing overhead was included in the 2013 and the 2014 ending inventory under absorption costing?
3. Reconcile and explain the difference in 2014 operating incomes under variable and absorption costing.
4. Tim Sweeney is concerned: He notes that despite an increase in sales over 2013, 2014 operating income has actually declined under absorption costing. Explain how this occurred.

Question 2

The left side is always the debit side.
Indicate whether the statement is true or false

chevyboi1976 · **Reply #1 on:** Jul 6, 2018

Answer to Question 1

1. Because production volume variance is unfavorable, the budgeted fixed manufacturing overhead must be larger than the fixed manufacturing overhead allocated.

Production - volumevariance = Budgeted fixedmanufacturing overhead Fixed manufacturingoverhe ad allocated

405,000 = 1,350,000 Allocated

Allocated = 945,000, which is 70 of 1,350,000

If 70 percent of the budgeted fixed costs were allocated, the plant must have been operating at 70 percent of denominator level in 2014.

2. The problem provides the beginning and ending inventory balances under both variable and absorption costing. Under variable costing, all fixed costs are written off as period costs, i.e., they are not inventoried. Under absorption costing, inventories include variable and fixed costs. Therefore the difference between inventory under absorption costing and inventory under variable costing is the amount of fixed costs included in the inventory.

Fixed Manuf.
Absorption Variable Overhead
Costing Costing in Inventory
Inventories:
December 31, 2013 1,730,000 1,345,000 385,000
December 31, 2014 215,000 45,000 170,000

3. Note that the answer to (3) is independent of (1). The difference in operating income of 215,000 (1,610,000 1,395,000) is explained by the release of 215,000 of fixed manufacturing costs when the inventories were decreased during 2014:

Fixed Manuf.
Absorption Variable Overhead
Costing Costing in Inventory
Inventories:
December 31, 2013 1,730,000 1,345,000 385,000
December 31, 2014 215,000 45,000 170,000
Release of fixed manuf. costs 215,000

The above schedule in this requirement is a formal presentation of the equation:

Absorptingcostingop eratingincome Variablecostingoper atingincome = Fixedmanuf. costs inendinginventory Fixedmanuf. costs inbeginninginventor y

(1,395,000 1,610,000) = (170,000 385,000)
215,000 = 215,000

4. Under absorption costing, operating income is a function of both sales and production (i.e., change in inventory levels). During 2014, Gammaro experienced a severe decline in inventory levels: sales were probably higher than anticipated, production was probably lower than planned (at 70 percent of denominator level), resulting in much of the 2014 beginning inventory passing through cost of goods sold in 2014. This means that under absorption costing, large amounts of inventoried fixed costs have flowed through 2014 cost of goods sold, resulting in a smaller operating income than in 2013, despite an increase in sales volume.

Answer to Question 2

T