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Author Question: Variable costing versus absorption costing. The Mavis Company uses an absorption-costing system ... (Read 111 times)


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Variable costing versus absorption costing.
  The Mavis Company uses an absorption-costing system based on standard costs. Total variable manufacturing cost, including direct material cost, is 3 per unit; the standard production rate is 10 units per machine-hour. Total budgeted and actual fixed manufacturing overhead costs are 420,000. Fixed manufacturing overhead is allocated at 7 per machine-hour (420,000  60,000 machine-hours of denominator level). Selling price is 5 per unit. Variable operating (nonmanufacturing) cost, which is driven by units sold, is 1 per unit. Fixed operating (nonmanufacturing) costs are 120,000. Beginning inventory in 2014 is 30,000 units; ending inventory is 40,000 units. Sales in 2014 are 540,000 units. The same standard unit costs persisted throughout 2013 and 2014. For simplicity, assume that there are no price, spending, or efficiency variances.
  1. Prepare an income statement for 2014 assuming that the production-volume variance is written off at year-end as an adjustment to cost of goods sold.
  2. The president has heard about variable costing. She asks you to recast the 2014 statement as it would appear under variable costing.
  3. Explain the difference in operating income as calculated in requirements 1 and 2.
  4. Graph how fixed manufacturing overhead is accounted for under absorption costing. That is, there will be two lines: one for the budgeted fixed manufacturing overhead (which is equal to the actual fixed manufacturing overhead in this case) and one for the fixed manufacturing overhead allocated. Show the production-volume variance in the graph.
  5. Critics have claimed that a widely used accounting system has led to undesirable buildups of inventory levels. (a) Is variable costing or absorption costing more likely to lead to such buildups? Why? (b) What can managers do to counteract undesirable inventory buildups?

Question 2

An entry to Accounts Payable will be on the left side of the account if there is a decrease and on the right side of the account if there is an increase.
  Indicate whether the statement is true or false

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Answer to Question 1

1. Absorption Costing:
Mavis Company Income Statement
For the Year Ended December 31, 2014

Revenues (540,000  5.00) 2,700,000
Cost of goods sold:
Beginning inventory (30,000  3.70a)  111,000
Variable manufacturing costs (550,000  3.00) 1,650,000
Allocated fixed manufacturing costs (550,000  0.70) 385,000
Cost of goods available for sale 2,146,000
Deduct ending inventory (40,000  3.70) (148,000)
Add adjustment for prod.-vol. variance (50,000b  0.70) 35,000 U
Cost of goods sold 2,033,000
Gross margin 667,000
Operating costs:
Variable operating costs (540,000  1) 540,000
Fixed operating costs 120,000
Total operating costs 660,000
Operating income  7,000

a 3.00 + (7.00  10) = 3.00 + 0.70 = 3.70
b (10 units per mach. hr.  60,000 mach. hrs.)  550,000 units) = 50,000 units unfavorable

2. Variable Costing:
Mavis Company Income Statement
For the Year Ended December 31, 2014

Revenues (540,000  5.00) 2,700,000
Variable cost of goods sold:
Beginning inventory (30,000  3.00)  90,000
Variable manufacturing costs
(550,000  3.00) 1,650,000
Cost of goods available for sale 1,740,000
Deduct ending inventory (40,000  3.00) (120,000)
Variable cost of goods sold 1,620,000
Variable operating costs 540,000
Contribution margin 540,000
Fixed costs:
Fixed manufacturing overhead costs 420,000
Fixed operating costs 120,000
Total fixed costs 540,000
Operating income  0

3. The difference in operating income between the two costing methods is:

Absorption-costingoperatingincome  Variable-costingoperatingincome = Fixedmanuf. costsin endinginventory  Fixedmanuf. costsin beginninginventory

7,000  0 = (40,000  0.70)  (30,000  0.70)
7,000 = 28,000  21,000
7,000 = 7,000

The absorption-costing operating income exceeds the variable costing figure by 7,000 because of the increase of 7,000 during 2014 of the amount of fixed manufacturing costs in ending inventory vis--vis beginning inventory.


5. Absorption costing is more likely to lead to buildups of inventory than does variable costing. Absorption costing enables managers to increase reported operating income by building up inventory, which reduces the amount of fixed manufacturing overhead included in the current period's cost of goods sold.
Ways to reduce this incentive include:
(a) Carefully plan budget and inventory.
(b) Change the accounting system to variable costing or throughput costing.
(c) Incorporate a carrying charge for carrying inventory.
(d) Use a longer time period to evaluate performance than a quarter or a year.
(e) Include nonfinancial as well as financial measures when evaluating management performance.

Answer to Question 2



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