MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 12
VARIABLE COSTING
I.

Questions
1. The variable costing technique does not consider fixed costs as
unimportant or irrelevant, but it maintains that the distinction between
behaviors of different costs is crucial for certain decisions.
2. The central issue in variable costing is what is the proper timing for
release of fixed manufacturing overhead as expense: at the time of
incurrence, or at the time the finished units to which the fixed overhead
relates are sold.
3. Direct costing would be more accurately called variable or marginal
costing because in substance it is the inventory costing method which
applies only variable production costs to product; fixed factory overhead
is not assigned to product.
4. Marketing and administrative costs are treated as period costs under both
variable costing and absorption costing methods of product costing.
5. Under absorption costing, as a company manufactures units of product,
the fixed manufacturing overhead costs of the period are added to the
units, along with direct materials, direct labor, and variable manufacturing
overhead. If some of these units are not sold by the end of the period, then
they are carried into the next period as inventory.
The fixed
manufacturing overhead cost attached to the units in ending inventory
follow the units into the next period as part of their inventory cost. When
the units carried over as inventory are finally sold, the fixed
manufacturing overhead cost that has been carried over with the units is
included as part of that periods cost of goods sold.
6. Many accountants and managers believe absorption costing does a better
job of matching costs with revenues than variable costing. They argue
that all manufacturing costs must be assigned to products to properly
match the costs of producing units of product with the revenues from the
units when they are sold. They believe that the fixed costs of depreciation,
taxes, insurance, supervisory salaries, and so on, are just as essential to
manufacturing products as are the variable costs.

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Chapter 12 Variable Costing

7. If fixed manufacturing overhead cost is released from inventory, then

inventory levels must have decreased and therefore production must have
been less than sales.
8. Under absorption costing it is possible to increase net operating income
without increasing sales by increasing the level of production. If
production exceeds sales, units of product are added to inventory. These
units carry a portion of the current periods fixed manufacturing overhead
costs into the inventory account, thereby reducing the current periods
reported expenses and causing net operating income to rise.
9. Generally speaking, variable costing cannot be used externally for
financial reporting purposes nor can it be used for tax purposes.
10. If production exceeds sales, absorption costing will show higher net
operating income than variable costing. The reason is that inventories will
increase and therefore part of the fixed manufacturing overhead cost of
the current period will be deferred in inventory to the next period under
absorption costing. By contrast, all of the fixed manufacturing overhead
cost of the current period will be charged immediately against revenues as
a period cost under variable costing.
II. Exercises
Exercise 1 (Variable and Absorption Costing Unit Product Costs and
Income Statements)
Requirement 1
a. The unit product cost under absorption costing would be:
Direct materials..........................................................................
Direct labor.................................................................................
Variable manufacturing overhead................................................
Total variable manufacturing costs.............................................
Fixed manufacturing overhead (P160,000 20,000 units)..........
Unit product cost........................................................................

P18
7
2
27
8
P35

b. The absorption costing income statement:

Sales (16,000 units P50 per unit)........................
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P800,000

Variable Costing Chapter 12

Less cost of goods sold:

Beginning inventory...........................................
Add cost of goods manufactured
(20,000 units P35 per unit).........................
Goods available for sale.....................................
Less ending inventory
(4,000 units P35 per unit)...........................
Gross margin..........................................................
Less selling and administrative expenses................
Net operating income.............................................

700,000
700,000
140,000

560,000
240,000
190,000*
P 50,000

*(16,000 units P5 per unit) + P110,000 = P190,000.

Requirement 2
a. The unit product cost under variable costing would be:
Direct materials...............................................................................
Direct labor.....................................................................................
Variable manufacturing overhead.....................................................
Unit product cost.............................................................................

P18
7
2
P27

b. The variable costing income statement:

Sales (16,000 units P50 per unit)......................
Less variable expenses:
Variable cost of goods sold:
Beginning inventory......................................
Add variable manufacturing costs
(20,000 units P27 per unit)....................
Goods available for sale................................
Less ending inventory
(4,000 units P27 per unit)......................
Variable cost of goods sold...............................
Variable selling expense
(16,000 units P5 per unit)..........................
Contribution margin.............................................
Less fixed expenses:
Fixed manufacturing overhead..........................
Fixed selling and administrative........................
Net operating income............................................

P800,000
P

540,000
540,000
108,000
432,000 *
80,000
160,000
110,000

512,000
288,000
270,000
P 18,000

* The variable cost of goods sold could be computed more simply as:
16,000 units P27 per unit = P432,000.
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Chapter 12 Variable Costing

Exercise 2 (Variable and Absorption Costing Unit Product Costs)

Requirement 1
Sales (40,000 units P33.75 per unit)....................................
P1,350,000
Less variable expenses:
Variable cost of goods sold
(40,000 units P16 per unit*).........................................
P640,000
Variable selling and administrative expenses
(40,000 units P3 per unit).............................................
120,000
760,000
Contribution margin................................................................
590,000
Less fixed expenses:
Fixed manufacturing overhead.............................................
250,000
Fixed selling and administrative expenses............................
300,000
550,000
Net operating income...............................................................
P 40,000
*Direct materials.......................................................................................................
P10
Direct labor.............................................................................................................
4
Variable manufacturing overhead.............................................................................
2
Total variable manufacturing cost............................................................................
P16
Requirement 2
The difference in net operating income can be explained by the P50,000 in
fixed manufacturing overhead deferred in inventory under the absorption
costing method:

Variable costing net operating income..........................................

Add: Fixed manufacturing overhead cost
deferred in inventory under absorption
costing: 10,000 units P5 per unit in
fixed manufacturing overhead cost............................................
Absorption costing net operating income......................................

P40,000

50,000
P90,000

Exercise 3 (Variable Costing Unit Product Cost and Income Statement;

Break-even)
Requirement 1
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Variable Costing Chapter 12

Under variable costing, only the variable manufacturing costs are included in
product costs.
Direct materials............................................................................
Direct labor..................................................................................
Variable manufacturing overhead.................................................
Unit product cost..........................................................................

P60
30
10
P100

Note that selling and administrative expenses are not treated as product costs;
that is, they are not included in the costs that are inventoried. These expenses
are always treated as period costs and are charged against the current periods
revenue.
Requirement 2
The variable costing income statement appears below:
Sales.......................................................................
Less variable expenses:
Variable cost of goods sold:
Beginning inventory.......................................
Add variable manufacturing costs
(10,000 units P100 per unit)....................
Goods available for sale.................................
Less ending inventory (1,000 units P100
per unit)...................................................
Variable cost of goods sold*................................
Variable selling and administrative (9,000 units
P20 per unit).......................................................
Contribution margin................................................
Less fixed expenses:
Fixed manufacturing overhead................................
Fixed selling and administrative..............................
Net operating loss....................................................

P1,800,000
P

1,000,000
1,000,000
100,000
900,000
180,000
300,000
450,000

1,080,000
720,000
750,000
P (30,000)

* The variable cost of goods sold could be computed more simply as: 9,000 units
sold $100 per unit = $900,000.

Requirement 3
The break-even point in units sold can be computed using the contribution
margin per unit as follows:
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Chapter 12 Variable Costing

Selling price per unit................................................................................................

P200
Variable cost per unit...............................................................................................
120
P80
Contribution margin per unit....................................................................................
Break-even unit sales

Fixed expenses
Unit contribution margin

P750,000
P80 per unit

9,375 units

III. Problems
Problem 1
Requirement 1: Variable Costing Method
Romero Parts, Inc.
Income Statement - Manufacturing
For the Year Ended December 31, 2005
Sales
Less: Variable Cost of Sales
Inventory, Jan. 1
Current Production
Total Available for Sale
Inventory, Dec. 31
Contribution Margin
Less Fixed Costs and Expenses
Net Income

P20,700,000
P1,155,000
7,700,000
P8,855,000
805,000

8,050,000
P12,650,000
6,000,000
P 6,650,000

Requirement 2: Absorption Costing Method

Romero Parts, Inc.
Income Statement - Manufacturing
For the Year Ending December 31, 2006
Sales
Less Cost of goods sold:
Inventory, Jan. 1
Current Production
Total Available for Sale

P26,100,000
P 1,380,000
16,100,000
P17,480,000
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Variable Costing Chapter 12

Inventory, Dec. 31
Cost of Sales - Standard
Favorable Capacity Variance
Income from Manufacturing

747,500
P16,732,500
900,000

15,832,500
P10,267,500

Requirement 3: Variable Costing Method

Romero Parts, Inc.
Income Statement - Manufacturing
For the Year Ending December 31, 2006
Sales
Less Variable Cost of Sales:
Inventory, Jan. 1
Production
Total Available for Sale
Inventory, Dec. 31
Contribution Margin - Manufacturing
Less Fixed Cost
Income from Manufacturing

P26,100,000
P

805,000
9,800,000
P10,605,000
455,000

10,150,000
P15,950,000
5,400,000
P10,550,000

Reconciliation
Net Income, absorption costing
Add Fixed Factory Overhead Inventory, 1/1
Total
Less Fixed Factory Overhead Inventory, 12/31
Net Income, direct costing

P10,267,500
575,000
P10,842,500
292,500
P10,550,000

Problem 2
Requirement 1
Honey Company
Income Statement - Direct Costing
For the Year Ended December 31, 2005
Sales
Less Variable Cost of Sales:
Finished Goods Inventory, 1/1
Current Production
Total Available for Sale
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P280,000
P 4,000
120,000
P124,000

Chapter 12 Variable Costing

Finished Goods Inventory, 12/31

Variable Cost of Sale - Standard
Unfavorable Variance
Contribution Margin - Manufacturing
Less Variable Marketing Expenses
Contribution Margin - Final
Less Fixed Costs and Expenses:
Fixed Factory Overhead
Fixed Marketing and
Administrative Expenses
Net Income

12,000
P112,000
5,000

117,000
P163,000
28,000
P135,000

P 54,000
20,000

74,000
P 61,000

Requirement 2
Honey Company
Income Statement - Absorption Costing
For the Year Ended December 31, 2005
Sales
P280,000
Less: Cost of Sales
Finished goods inventory, Jan. 1 (1,000 x P5.50)
Current production costs
Variable (30,000 x P4.00)
P120,000
Fixed (30,000 x P1.50)
45,000
Less: Finished goods inventory, Dec. 31
(3,000 x P5.50)
Cost of Sales - at Standard
Add (Deduct) Variance
Unfavorable variable manufacturing
costs variances
Underapplied fixed factory overhead
(6,000 x P1.50)
Cost of Sales - Actual
Gross Profit
Less: Selling and administrative expenses
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5,500

165,000
P170,500
16,500
P154,000
5,000
9,000
P168,000
P112,000

Variable Costing Chapter 12

Variable
Fixed

28,000
20,000
P 48,000
P 64,000

Net Income
Problem 3 (Variable Costing Income Statement; Reconciliation)
Requirement 1

The unit product cost under the variable costing approach would be computed
as follows:
P8
Direct materials.......................................................................................................
Direct labor.............................................................................................................
10
Variable manufacturing overhead.............................................................................
2
Unit product cost.....................................................................................................
P20
With this figure, the variable costing income statements can be prepared:
Year 1
Year 2
Sales........................................................................................................................
P1,000,000 P1,500,000
Less variable expenses:
Variable cost of goods sold @ P20 per unit..........................................................
400,000
600,000
Variable selling and administrative
@ P3 per unit...................................................................................................
60,000
90,000
Total variable expenses............................................................................................
460,000
690,000
Contribution margin.................................................................................................
540,000
810,000
Less fixed expenses:
Fixed manufacturing overhead.............................................................................
350,000
350,000
Fixed selling and administrative...........................................................................
250,000
250,000
Total fixed expenses................................................................................................
600,000
600,000
Net operating income (loss).....................................................................................
P (60,000) P 210,000
Requirement 2
Variable costing net operating income (loss).................
P (60,000) P 210,000
Add: Fixed manufacturing overhead cost deferred
in inventory under absorption costing (5,000
units P14 per unit)................................................ 70,000
Deduct: Fixed manufacturing overhead cost
released from inventory under absorption
costing (5,000 units P14 per unit)........................
(70,000)
Absorption costing net operating income......................
P 10,000 P 140,000

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Chapter 12 Variable Costing

Problem 4 (Prepare and Interpret Statements; Changes in Both Sales and

Production; JIT)
Requirement 1
Year 1
P1,000,000

Sales
Less variable expenses:
Variable cost of goods sold
@ P4 per unit
Variable selling and administrative
@ P2 per unit
Total variable expenses
Contribution margin
Less fixed expenses:
Fixed manufacturing overhead
Fixed selling and administrative
Total fixed expenses
Net operating income (loss)

Year 2
Year 3
P 800,000 P1,000,000

200,000

160,000

200,000

100,000
300,000
700,000

80,000
240,000
560,000

100,000
300,000
700,000

600,000
70,000
670,000
P 30,000

600,000
600,000
70,000
70,000
670,000
670,000
P(110,000) P 30,000

Requirement 2
a.
Year 1
P4

Variable manufacturing cost

Fixed manufacturing cost:
P600,000 50,000 units
P600,000 60,000 units
P600,000 40,000 units
Unit product cost

Year 2
P4

Year 3
P4

12
10
P16

P14

15
P19

b.
Variable costing net operating income
(loss)
Add (Deduct): Fixed manufacturing
overhead cost deferred in inventory
from Year 2 to Year 3 under
absorption costing (20,000 units
P10 per unit)
Add: Fixed manufacturing overhead
cost deferred in inventory from Year
3 to the future under absorption
costing (10,000 units P15 per unit)
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P30,000 P(110,000)

200,000

P 30,000

(200,000)
150,000

Variable Costing Chapter 12

Absorption costing net operating income

(loss)

P30,000

P 90,000

P(20,000)

Requirement 3
Production went up sharply in Year 2 thereby reducing the unit product cost,
as shown in (2a). This reduction in cost, combined with the large amount of
fixed manufacturing overhead cost deferred in inventory for the year, more
than offset the loss of revenue. The net result is that the companys net
operating income rose even though sales were down.
Requirement 4
The fixed manufacturing overhead cost deferred in inventory from Year 2 was
charged against Year 3 operations, as shown in the reconciliation in (2b). This
added charge against Year 3 operations was offset somewhat by the fact that
part of Year 3s fixed manufacturing overhead costs was deferred in inventory
to future years [again see (2b)]. Overall, the added costs charged against Year
3 were greater than the costs deferred to future years, so the company reported
less income for the year even though the same number of units was sold as in
Year 1.
Requirement 5
a. Several things would have been different if the company had been using
JIT inventory methods. First, in each year production would have been
geared to sales so that little or no inventory of finished goods would have
been built up in either Year 2 or Year 3. Second, unit product costs
probably would have been the same in all three years, since these costs
would have been established on the basis of expected sales (50,000 units)
for each year. Third, since only 40,000 units were sold in Year 2, the
company would have produced only that number of units and therefore
would have had some underapplied overhead cost for the year. (See the
discussion on underapplied overhead in the following paragraph.)
b. If JIT had been in use, the net operating income under absorption costing
would have been the same as under variable costing in all three years.
The reason is that with production geared to sales, there would have been
no ending inventory on hand, and therefore there would have been no fixed
manufacturing overhead costs deferred in inventory to other years.
Assuming that the company expected to sell 50,000 units in each year and
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Chapter 12 Variable Costing

that unit product costs were set on the basis of that level of expected
activity, the income statements under absorption costing would have
appeared as follows:

Sales
Less cost of goods sold:
Cost of goods manufactured @ P16 per unit
Add underapplied overhead
Cost of goods sold
Gross margin
Selling and administrative expenses
Net operating income (loss)

Year 1
P1,000,000
800,000
800,000
200,000
170,000
P 30,000

Year 2
Year 3
P 800,000 P1,000,000
640,000 *
120,000 **
760,000
40,000
150,000
P(110,000) P

800,000
800,000
200,000
170,000
30,000

* 40,000 units P16 per unit = P640,000.

** 10,000 units not produced P12 per unit fixed manufacturing overhead cost =
P120,000 fixed manufacturing overhead cost not applied to products.

IV. Multiple Choice Questions

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

D
B
B
B
B
C
A
B
A
A

11.
12.
13.
14.
15.
16.
17.
18.
19.
20.

B
A
C
D
B
A
C
C
B
C

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