Professional Documents
Culture Documents
2018
CHAPTER 7
Tutorial Questions
Discussion:
1. Explain how fixed manufacturing overhead costs are shifted from one period
to another under absorption costing.
Suggestion solution:
1. 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 period’s cost
of goods sold.
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4. If production exceeds sales, which method would you expect to show higher
net operating income, variable or absorption costing? Why?
Suggested solution:
4. 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.
Computation:
5. A company has £8.00 per unit in variable production cost and £3.00 per unit
in variable selling and administrative cost. The annual fixed production cost
is £300,000. The annual fixed selling and administrative cost is £50,000.
a. Complete the table below for the number of units and dollar value of
ending inventory for each year. Assume a FIFO flow.
b. Assume that the selling price and cost structure stayed the same over
the 4-year period. How would the total income compare over the
period between variable and full costing?
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5. Suggested Solution:
a.
2004 2005 2006 2007
Units Produced 120,000 150,000 100,000 100,000
Units Sold 110,000 120,000 140,000 100,000
Units in ending 10,000 40,000 0 0
inventory
Ending inventory £80,000 £320,000 0 0
using variable
costing
Ending inventory £105,000 £400,000 0 0
using full costing
b. Since sales equals production for the 4-year period, income would be the
same.
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6. The Dean Company produces and sells a single product--a microwave oven.
The following data refer to the year just completed:
£
Beginning inventory ................... 0
Units produced ......................... 20,000
Units sold ............................. 19,000
Sales price per unit ................... 350
Selling and administrative expenses:
Variable per unit .................... 10
Fixed (total) ........................ 225,000
Manufacturing costs:
Direct materials cost per unit ...... 190
Direct labor cost per unit .......... 40
Variable overhead cost per unit 25
Fixed overhead (total) ............... 250,000
a. Compute the cost of a single unit of product under both the absorption costing
and variable costing approaches.
b. Prepare an income statement for the year using absorption costing.
c. Prepare an income statement for the year using variable costing.
d. Reconcile the absorption costing and variable costing net income figures in (b)
and (c) above.
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Suggested Solution:
£
Direct materials.................... 190.00
Direct labor........................ 40.00
Variable overhead.................. 25.00
Fixed overhead (£250,000 ÷ 20,000) 12.50
Total cost per unit................. £267.50
£
Sales................................. 6,650,000
Cost of goods sold:
Beginning inventory................... £ 0
Cost of goods manufactured
(20,000 @ £267.50) ................. 5,350,000
Cost of goods available............... 5,350,000
Less ending inventory
(1,000 units @ £267.50) ............ 267,500 5,082,500
Gross profit.......................... 1,567,500
Less selling and administrative expenses:
[(£10 x 19,000) + £225,000]......... 415,000
Net income............................ £1,152,500
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6d.
£
Net income under variable costing..... 1,140,000
Add fixed manufacturing overhead costs
deferred in inventory under absorption
costing (1,000 units X £12.50) ......... 12,500
Net income under absorption costing... £1,152,500
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Required:
a. Prepare an income statement using variable costing. (5 marks)
b. Prepare an income statement using absorption costing. (5 marks)
c. Can a company continue to increase income indefinitely by using absorption costing?
(3 marks)
d. Explain how fixed manufacturing overhead costs are shifted from one period to another under
absorption costing. (4 marks)
7c. It is possible that a growing company can do this. The only way to do this is to produce more than
is sold in each year. This will result in a continuous buildup of inventory. For most companies,
that would not be a good strategy as it would lead to expensive cash outflow for buildups of
inventories along with all the associated carrying costs.
(3 marks)
7d. 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 period’s cost of goods sold.
(4 marks)