jiambalvo text book solutions (3)

Chapter 5Variable Costing

QUESTIONS

1. In full costing, fixed manufacturing overhead is treated as a product cost. In variablecosting, fixed manufacturing overhead is treated as a period cost.

2. When production exceeds sales, part of fixed manufacturing overhead will remain ininventory. In variable costing, the entire amount of fixed manufacturing overhead will beexpensed since it is treated as a period cost. Thus, income computed under full costing will

exceed income computed under variable costing when production exceeds sales.

3. Variable costing facilitates C-V-P analysis since fixed and variable costs are separated anda contribution margin is calculated. Also, under variable costing, managers cannotartificially inflate profit by producing more units than they sell and burying fixedmanufacturing overhead in inventory.

4. Companies using JIT generally have low levels of work in process and finished goodsinventory. Thus, even when a company uses full costing, very little of fixed manufacturingoverhead is in inventory at the end of a period. Rather, most of it is in cost of goodssold—an expense.

5. Under full costing, ending inventory includes direct material, direct labor, variablemanufacturing overhead, and fixed manufacturing overhead. Under variable costing,ending inventory includes each of these items except fixed manufacturing overhead. Thus,the inventory balance under variable costing is always less than the balance under fullcosting (assuming the balance is not zero).

Jiambalvo Managerial Accounting5-2

EXERCISES

E1. The income statement produced using variable costing provides a contribution

margin. If we divide this by sales, we have the contribution margin ratio (thecontribution margin per dollar of sales). Once we have this value, we can

estimate the incremental effect on profit of an increase in sales.

E2. Increasing production will increase profit since more fixed manufacturing

overhead will be buried in ending inventory rather than expensed in cost ofgoods sold. For example, if the company produced and sold 40,000 items, the

entire $20,000,000 of fixed manufacturing overhead would be in cost of goods

sold. However, if the company produces 50,000 units, the fixedmanufacturing overhead per unit will be $400. Then $16,000,000 will end up

in cost of goods sold when the company sells only 40,000 units (i.e., $400 x40,000) and $4,000,000 will be in ending inventory ($400 x 10,000).

E3. Most Web sites make the point that variable costing aids planning anddecision making. And, it prevents managers from artificially inflating profit

by over-producing.

Some Web sites seem to imply that variable costing is simply “wrong”

because fixed overhead is a real cost and it is not included in inventory undervariable costing. However, these same Web sites state or imply that variable

costing is more useful for decision making. Frankly, it’s hard to see how the

method can be more useful for decision making and still be “wrong.”

E4. Variable cost per unit $300Fixed manufacturing overhead per unit

($600,000 ÷ 1,000 units) 600

Full cost per unit $900

Ending inventory under full costing: $900 x 100 units = $90,000

Chapter 5 Variable Costing 5-3

E5. Ending inventory under variable costing: $300 x 100 = $30,000

E6. Full cost per unit is $900 per exercise 4. Therefore, cost of goods sold under

full costing is $900 x 900 units sold = $81,000.

E7. Variable cost per unit is $300. Therefore variable cost of goods sold is $300 x

900 = $27,000. Under variable costing, the $600,000 of fixed manufacturingoverhead is treated as a period expense.

E8. Sales ($1,500 x 900 pairs) $1,350,000Less cost of goods sold ($900 x 900 pairs) 810,000

Gross margin 540,000Less selling expense 200,000

Less administrative expense 100,000

Net income $ 240,000

E9. Sales ($1,500 x 900 pairs) $1,350,000Less variable cost of goods sold ($300 x 900 pairs) 270,000

Contribution margin 1,080,000Less fixed manufacturing overhead 600,000

Less selling expense 200,000

Less administrative expense 100,000Net income $ 180,000

E10.The difference in net income between full and variable costing is $240,000 -

$180,000 = $60,000. This is equal to the amount of fixed manufacturing

overhead in ending inventory under full costing ($600 x 100 pairs = $60,000).


PROBLEMS

P1. a.2006 2007 2008

Fixed manufacturing overhead $ 600,000 $ 600,000 $ 600,000

Divided by units produced 10,000 12,000 8,000

Fixed manufacturing overhead per unit 60 50 75

Variable manufacturing costs 100 100 100

Full cost per unit $ 160 $ 150 $ 175

Sales ($200 x 10,000 units) $2,000,000 $2,000,000 $2,000,000

Less cost of goods sold:

($160 x 10,000) 1,600,000

($150 x 10,000) 1,500,000

($150 x 2,000 + $175 x $8,000) 1,700,000

Gross margin 400,000 500,000 300,000

Less selling and administrative expense 200,000 200,000 200,000

Net income $ 200,000 $ 300,000 $ 100,000 $ 600,000

Ending inventory

-0-

($150 x 2,000) $ 300,000

-0-

b. Even though sales is the same in each period, profit fluctuates. That resultsbecause different quantities are produced each period which affects the

fixed manufacturing overhead in cost of goods sold versus ending

inventory.


c.2006 2007 2008

Fixed manufacturing overhead $ 600,000 $ 600,000 $ 600,000

Variable manufacturing costs per unit 100 100 100

Sales ($200 x 10,000 units) $2,000,000 $2,000,000 $2,000,000

Less variable cost of goods sold:

($100 x 10,000) 1,000,000 1,000,000 1,000,000

Contribution margin 1,000,000 1,000,000 1,000,000

Less fixed costs:

Manufacturing 600,000 600,000 600,000

Selling and administrative 200,000 200,000 200,000

Net income $ 200,000 $ 200,000 $ 200,000 $ 600,000

Ending inventory

-0-

($100 x 2,000) $ 200,000

-0-

d. Profit does not fluctuate each period because fixed manufacturing overheadis treated as a period cost and expensed each year even if more units are

produced than sold.

Note that income is the same under variable and full costing in 2006 since

the quantity produced is equal to the quantity sold. Income under fullcosting is higher than variable costing income in 2007 since the quantity

produced is greater than the quantity sold. Income under full costing is lessthan income under variable costing in 2008 since the quantity produced is

less than the quantity sold.


P2. a.2006 2007 2008

Fixed manufacturing overhead $ 20,000,000.00 $ 20,000,000.00 $ 20,000,000.00

Divided by units produced 20,000.00 20,000.00 14,000.00

Fixed manufacturing overhead per unit 1,000.00 1,000.00 1,428.57

Variable manufacturing costs per unit 800.00 800.00 800.00Full cost per unit $ 1,800.00 $ 1,800.00 $ 2,228.57

Sales

($2,000 x 20,000 units) $ 40,000,000.00

($2,000 x 18,000) $ 36,000,000.00

($2,000 x 16,000) $ 32,000,000.00


($1,800.00 x 20,000) 36,000,000.00($1,800.00 x 18,000) 32,400,000.00

($1,800.00 x 2,000 + 2,228.57 x 14,000) 34,799,980.00

Gross margin 4,000,000.00 3,600,000.00 (2,799,980.00)

Less selling and administrative expense 300,000.00 300,000.00 300,000.00Net income $ 3,700,000.00 $ 3,300,000.00 $ (3,099,980.00) $ 3,900,020.00

Ending inventory

-0-

($1,800 x 2,000) $ 3,600,000.00

-0-

b.2006 2007 2008

Fixed manufacturing overhead $ 20,000,000.00 $ 20,000,000.00 $ 20,000,000.00Variable manufacturing costs per unit $ 800.00 $ 800.00 $ 800.00

Sales

($2,000 x 20,000 units) $ 40,000,000.00

($2,000 x 18,000) $ 36,000,000.00

($2,000 x 16,000) $ 32,000,000.00Less variable cost of goods sold:

($800 x 20,000 units) 16,000,000.00

($800 x 18,000) 14,400,000.00

($800 x 16,000) 12,800,000.00

Contribution margin 24,000,000.00 21,600,000.00 19,200,000.00Less fixed costs:

Manufacturing 20,000,000.00 20,000,000.00 20,000,000.00

Selling and administrative 300,000.00 300,000.00 300,000.00Net income $ 3,700,000.00 $ 1,300,000.00 $ (1,100,000.00) $ 3,900,000.00

Ending inventory-0-

($800 x 2,000) $ 1,600,000.00

-0-


Note that the $20 difference in net income for the three years between full andvariable costing is due to rounding.

c. Under full costing, management could manipulate profit in 2007 by

overproducing (producing more units than really needed in 2007). This

results in fixed manufacturing overhead being buried in ending inventory.Note that the difference in profit in 2007 between full and variable costing

is equal to the difference in ending inventory under full and variablecosting.

This approach to manipulating earnings could not be repeated year afteryear—eventually the inventory build-up would be quite obvious.

P3. a.2006 2007

Fixed manufacturing overhead $ 2,000,000.00 $ 2,000,000.00

Divided by units produced 10,000.00 6,000.00

Fixed manufacturing overhead per unit 200.00 333.33

Variable manufacturing costs per unit 2,200.00 2,200.00

Full cost per unit $ 2,400.00 $ 2,533.33

Sales ($3,000 x 8,000 units) $ 24,000,000.00 $ 24,000,000.00


($2,400 x 8,000) 19,200,000.00

($2,400 x 2,000 + $2,533.33 x 6,000) 19,999,980.00

Gross margin 4,800,000.00 4,000,020.00

Less selling and administrative expense 1,000,000.00 1,000,000.00Net income $ 3,800,000.00 $ 3,000,020.00 $ 6,800,020.00

Ending inventory

($2,400 x 2,000) $ 4,800,000.00

-0-

b. Company performance is really not worse in 2007—note that the companyhad the same cost structure and the same level of sales. The difference is

due to greater production in 2006 which lowered unit cost and buried fixed

manufacturing overhead in inventory.


c.2006 2007

Fixed manufacturing overhead $ 2,000,000.00 $ 2,000,000.00

Variable manufacturing costs per unit $ 2,200.00 $ 2,200.00

Sales ($3,000 x 8,000 units) $ 24,000,000.00 $ 24,000,000.00


($2,200 x 8,000 units) 17,600,000.00 17,600,000.00

Contribution margin 6,400,000.00 6,400,000.00

Less fixed costs:

Manufacturing 2,000,000.00 2,000,000.00

Selling and administrative 1,000,000.00 1,000,000.00

Net income $ 3,400,000.00 $ 3,400,000.00 $ 6,800,000.00

Ending inventory

($2,200 x 2,000) $ 4,400,000.00

-0-

Note that the difference in income between full and variable costing over

the two years is due to rounding.

d. Variable costing presents a more realistic view of firm performance in that

income is the same in both years which is consistent with the firm havingthe same cost structure and level of sales in both years.

P4. Income computed under full costing is $4,000 higher than income computedunder variable costing. Under variable costing, the entire amount of fixed

manufacturing overhead ($24,000) was treated as a period cost. Under fullcosting, $4,000 remains in ending inventory.

Fixed manufacturing overhead $24,000Divided by units produced 1,200

Fixed manufacturing overhead per unit $ 20

Amount of fixed manufacturing overhead in ending inventory:

$20 x 200 units = $4,000


P5. a. Contribution margin ÷ sales = contribution margin ratio$8,100,000 ÷ $18,000,000 = .45.

(Incremental sales x contribution margin ratio) – incremental salaries =

incremental profit

($1,600,000 x .45) - $120,000 = $600,000.

b. The chief accountant is treating income per dollar of sales as the

contribution margin ratio. Income only varies in proportion to sales if all

costs are variable which is clearly not the case for Wilner Glass Company.

P6. a.Variable Costing 2004 2005 2006Sales $ 10,000,000 $ 12,500,000 $ 15,000,000Less variable cost of goods sold 4,000,000 5,000,000 6,000,000Contribution margin 6,000,000 7,500,000 9,000,000Less:Fixed production costs 6,000,000 6,000,000 6,000,000

Fixed selling and administrative costs 2,000,000 2,000,000 2,000,000Net income $ (2,000,000) $ (500,000) $ 1,000,000

b. Under full costing, it appears that Ed did a good job since the company hit

the break-even point in its first year and then earned a profit of $500,000 in

its second year. However, variable costing provides a better picture of thefirms profitability under Ed’s guidance. Note that under variable costing,

the company had a $500,000 loss in its second year. Ed was able to showa profit under full costing by producing more than needed for current

period sales and burying a substantial amount of fixed manufacturing cost

in ending inventory. That’s why Zac could not show a profit under fullcosting in 2004. He had to cut production in 2004 to avoid building up

excess inventory. This increased per unit cost. Income statementsprepared under variable costing indicate that Zac’s performance was quite

good. Sales have increased and so has profit.


c. The company should not get out of the tractor business. As indicated inthe variable costing income statement, the company is generating a

substantial profit. If the company can continue performing at this level, itwill be quite successful.

P7. a. Fixed manufacturing overhead ÷ Units produced = fixed overhead per unit$500,000 ÷ 100,000 = $5

$5 x 80,000 units sold = $400,000.

b. With variable costing, the entire amount of fixed manufacturing overhead($500,000) will be expensed.

c. The amount of fixed manufacturing overhead in ending inventory under

full costing is $100,000:

$5 x 20,000 units = $100,000.

This accounts for the difference between income under full versus variablecosting.


P8. a. 2006Fixed manufacturing overhead $ 2,000,000.00

Divided by units produced 200,000.00Fixed manufacturing overhead per unit 10.00

Variable manufacturing costs per unit

($60 + $20 + $5) 85.00Full cost per unit $ 95.00

Sales ($120 x 170,000 units) $ 20,400,000.00


($95.00 x 170,000) 16,150,000.00Gross margin 4,250,000.00

Less selling expense($1,000,000.00 + .10 x $20,400,000) 3,040,000.00

Less administrative expense 800,000.00

Net income $ 410,000.00

Ending inventory

($95 x 30,000) $ 2,850,000.00


b.2006

Sales ($120 x 170,000 units) $ 20,400,000.00Less variable cost of goods sold:

($85.00 x 170,000) 14,450,000.00

Less variable selling expense($.10 x $20,400,000) 2,040,000.00

Contribution margin 3,910,000.00Less fixed costs:

Manufacturing 2,000,000.00

Selling expense 1,000,000.00Administrative expense 800,000.00

Net income $ 110,000.00

Ending inventory

($85 x 30,000) $ 2,550,000.00

c. The amount of fixed manufacturing inventory that is included in ending

inventory under full costing is $300,000 ($10 x 30,000 units). Thisaccounts for the difference in income under full versus variable costing.

jiambalvo text book solutions (3)

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