Solution manual cost management measuaring monitoring and motivating performance 1st by wolcott ch14

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Chapter 14
Measuring and Assigning Costs for Income Statements
LEARNING OBJECTIVES
Chapter 14 addresses the following questions:
Q1 How are absorption costing income statements constructed?
Q2 What factors affect the choice of production volume measures for allocating fixed
overhead?
Q3 How are variable costing income statements constructed?
Q4 How are throughput costing income statements constructed?
Q5 What are the uses and limitations of absorption, variable, and throughput costing income
statements?
These learning questions (Q1 through Q5) are cross-referenced in the textbook to individual
exercises and problems.

COMPLEXITY SYMBOLS
The textbook uses a coding system to identify the complexity of individual requirements in the
exercises and problems.
Questions Having a Single Correct Answer:
No Symbol
This question requires students to recall or apply knowledge as shown in the
textbook.
This question requires students to extend knowledge beyond the applications
e
shown in the textbook.

Open-ended questions are coded according to the skills described in Steps for Better Thinking
(Exhibit 1.10):

Step 1 skills (Identifying)


Step 2 skills (Exploring)

Step 3 skills (Prioritizing)

Step 4 skills (Envisioning)


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14-2 Cost Management

QUESTIONS
14.1

The three methods are similar because they assign some costs to inventory as product
costs, and expense other costs as period costs. The three methods differ in the categories
that are used for product and period costs. Details of these categorizations follow.
Absorption costing allocates all production costs, both fixed and variable, to units as
product costs so cost of goods sold and inventory on the balance sheet include fixed
manufacturing costs. Cost of goods sold is subtracted from revenue to arrive at gross
margin, and then other nonmanufacturing expenses are subtracted to arrive at operating
income.
Variable costing assigns direct costs (direct labor and direct materials) and variable
overhead costs to inventory and variable cost of goods sold. Variable cost of goods sold
and all other non-manufacturing variable costs are subtracted from revenue to arrive at
contribution margin. All fixed costs, both manufacturing and non-manufacturing, are then
subtracted from contribution margin to arrive at operating income.
Throughput costing assigns only direct materials costs to inventory and throughput cost
of goods sold. Throughput cost of goods sold is subtracted from revenue to arrive at

throughput margin. All other costs are considered period costs and deducted from
throughput margin to arrive at operating income.
Uses of the three methods are different, also. Absorption costing income statements meet
GAAP and are used by shareholders and other external stakeholders. Variable costing
income statements generally do not meet GAAP and are only available for internal
reporting. Information from these reports is used in decision-making. Throughput
accounting income statements provide information for very short-term decisions and are
especially helpful when capacity constraints exist.

14.2

The allocated fixed manufacturing overhead that is added (if production is greater than
sales) or subtracted (if production is less than sales) from finished goods is the
reconciliation amount between variable versus absorption costing.

14.3

The volume variance arises because of differences between actual volumes and budgeted
volumes used to allocate fixed manufacturing overhead. Under variable costing all fixed
manufacturing overhead is treated as a period expense; there are no allocations of fixed
manufacturing overhead to inventory or variable cost of goods sold. Hence, there will be
no volume variances.

14.4

Under variable costing, all fixed manufacturing overhead is treated as an expense of the
period, regardless of how many units were produced or sold; income will vary only with
the number of units sold, the level of production has no effect. Under absorption costing,
fixed manufacturing overhead is first assigned to product; the amount of fixed overhead
that appears on the income statement depends on unit sales. Income depends upon both

the level of production and the level of sales.


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-3
14.5

Eventually all of the units are sold under either method, so eventually all of the fixed
manufacturing cost will be expensed under either method. Under variable costing, it is
expensed during the period it is incurred, whereas under absorption costing, a portion of
fixed manufacturing cost is inventoried and expensed when the inventory is sold rather
than during the period it was incurred.

14.6

A variable cost increases proportionately with volume. Variable costing is a method of
calculating income.

14.7

Unless the organization is not-for-profit, none. For most on-going, profit-seeking firms,
denominator volume should exceed breakeven volume because the firm plans to be
operating at volumes greater than breakeven.

14.8

The fixed manufacturing overhead of the current period will be shown in its entirety as an
expense if variable costing is used. If absorption costing is used, some of it will be
assigned to the units added to inventory, so that the fixed manufacturing overhead

included in cost of goods sold will be less than the total fixed manufacturing overhead
that is expensed on the variable costing income statement.

14.9

GAAP requires absorption costing to match production-related expenses to revenues.

14.10 This can be accomplished through the use of an adjusting journal entry at the end of the
period. The objective is to distribute or allocate the fixed manufacturing overhead of the
period between inventories on hand (WIP and FG) and cost of goods sold.
14.11 A joint cost may be either fixed or variable and a separable cost may be either fixed or
variable. Both variable and absorption costing can be applied to joint product situations.
Under variable costing, the joint costs are first categorized as fixed or variable and then
listed on the income statement under the headings of variable or fixed production costs.
Under absorption costing, the common and separable costs are considered product costs
and assigned to inventory.


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14-4 Cost Management

EXERCISES
14.12 Famous Desk Company
A and B. First list all pertinent information:
Revenue = 220 desks x $300 = $66,000
Variable production costs = 220 desks x $80 = $17,600
Variable selling and administrative costs = 220 desks x $30 = $6,600
Fixed selling and administrative = $6,000
Fixed overhead absorbed into inventory under normal production = $10,000/150 desks =

$66.67 per desk
Fixed overhead volume variance = $10,000 – (200 desks x $66.67) = $3,334 overapplied,
which is closed to COGS
Variable Costing

Absorption Costing

Revenue
Variable costs:
Production
Selling
Contribution Margin

$66,000 Revenue
Cost of goods sold
(17,600)
220 desks x ($80 + $66.67)
(6,600)
Volume variance
41,800 Gross Margin

Fixed costs:
Production
Admin and Sales
Operating income

Selling and administrative
(10,000)
($6,600 + $6,000)
(6,000) Operating income

$25,800

$66,000
(32,267)
3,334
37,067

(12,600)
$24,467

Double-check calculations: Difference in operating income = 20 units x $66.67 = $1,333
(fixed overhead brought onto income statement from units produced in prior periods)
Difference in income = $25,800 - $24,467 = $1,333.


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-5
14.13 Rock Crusher Corp.
A sample spreadsheet showing the calculations for this problem is available on the Instructor’s
web site for the textbook (available at www.wiley.com/college/eldenburg).
A. Variable costing income statement
VARIABLE COSTING
Variable cost per unit produced

Revenue
Variable costs:
Production:
A100
A300

Selling
Contribution margin
Fixed costs:
Production:
Selling and administrive
Operating income

A100
$5.00

A300
$2.50

$240,000

$15,000
10,000

(25,000)
(35,000)
180,000
(100,000)
(60,000)
$20,000

Computation details for variable production cost per unit:
A100: $20,000/4,000 tons = $5 per ton
A300: $15,000/6,000 tons = $2.50 per ton
B. Absorption costing income statement:
ABSORPTION COSTING

Fixed production cost per ton
Total production cost per ton:
A100
A300

Revenue
Cost of goods sold:
A100
A300
Gross margin
Selling and administrative:
Variable
Fixed
Operating income

$10.00
$15.00
$12.50

$240,000
$45,000
50,000

$35,000
60,000

(95,000)
145,000

(95,000)

$50,000


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14-6 Cost Management
Calculation details for cost of goods sold:
Fixed production cost per ton = $100,000/10,000 tons = $10 per ton
Variable production cost per ton was calculated in Part A
Cost of goods sold:
A100 [($10+$5) x 3,000]
$45,000
A300 [($10+$2.50) x 4,000]
50,000
Total
$95,000
C. The difference in income resides in inventory. There was no beginning inventory, but
there were 3,000 tons (10,000 tons produced – 7,000 tons sold) with $10 of fixed
production cost per ton absorbed into inventory on the balance sheet under absorption
costing. The difference in income = $50,000 - $20,000 = $30,000, and the fixed
production cost in inventory is 3,000 x $10 = $30,000.

14.14 Plains Irrigation
A. The value of inventory is higher when absorption costing is used because some fixed
manufacturing overhead is allocated to inventory to match revenue with expense at the
time of sale. If there is fixed manufacturing overhead, the value of inventory under
absorption costing will always be higher than under variable costing.
B. To identify the costing method that would result in higher income, first calculate the
change in inventory during October under both methods:
October inventory added under absorption costing ($2,598-$1,346)

October inventory added under variable costing ($1,647-854)
Difference

$1,252
793
$ 459

Because $459 more cost was assigned to inventory under absorption costing, income
during October would be higher by $459 under absorption than under variable costing.

14.15 Asian Iron
A.
1. Under variable costing:
Total variable production cost = (NT$2,300 + 3,300 + 2,800) = NT$8,400
Variable cost per unit = NT$8,400/10,500 = NT$0.80 per unit
Units in ending inventory = 10,500 – 9,400 = 1,100 units
Ending inventory = NT$0.80 x 1,100 units = NT$880
2. Under absorption costing:
Fixed manufacturing overhead = NT$8,250/10,500 units = NT$0.7857 per unit
Total cost per unit = NT$0.80 + NT$0.7857 = NT$1.5857
Ending inventory = NT$1.5857 x 1,100 units = NT$1,744


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-7
3. Under throughput costing:
Total direct materials cost per unit = NT$2,300/10,500 units = NT$0.21905
Ending inventory = NT$0.21905 x 1,100 units = NT$241
B.1, 2, 3

Variable Costing

Absorption Costing

Throughput Costing

Revenue
NT$32,900
Variable costs:
Production
(NT$0.80 x 9,400)
(7,520)
Selling
(940)
Contribution margin
24,440
Fixed costs:
Production
(8,250)
Selling and admin.
(14,560)
Operating income
NT$ 1,630

Revenue
NT$32,900
Cost of goods sold
(NT$1.5857 x 9,400)
(14,906)
Gross margin

17,994
Selling and admin.
(NT$940 + 14,560)
(15,500)
Operating income
NT$ 2,494

Revenue
NT$32,900
Direct materials
(NT$0.21905 x 9,400)
(2,059)
Throughput margin
30,841
Operating expenses (a)
(29,850)
Operating income
NT$ 991

(a) NT$(3,300 + 2,800 + 940 + 8,250 + 14,560) = NT$29,850
Double-check computations for absorption versus variable costing:
There were no beginning inventories. Therefore, the change in inventory is equal to the
ending inventory (calculated in Part A).
Inventory under absorption costing
NT$1,744
Inventory under variable costing
880
Difference in inventory
NT$ 864
Difference in operating income - NT$2,494 - NT$1,630

NT$ 864

Double-check computations for absorption versus throughput costing:
Inventory under absorption costing
Inventory under throughput costing
Difference in inventory

NT$1,744
241
NT$1,503

Difference in operating income - NT$2,494 - NT$991

NT$1,503

C. It is first necessary to calculate the revenue and variable costs per unit:
Revenue per unit = NT$32,900/9,400 = NT$3.50
Variable production cost per unit = NT$0.80
Variable selling cost per unit = NT$940/9,400 = NT$0.10


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14-8 Cost Management
There are several ways to estimate variable costing operating income at 12,110 units.
One way is to prepare an estimated income statement:
Revenue (12,110 x $3.50)
Variable costs:
Production (12,110 x NT$0.80)

Selling (12,110 x NT$0.10)
Contribution margin
Fixed costs:
Production
Selling and administrative
Operating income

NT$42,385
(9,688)
(1,211)
31,486
(8,250)
(14,560)
NT$ 8,676

Another way is to begin with operating income at 9,400 units (calculated in Part B) and
add the incremental contribution margin for the additional 2,710 units (12,110 – 9,400):
Operating income at 9,400 units
Incremental contribution margin [2,710 x (NT$3.50 – 0.80 – 0.10)]
Operating income at 12,110 units

NT$1,630
7,046
NT$8,676

14.16 Wild Bird Feeders
A sample spreadsheet showing the calculations for this problem is available on the Instructor’s
web site for the textbook (available at www.wiley.com/college/eldenburg).
A and B. Absorption and variable costing ending inventory
The problem does not provide the company’s cost flow assumption (LIFO or FIFO).

However, the problem states that the prior costs are the same as 2004 planned costs. The
2004 actual costs for direct materials, direct labor, and variable manufacturing overhead
are the same as the planned costs (i.e., $3,120,000/130,000 units = $24.00 for direct
materials, $2,340,000/130,000 units = $18.00 for direct materials, and
$520,000/130,000=$4.00 for variable manufacturing overhead). The problem also states
that all over- or underapplied overhead is assigned directly to cost of goods sold.
Therefore, the 2004 overhead costs assigned to inventory are the same as the planned
costs. Thus, the prior year inventory costs are the same as the current year inventory
costs, and it does not matter which cost flow assumption the company uses.


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-9
COST OF ENDING INVENTORY
Production cost per unit:
Direct materials (actual)
Direct labor (actual)
Variable manufacturing overhead (allocated=actual)
Fixed manufacturing overhead (allocated)
Total
Units:
Beginning inventory
Production
Sales
Ending inventory

2003
Absorption
Variable

Costing
Costing
$24.00
$24.00
18.00
18.00
4.00
4.00
5.00
$51.00
$46.00

2004
Absorption
Variable
Costing
Costing
$24.00
$24.00
18.00
18.00
4.00
4.00
5.00
$51.00
$46.00

30,000
130,000
(125,000)

5,000
35,000

Cost of ending inventory--Assuming FIFO

$1,785,000

$1,610,000

Cost of ending inventory--Assuming LIFO
Beginning inventory
Increase in inventory
Total

$1,530,000
255,000
$1,785,000

$1,380,000
230,000
$1,610,000

C. Manufacturing and total contribution margin
VARIABLE COSTING
Revenue
Variable production costs
Manufacturing contribution margin
Other variable costs:
Variable selling

Variable administrative
Total contribution margin
Fixed costs:
Manufacturing overhead
Selling
Administrative
Operating income

$12,375,000
(5,750,000)
6,625,000
$1,750,000
125,000

$710,000
980,000
850,000

(1,875,000)
4,750,000

(2,540,000)
$2,210,000

D. This question asks for the total fixed costs on the income statement and then proceeds to
develop that cost in steps as follows.
1. Fixed selling and administration = ($980,000 + $850,000) = $1,830,000
2. Fixed manufacturing overhead allocated to COGS:
Fixed overhead at given allocation rate (125,000 x $5)

$625,000

3. As noted in the answer to Parts A and B, the cost per unit during 2003 was the same
as the cost per unit assigned to inventory during 2004. Therefore, the cost per unit
assigned to cost of goods sold and to inventory is not affected by whether the
company’s inventory levels increased or decreased during 2004. In other words, sales
of units that were produced last year do not need to be considered.
4. Calculation of overapplied (underapplied) overhead:
Overhead allocated to production
Actual overhead
(Underapplied) overhead

$650,000
710,000
$ (60,000)


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14-10 Cost Management

5. Total fixed costs on income statement = $1,830,000 + $625,000 + $60,000 (because
the underapplied overhead is closed to COGS) = $2,515,000.
E. Variable costs on variable costing income statement (see the solution to Part C):
$5,750,000 + $1,875,000 = $7,625,000.
F. Absorption income would be higher than variable income because the company produced
more units that it sold, and the units remaining in ending inventories include an allocation
of fixed manufacturing overhead cost under absorption costing. Therefore, total
overhead expense on the income statement is less under absorption than under variable
costing, where the total fixed cost for the period is expensed.

G. There are two ways to answer this question. The first method is to calculate the amount
of fixed overhead added to inventory under absorption costing. The fixed overhead
allocation rate is $5 per unit, and 5,000 units were added to inventory. Therefore,
absorption costing income should be $25,000 higher than variable costing income.
The second method is to prepare the two income statements and compare the results. The
difference in income is (income statements are available on the sample spreadsheet for
this problem):
Absorption costing operating income
$2,235,000
Variable costing operating income
2,210,000
Difference
$ 25,000

14.17 Happy Bikers Motorcycle Company
A, B, C.
Variable Costing
Revenue (a)
Variable costs:
Production (b)
Selling (c)
Contribution margin
Fixed costs:
Production
Selling and admin.
Operating income

$150,000
(45,000)
(3,750)

101,250

Absorption Costing
Revenue (a)
Cost of goods sold (d)
Volume variance (e)
Gross margin
Selling and admin. (f)
Operating income

$150,000
(105,000)
26,667
71,667
(43,750)
$ 27,917

Throughput Costing
Revenue (a)
Raw materials (g)
Throughput margin
Operating expenses (h)
Operating income

$150,000
(30,000)
120,000
(101,750)
$ 18,250

(40,000)
(40,000)
$ 21,250

Calculation details:
(a) Revenue = 15 motorcycles x $10,000
(b) Variable production costs = 15 motorcycles x ($2,000 + $1,000) = $45,000
(c) Variable selling and administrative costs = 15 motorcycles x $250 = $3,750


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-11
(d) Absorption cost of goods sold:
Normal capacity = 10 motorcycles per month
Estimated fixed overhead per motorcycle = $40,000/10 = $4,000
Total fixed and variable production cost per unit = $4,000 + $2,000 + $1,000
= $7,000
Cost of goods sold = 15 motorcycles x $7,000 = $105,000
(e) Volume variance:
Fixed production overhead
$ 40,000
Allocated overhead (18 motorcycles x $4,000)
72,000
Overapplied overhead
$(32,000)
Because the volume variance is material relative to actual production costs, it will
be prorated between cost of goods sold and ending inventory. The portion
allocated to cost of goods sold is:
$32,000 x (15/18 motorcycles)

$(26,667)
(f) Total selling and administrative expense = $40,000 + 15 motorcycles x $250 =
$43,750
(g) Total raw materials = 15 motorcycles x $2,000 = $30,000
(h) Total operating expenses:
Direct labor and variable overhead (18 motorcycles x $1,000)
$ 18,000
Fixed production costs
40,000
Variable selling and administrative (15 motorcycles x $250)
3,750
Fixed selling and administrative
40,000
Total
$101,750
D. Here is a schedule to reconcile the three income statements. Recall that inventory
increased during the month by 3 units (18 motorcycles manufactured – 15 motorcycles
sold).
Throughput costing operating income
$18,250
Direct labor and variable overhead costs added to ending variable
costing inventory (3 motorcycles x $1,000)
3,000
Variable costing operating income
21,250
Fixed overhead costs allocated to ending absorption costing
income (after the volume variance adjustment, this is equal
to actual fixed overhead cost per unit
[3 motorcycles x ($40,000/18)]
6,667

Absorption costing operating income
$27,917


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14-12 Cost Management

PROBLEMS
14.18 Maine Lobster Company
A. Absorption income statements assign all direct production costs and allocate all indirect
production costs to inventory. At the time of sale, per unit revenue is matched with per
unit expense on the income statement. Variable income statements categorize costs into
fixed and variable, and production related and non-production related costs.
B. If the company has no shareholders, the company may have no need for GAAP-based
income statements. The variable income statement would be more useful for internal
management use.
C. If the company wishes to apply for external funds, such as a bank loan, the company may
be required to prepare GAAP-basis financial statements.
D. It is easy to prepare both types of statements. However, for decision-making purposes
the variable statements are better.
E. If Maine Lobster wants other family members to know how the business is doing, GAAP
statements would be prepared in a manner that would allow comparison with other
businesses.

14.19 Giant Jets
A. Production and sales data:
Year
Production
Sales

2004
10
10

2005
6
4

2006
8
10


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-13
Variable costing income statements:
2004

2005
2006
€10,000,000
€4,000,000
€10,000,000

Revenues (jets sold x €1,000,000)
Variable costs:
Production (jets sold x €200,000 +
€150,000 + €50,000)

(4,000,000)
(4,000,000)
(1,000,000)

Selling (jets sold x €100,000)
(1,000,000)
Contribution margin
Fixed costs:
Production
Administrative and selling
(100,000)
Operating income
4,300,000

5,000,000
5,000,000

(1,600,000)
(400,000)
2,000,000

(600,000)
(100,000)

(600,000) (600,000)
(100,000)

€ 4,300,000

€1,300,000

€

B. Throughput costing income statements:
2004
Revenues (jets sold x €1,000,000)
Direct materials (jets sold x €200,000)
(2,000,000)
Throughput margin
Operating expenses:
Direct labor (jets produced x €150,000)
Variable production overhead
(jets produced x €50,000)
Variable selling (jets sold x €100,000)
Fixed production overhead
Fixed administrative and selling
(100,000)
Operating income
4,700,000

2005
2006
€10,000,000
€4,000,000
€10,000,000
(2,000,000) (800,000)
8,000,000
8,000,000

3,200,000

(1,500,000) (900,000)
(1,200,000)
(500,000)
(1,000,000)
(1,000,000)
(600,000)
(100,000)

(300,000) (400,000)
(400,000)
(600,000) (600,000)
(100,000)

€ 4,300,000€ 900,000

€

C. Cost per jet under absorption costing:
Direct materials
Direct labor
Variable production overhead
Fixed production overhead per unit:
€600,000/units produced
Total cost per jet

2004
€200,000
150,000

50,000

2005
€200,000
150,000
50,000

2006
€200,000
150,000
50,000

60,000
€460,000

100,000
€500,000

75,000
€475,000


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14-14 Cost Management

Jets sold
Jets produced

10

10

Cost of goods sold:
Units produced this year

€4,600,000
€3,800,000
0
€4,600,000
€4,800,000

Units produced last year
Total

4
6

10
8

€2,000,000
0
1,000,000
€2,000,000

Absorption costing income statements:
2004
Revenues (jets sold x €1,000,000)
Cost of goods sold
(4,800,000)

Throughput margin
Administrative and selling
[€100,000 + (jets sold x €100,000)]
(1,100,000)
Operating income
4,100,000

2005
2006
€10,000,000
€4,000,000
€10,000,000
(4,600,000) (2,000,000)
5,400,000
5,200,000
(1,100,000)
€ 4,300,000

2,000,000

(500,000)
€1,500,000

€

D. Normal capacity is an average capacity over time. It represents the volume of production
that is expected to occur in a typical year.
E. There are likely to be differences of opinion on the normal volume. One way to estimate
the normal volume is to calculate the average over the three years presented, or 8 jets per
year. The following income statement is calculated using 8 jets as the normal volume.

Cost per jet under absorption costing:
Direct materials
Direct labor
Variable production overhead
Fixed production overhead per unit:
€600,000/8 jets
Total cost per jet

€200,000
150,000
50,000
75,000
€475,000


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-15
Volume variance:
Jets produced
Fixed production overhead allocated
Actual fixed production overhead
Over (under)applied overhead

2004
2005
2006
10
6
8

€750,000
€ 450,000 €600,000
600,000
600,000
600,000
€150,000
€(150,000) €
0

The volume variance does not appear to be material relative to total production costs
in 2004 or 2005. Therefore, all of it is allocated to cost of goods sold.
Absorption costing income statements:
2004
Revenues (jets sold x €1,000,000)
Cost of goods sold (jets sold x €475,000)
Volume variance adjustment
0
Throughput margin
Administrative and selling
[€100,000 + (jets sold x €100,000)]
(1,100,000)
Operating income
4,150,000

2005
2006
€10,000,000
€4,000,000
€10,000,000
(4,750,000) (1,900,000)

(4,750,000)
150,000
(150,000)
5,400,000
5,250,000
(1,100,000)
€ 4,300,000

1,950,000

(500,000)
€1,450,000

€

F. The textbook is not clear about which absorption costing income (the one in Part C or the
one in Part E) to use in the reconciliation. Therefore, reconciliations are shown for both
income statements.
2004
2005
2006
Jets produced
10
6
8
Jets sold
10
4
10
Increase (decrease) in inventory of jets

0
2
(2)
Throughput costing income (Part B)
Direct labor and variable production
overhead added to (subtracted from)
ending variable costing inventory
[Change in inventory x (€150,000+€50,000)]

Variable costing income (Part A)
Fixed overhead costs allocated to ending
absorption costing income
Change in inventory x €100,000
(200,000)
Absorption costing income (Part C)
4,100,000

€4,300,000€ 900,000€4,700,000

0
4,300,000
4,300,000

400,000 (400,000)
1,300,000

0

200,000

€ 4,300,000

€1,500,000

€


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14-16 Cost Management
€4,300,000
€4,300,000

Variable costing income (Part A)
Fixed overhead costs allocated to ending
absorption costing income
Change in inventory x €75,000 (a)
(150,000)
Absorption costing income (Part E)
4,150,000

0

€1,300,000

150,000

€ 4,300,000

€1,450,000

€

(a) Because the volume variance was allocated 100% to cost of goods sold
during 2004 and 2005, it can be ignored in this reconciliation.

14.20 Fighting Kites
A, B, and C.
Product costs:
Direct materials
Other variable production costs
Fixed production costs (a)
Total product costs

Variable Throughput
Absorption
$ 40,000
$40,000 $ 40,000
60,000
60,000
80,000
$100,000
$40,000 $180,000

(a) Absorption costing fixed production rate: $100,000/25,000 kits = $4 per kit
Fixed production cost allocated to kits produced: $4 x 20,000 kits = $80,000
Cost per kit (20,000 produced)

$5

Cost for 18,000 kits sold (assuming LIFO)
Cost for 2,000 kits added to inventory
Total product costs
Variable Costing
Revenue (a)
Variable costs:
Production (above)
Selling
Contribution margin
Fixed costs:
Production
Selling and admin.
Operating income

$540,000
(90,000)
(18,000)
432,000

$ 90,000
10,000
$100,000

Throughput Costing
Revenue (a)
Raw materials (above)
Throughput margin
Operating expenses (b)
Operating income

(100,000)
(100,000)
$232,000

Calculation details:
(a) Revenue = 18,000 kits x $30 = $540,000

$2

$540,000
(36,000)
504,000
(278,000)
$226,000

$36,000
4,000
$40,000

$9
$162,000
18,000
$180,000

Absorption Costing
Revenue (a)
$540,000
Cost of goods sold (above) (162,000)
Volume variance (c)
(18,000)

Gross margin
360,000
Selling and admin. (d)
(118,000)
Operating income
$242,000


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-17
(b) Throughput costing operating expenses:
Other variable production costs
Fixed production costs
Variable selling costs
Fixed selling and administrative costs
Total
(c) Volume variance:
Fixed production cost allocated ($4 x 20,000 kits)
Actual fixed production cost
(Underallocated) fixed production costs

$ 60,000
100,000
18,000
100,000
$278,000
$ 80,000
100,000
$ (20,000)

Because the volume variance is material, it is prorated between cost of goods sold
and ending inventory:
Cost of goods sold ($20,000 x 18,000/20,000 kits)
$(18,000)
Ending inventory ($20,000 x 2,000/20,000 kits)
(2,000)
Total volume variance adjustment
$(20,000)
(d) Selling and administrative:
Variable selling costs
$ 18,000
Fixed selling and administrative costs
100,000
Total
$118,000
Although the problem does not ask for a reconciliation of income across the three
methods, it is useful to prepare a reconciliation to double-check the preceding
computations:
Throughput costing operating income
Direct labor and variable overhead costs added to ending variable
costing inventory ($60,000 x 2,000/20,000 kits)
Variable costing operating income
Fixed overhead costs allocated to ending absorption costing
income (after the volume variance adjustment, this is equal
to actual fixed overhead cost per unit
$100,000 x 2,000/20,000 kits
Absorption costing operating income

$226,000

6,000
232,000

10,000
$242,000

D. Student answers to this question should demonstrate that they have considered how the
managers might use the absorption costing information, and they should also clarify their
assumptions. If the managers’ primary goal in using absorption costing is to assign
actual costs to inventory as accurately as possible, then next year’s expected production
volume should be used as the denominator value. If demand and production volumes are
expected to remain at 20,000, then a volume of 20,000 would be appropriate. If
production volumes are not stable, then next year’s volume could be estimated using
sales forecasts for next year and/or production volumes over several past years. On the
other hand, the managers may wish to monitor use of capacity, particularly if production
volumes vary. In that case, a volume such as practical capacity might be best.


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14-18 Cost Management
E. Student responses will vary. Following is an example of a good response.
I recommend that Fighting Kites use variable income or throughput income because both
of these methods provide less incentive to build up inventories and more incentive to
control fixed and overhead costs. In addition, these statements provide information about
current period costs to those individuals charged with evaluating managers’ performance.
The variable income statement displays fixed and variable, production and nonproduction
costs in such a manner that they are easily compared across time for meaningful
performance evaluation. For example, if manufacturing fixed costs are considerably
higher or lower in one period than in the prior periods, this information would be easy to

identify and managers could be rewarded or encouraged to control costs better. In
addition, the information from both variable and throughput costing income statements is
broken down into categories that are useful for decision-making. When Fighting Kites
needs to make a short or long term production decision, the variable costing income
statement provides ample relevant information. When capacity constraints exist,
throughput costing information may be better. If Fighting Kites guarantees its direct
labor employees a 40-hour work week, then throughput costing information provides the
best information for decision-making.

14.21 Security Vehicles
A. Variable costing income statement for January:
Revenue (3 vehicles x $100,000)
Variable costs:
Production (3 vehicles x $60,000)
Administrative and selling (3 vehicles x $5,000)
Contribution margin
Fixed costs:
Production
Administrative and selling
Operating income
B. Absorption costing income statement for January:
Revenue (3 vehicles x $100,000)
Cost of goods sold (a)
Gross margin
Operating expenses:
Administrative and selling ($20,000 + $5,000 x 3 vehicles)
Operating income

$300,000
(180,000)

(15,000)
105,000
(60,000)
(20,000)
$ 25,000

$300,000
(225,000)
75,000
(35,000)
$ 40,000

(a) Absorption cost per unit (assuming that fixed costs are allocated based on
actual costs and actual production volume):
Variable production costs
$60,000
Fixed production costs ($60,000/4 vehicles)
15,000
Total absorption cost per unit
$75,000
Cost of goods sold (3 vehicles x $75,000)

$225,000


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-19

C. This question calls for a reconciliation of February incomes under variable and

absorption costing. First calculate February income under these two methods:
Variable Costing
Revenue (6 x $100,000)
Variable costs:
Production (6 x $60,000)
Selling (6 x $5,000)
Contribution margin
Fixed costs:
Production
Administrative and selling
Operating income

Absorption Costing
$600,000 Revenue (6 x $100,000)
$600,000
Cost of goods sold (a)
(435,000)
(360,000) Gross margin
165,000
(30,000) Administrative and selling
210,000
($20,000 + $5,000 x 6 vehicles)
(50,000)
Operating income
$115,000
(60,000)
(20,000)
$130,000

Computation details:

(a) Absorption cost per unit (assuming that fixed costs are allocated based on actual
costs and actual production volume):
Variable production costs
$60,000
Fixed production costs ($60,000/5 vehicles)
12,000
Total absorption cost per unit during February
$72,000
Cost of goods sold:
Vehicles produced during February (5 vehicles x $72,000)
Vehicle produced during January (1 vehicle x $75,000)
Total

$360,000
75,000
$435,000

C. In February, under absorption cost income, one Hummer was sold from January’s
production. In January, overhead allocated to production was $15,000, so February’s
income under absorption costing is $15,000 less than variable costing.
D. An organization could produce absorption cost income statements for external users such
as shareholders, creditors, and suppliers. For internal decision-making information,
variable cost income statements could be produced.

14.22 Northcoast Manufacturing Company
[Note: Parts B and C require students to use and evaluate overhead allocation methods
introduced in Chapters 5 and 11.]
A. Among the 3 budgeted levels of activity presented in the problem, the one closest to the
actual production of 500,000 units is for 540,000 units of production. Based on this
budgeted level of activity, the amount of over/underapplied overhead is calculated as

follows:


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14-20 Cost Management
Estimated overhead allocation rate
= Total budgeted overhead/budgeted direct labor cost
= $961,200/(36,000 x $15)
= 178% of direct labor cost
Allocated overhead [(35,000 x $15) x 178%]
Actual incurred overhead
Overapplied (Underapplied) Overhead

$ 934,500
1,130,000
$ (195,500)

This amount is material because it is over 11% of COGS ($195,500/$1,720,960)
B. If machine hours were used, the amount of over/underapplied overhead would have been:
Overhead allocation rate
$961,200/108,000 machine hours
= $8.90 per machine hour
Allocated overhead ($8.90 x 130,000 machine hours)
Actual incurred overhead
Overapplied (Underapplied) Overhead

$1,157,000
1,130,000
$ 27,000

C. Machine hours would be a more appropriate allocation base for Northcoast
Manufacturing’s fixed manufacturing overhead because the company appears to have a
capital-intensive manufacturing process where each direct laborer operates two to four
machines simultaneously. In this type of setting, the use of machines drives a large
portion of overhead costs, such as depreciation, maintenance, and utilities. Consequently,
using machine hours as the allocation base results in more reliable cost information and
better decisions.
D. If units are used as the denominator volume, managers can shift costs from the income
statement to the balance sheet by producing more inventory than is sold. Each unit of
inventory carries with it a portion of fixed cost that is booked as an asset (inventory) on
the balance sheet and so fixed overhead cost is not completely expensed for the
accounting period.

14.23 GameZ
A. Three choices are available for income statement formats, absorption costing, variable
costing, and throughput costing. Absorption costing meets GAAP standards and is used
for income statements required by banks and creditors. Variable and throughput costing
income statements produce detailed information that can be used in decision-making.
B. Absorption costing matches revenues with expenses under accrual accounting. Because
this is required for GAAP, these statements are appropriate for external reports to
creditors and shareholders. Variable costing separates costs into fixed and variable
categories and expenses all fixed costs as period costs. Income levels are not affected by
changes in inventory levels so managers have no incentive to manipulate inventory when


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-21
income is reported using variable costing. The same advantages and disadvantages apply

to absorption costing.
C. As mentioned above, the bank and other creditors will want the absorption income
statement, but the brother will want information produced by either the variable cost or
throughput income statements. Variable cost statements provide more detail than
throughput costing so variable income statements would likely be preferred for
developing information for decision-making. For compensation purposes, variable or
throughput income statements are best because income is less subject to manipulation
through inventory level adjustments.

14.24 Palm Producers
A. San Jose plant manager’s bonus = 5% of $12,646 = $632.30
Singapore plant manager’s bonus = 5% of $5,791 = $289.55
Each plant manager would prefer higher income to receiver higher bonus amounts
B. For the San Jose plant, sales increase but cost of goods sold decreases. Either cost
reductions were instituted or there was a build-up of inventory over the period, which
would reduce the amount of fixed overhead in cost of goods sold.
C. If variable costs are immaterial, the difference in inventory amounts between the last two
quarters is assumed to be expense that is on the balance sheet instead of on the income
statement.
San Jose Plant
Singapore Plant
Fourth quarter income
$12,646
$5,791
Change in inventory
(18,100)
(2,508)
Variable costing income
$ (5,454)
$3,283

D I would conclude that the San Jose plant manager’s performance was poor during the last
quarter of the year, and certainly not as good as the performance of the Singapore plant
manager.
E. There is no one answer to this part. Sample solutions and a discussion of typical student
responses will be included in assessment guidance on the Instructor’s web site for the
textbook (available at www.wiley.com/college/eldenburg).


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14-22 Cost Management

BUILD YOUR PROFESSIONAL COMPETENCIES
14.25 Focus on Professional Competency: Communication
The answers below provide suggestions for improved communication. Additional ideas can be
found in the following article: Jim Cole, “Speak English Please! How to Communicate Financial
Information to Non-Accountants,” SmartPros, October 2004, available at
www.smartpros.com/x44566.xml.
A.
Here are a few ideas for improving the conciseness and clarity of written and spoken
communications; students may think of others.
Practice eliminating unnecessary words. Re-read what you have written and
remove words or phrases that do not add meaning. Think of ways to say the same
thing with fewer words. Reflect on phrases or sentences you have spoken and
identify ways to simplify them.
Avoid using jargon and overly-technical language. Adopt words that will convey
your professionalism and also communicate effectively.
Read any written communication out loud to detect wordy passages or sentences
with unclear meaning. If you stumble over a phrase, it should be rewritten to
reflect simple, yet concise language.

Learn from your listeners’ reactions. Requests to repeat what you have said might
suggest that you mumble or speak too softly. Watch for nonverbal cues, such as
frowns or puzzled faces, which indicate your audience does not understand.
Avoid speaking too quickly, particularly when leaving telephone messages.
Speak slowly and distinctly when providing information such as your name and
telephone number. Also slow down when you are trying to make a point.
B.
1. Audience members vary in terms of their expectations, prior experience with the
subject matter, learning styles, and so on. It is not possible to fully anticipate the
needs of everyone in an audience.
2. Group brainstorming is an excellent way to learn about other peoples’ perceptions.
Try this activity and see what you learn!
3. There will be many different types of answers to this question. The purpose is to help
students recognize that communication styles should vary from setting to setting.
4. There are two major differences in communication among the three methods
introduced in this chapter. First, each costing method assigns a different proportion
of production costs to the cost of goods manufactured. All production costs are
assigned to products under absorption costing, whereas only variable production costs
are assigned to products under variable costing, and only direct materials costs are
assigned under throughput costing. Under all three methods, costs not assigned to
products are treated as period costs when calculating operating income. Second, each
method presents a subtotal on the operating statement that has a unique meaning.


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-23
Under absorption costing, the gross margin is the excess of revenues over the product
cost of goods sold. Under variable costing, the contribution margin is the excess of
revenues over both production and nonproduction variable costs. Under throughput

costing, the throughput margin in the excess of revenues over direct material costs of
goods sold.
C.
1. Indirect messages are any part of communication that is not explicit but that may
convey meaning. Examples include posture, facial and other body expressions, tone
of voice, connotation of words used, eye contact, personal appearance, quality of
penmanship, and physical materials used for written communications.
2. Indirect messages can help communication by conveying information, emphasizing
what is said, and improving interactions. Indirect messages can also hinder
communication because they may be misinterpreted, particularly between people
from different backgrounds who may fail to understand their intended meaning.
3. Effective communication over time involves engaging in continuous improvement in
both communicating and understanding others’ communications and ensuring that
interactions do not break down. Students’ examples for this question are likely to
vary widely. The purpose is to help students use what they have learned from past
communication experiences to actively promote more effective future
communication.
4. Again, student responses will vary.
D. Here is one possible answer to this question. Students are likely to think of additional
media and additional pros and cons.
Printed report
Pros: Easily generated and distributed; allows the user to read at own pace; some
people prefer reading printed material
Cons: May not contain useful information; may be ignored; no direct interaction
between the sending and receiving parties; may be costly to produce and
distribute; may take time to distribute; ineffective communication medium for
auditory learners; may be distributed to unauthorized parties
Best for: Reports with content that the receiving party needs to study; wide
distribution of information
Electronic report

Pros: Easily generated and distributed; allows the user to read at own pace; can be
accessible almost instantly
Cons: May not contain useful information; may be ignored; no direct interaction
between the sending and receiving parties; some people do not like reading
information electronically; ineffective communication medium for auditory
learners; may be distributed to unauthorized parties
Best for: Reports with content that the receiving party needs to study; wide
distribution of information at little cost


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14-24 Cost Management

Oral presentation
Pros: Allows opportunity for questions and interaction; ensures that audience is
exposed to the report content; allows control over distribution of information (i.e.,
recipients are present)
Cons: Requires individuals to be physically or electronically connected; ineffective
communication medium for visual learners; audience has little or no opportunity
to study the information and prepare questions
Best for: Relatively simple or highly aggregated information; situations where
interaction is desirable
Oral presentation with visual display (such as PowerPoint)
Pros: Allows opportunity for questions and interaction; ensures that audience is
exposed to the report content; addresses needs of both auditory and visual
learners; visual display can improve audience attention
Cons: Requires individuals to be physically or electronically connected; audience has
little or no opportunity to study the information and prepare questions
Best for: Relatively simple or highly aggregated information; situations where

interaction is desirable; professional appearance

14.26 Integrating Across the Curriculum: Financial Accounting and Auditing
A. Channel stuffing is the practice of coercing customers to take delivery of excess
merchandise for the purpose of improving the seller’s reported financial results.
B. Sales volumes are uncertain for most companies because they are subject to a variety of
economic factors that cannot be fully anticipated, such as shifts in customer tastes,
changes in competition, introduction of substitute products, changes in customer
perceptions about product quality, consumer spending habits, fluctuations in the
economy, variations in the sales effort of product distributors, and so on. Uncertainties
about sales quantities make it more difficult for companies to plan production volumes,
particularly when they cannot be rapidly increased or decreased.
C. In the case of Harley-Davidson and Bristol-Myers, customers were dealers or distributors
with whom they had developed long-term relationships. Accordingly, these customers
were willing to accept excess inventories because they were afraid that sufficient future
inventories could be in doubt if they failed to cooperate. Sometimes the threat is explicit.
For example, in the Bausch & Lomb case discussed in chapter 1, the distributors were
told that they would lose their distributorships if they refused to take additional shipments
at the end of 1993.
D. Here is a possible paragraph, written from the perspective of a Harley-Davidson
manager:
The demand for our bikes has not slowed down. For several years, we have steadily
increased our production to better meet customer demand. Our goal is to keep our
customers happy, which includes reducing delivery time. In the past, we have lost sales


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Chapter 14: Measuring and Assigning Costs for Income Statements 14-25
to competitors because we could not deliver bikes fast enough. Now we are in a better

position to compete, and we expect even stronger sales during our 100-year anniversary.
E. The first step is to examine the FASB’s accounting standards. Then the SEC’s
accounting guidelines will be examined. There are two major pronouncements by the
FASB with implications for revenue recognition in cases of channel stuffing.
According to FASB Concepts Statement No. 5, revenue must meet the following
two criteria to be recognized: the revenue must be (a) realized or realizable and
(b) earned.1 The first criterion requires the seller to have obtained cash or have a
claim to a known amount of cash from the buyer. The second criterion for a
typical manufacturer such as Harley-Davidson or Bristol-Myers generally refers
to the delivery of merchandise. According to paragraph 84, “…revenues from
manufacturing and selling activities … are commonly recognized at time of sale
(usually meaning delivery).” Channel stuffing typically meets both conceptual
criteria because the merchandise is delivered to customers, and the terms of
payment are known because they are specified in a contract.
Because channel stuffing involves selling customers more merchandise than they
need, a risk exists that the customers might later return the excess merchandise.
FAS No. 48 provides guidance for revenue recognition when buyers have the
right to return merchandise to the seller.2 According to FAS 48, companies
should not recognize revenue if they are unable to reasonably estimate the amount
of future returns (paragraph 6.f). FAS 48 also lists specific conditions that may
impair the ability to make a reasonable estimate (paragraph 8), which include:
Relatively long periods in which a particular product may be returned:
Returns of overstocked sales because of channel stuffing often occur over a
longer time period than regular returns. Thus, this condition could potentially
apply to channel stuffing. However, it is also possible for managers to argue
that no material amount of sales returns will occur. This argument is difficult
to refute when sales are made to long-time customers who in the past have
made few returns.
Absence of historical experience with similar types of sales of similar
products, or inability to apply such experience because of changing

circumstances, for example, changes in the selling enterprise's marketing
policies or relationships with its customers: Channel stuffing often occurs
during a period of changing conditions for the seller, in which it alters the
normal terms of sale to its customers. These shifts make it more difficult to
estimate returns. Thus, this condition could potentially apply to channel
stuffing. Once again, managers could argue that the sales are to long-time
customers who are not likely to return material amounts of merchandise.
1

Financial Accounting Standards Board (FASB), Statement of Financial Accounting Concepts No. 5, “Recognition
and Measurement in Financial Statements of Business Enterprises,” Paragraph 83,
2
Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards No. 48, “Revenue
Recognition When Right of Return Exists,” Paragraphs 6 and 8.