Solution manual cost accounting by lauderbach STANDARD COSTING AND VARIABLE COSTING

CHAPTER 13
STANDARD COSTING AND VARIABLE COSTING
13-1

JIT and Costing Methods

Throughput costing is most compatible because it penalizes production
in excess of sales. Variable costing does not penalize excess production,
while absorption costing actually rewards overproduction.
Throughput costing expenses everything except material cost as those
costs are incurred. It expenses material costs when material goes into
production. Thus, starting to make something gives rise to expense, which
encourages managers to produce only when they can sell the product.
Absorption costing rewards high production because it capitalizes fixed
production costs in inventory, thus postponing their appearance in the income
statement until products are sold.
13-2

Use of Costing Methods

The construction company is least likely to use standard costs because
it does not make standard products. Such a company could, and probably does,
budget costs for major projects, but these are not standards. An automaker
uses standard costs both for control and because it could not possibly use
actual or normal process costing because of product diversity. Job order
costing would be prohibitively costly. A processor of flour could use actual
or normal costing, but would benefit from the control uses of standards.
13-3

Product Cost--Period Cost

Classifying a cost as either product or period tells little about the
cost itself but rather describes how we treat it for reporting purposes.
Identifying a cost as a product cost results in its being reported as an
expense in the period in which the product is sold. Identifying a cost as a
period cost results in its being reported as an expense in the period in
which it is incurred. The distinction between period and product costs has
no relevance to decision making except, perhaps, in connection with capital
budgeting decisions where the period of expense reporting for tax purposes is
relevant to the determination of future cash flows.
13-4

Costing Methods and Zero Inventories

All three methods will give the same results. Total expenses will
equal total costs incurred, including purchases of materials and components.
13-5 Costing Methods and Cash Flows
Throughput costing will probably be the closest because the flow of
costs parallels their incurrence. Absorption costing will have the least
close relationship to cash flow.

13-1


13-6

Fundamentals of Absorption and Variable Costing

(15 minutes)

1.

Sales, 18,000 x $50
Standard cost of sales, 18,000 x $30
Standard gross margin
Selling and administrative expenses
Income

$900,000
540,000
360,000
300,000
$ 60,000

2.
Sales,
Standard variable cost of sales, 18,000 x $10
Standard gross margin, contribution margin
Fixed costs, $400,000 + $300,000
Income

$900,000
180,000
720,000
700,000
$ 20,000

The cost of sales sections of the income statement focus attention on
inventories.
Absorption
Variable
Beginning inventory

Variable production costs
Fixed production costs
Total available
Ending inventory, 2,000 units at $30, $10
Cost of sales

$

0
200,000
400,000
600,000
60,000
$540,000

$

0
200,000
0
200,000
20,000
$180,000

Because actual production equalled the level used to set the standard, there
is no volume variance. You might ask how much income the company should earn
per month if it continues to sell 18,000 units. The answer is $20,000,
because the company cannot indefinitely make 2,000 units more than it sells.
13-7 Fundamentals of Absorption and Variable Costing

(15 minutes)

1.
Sales, 22,000 x $50
Standard cost of sales, 22,000 x $30
Standard gross margin
Selling and administrative expenses
Income

$1,100,000
660,000
440,000
300,000
$ 140,000

2.
Sales, 22,000 x $50
Standard variable cost of sales, 22,000 x $10
Standard gross margin, contribution margin
Fixed costs, $400,000 + $300,000
Income

$1,100,000
220,000
880,000
700,000
$ 180,000

The cost of sales sections of the income statement again focus attention on
inventories.

Absorption
Variable
Beginning inventory, 13-5
Variable production costs
Fixed production costs
Total available
Ending inventory
Cost of sales

$ 60,000
200,000
400,000
660,000
0
$660,000

13-2

$ 20,000
200,000
0
220,000
0
$220,000


Because actual production again equalled the level used to set the standard,
there is no volume variance.
13-8 Basic Standard Costing--Absorption and Variable

(25 minutes)

Income Statements--Variable Costing
March
Sales at $7 per case
Cost of sales:
Beginning inventory:
30,000 x $3
Production costs:
130,000 x $3
90,000 x $3
Total
Ending inventory:
30,000 x $3
20,000 x $3
Variable cost of sales
Contribution margin
Fixed costs:
Production
Selling and administrative
Total fixed costs
Income

April

$700,000

90,000
390,000
____ ___

390,000

270,000
360,000

90,000
________
300,000
400,000

60,000
300,000
400,000

300,000
60,000
360,000
$ 40,000

300,000
60,000
360,000
$ 40,000

Income Statements--Absorption Costing
March
Sales, at $7 per case
Cost of sales:
Beginning inventory:
30,000 x ($3 + $2)*

Production costs applied:
Variable--130,000 x $3
-- 90,000 x $3
Fixed costs applied:
130,000 x $2
90,000 x $2
Total
Ending inventory:
30,000 x $5
20,000 x $5
Standard cost of sales at $5
Volume variance:
$300,000 - $260,000
$300,000 - $180,000
Actual cost of sales
Gross margin
Selling and administrative
Income

$700,000

$700,000

April
$700,000
150,000

390,000
270,000
260,000

________
650,000

180,000
600,000

150,000
________
500,000

100,000
500,000

40,000 U
________
540,000
160,000
60,000
$100,000

120,000 U
620,000
80,000
60,000
$ 20,000

* Standard fixed overhead per unit is $2 ($300,000 total fixed manufacturing
cost divided by 150,000 units at practical capacity).
2. B&Y should earn about $40,000 per month, the variable costing income.
Absorption costing income depends on production, which over time must

13-3


approximate sales. As inventories stabilize, income will approach $40,000,
the variable costing equilibrium amount.
This answer does not rely on the company's using absorption costing or
variable costing. In the long run, any method will give the same result.
(You might want to point out that variable costing is not acceptable for tax
purposes, so income differences cannot rise from investing tax savings, as
can happen with LIFO.)
Note to the Instructor:
You can do this exercise without the details of
the cost of sales section, as shown below. The cost of sales section can be
used to show how the costs flow and why incomes turn out the way they do, but
it is not necessary.
Income Statements--Variable Costing
Sales, at $7 per case
Variable cost of sales at $3
Contribution margin
Fixed costs:
Production
Selling and administrative
Total fixed costs
Income

March
$700,000
300,000
400,000

April
$700,000
300,000
400,000

300,000
60,000
360,000
$ 40,000

300,000
60,000
360,000
$ 40,000

Income Statements--Absorption Costing
March
Sales, at $7 per case
Standard cost of sales at $5
Volume variance:
$300,000 - $260,000
$300,000 - $180,000
Actual cost of sales
Gross margin
Selling and administrative
Income

$700,000
500,000

40,000 U
_________
540,000
160,000
60,000
$100,000

April
$700,000
500,000
120,000 U
620,000
80,000
60,000
$ 20,000

Note to the Instructor: Because this exercise is quite straightforward
and uncomplicated by variances for variable costs, it provides a basis for
drawing attention to the essential differences between variable and
absorption costing. You may, for example, wish to ask the students if they
can explain the differences between the incomes under the two methods. The
explanation might proceed as follows:
Explanation of the differences in income in the two months
March
April
Differences to be explained:
Income under variable costing
$ 40,000
$ 40,000
Income under absorption costing

100,000
20,000
Difference to be explained:
Variable costing income smaller
$ 60,000
Variable costing income larger
$ 20,000
Prior month's fixed costs deferred to
current month by inclusion in the
beginning inventory:
30,000 x $2
0
60,000
Current month's fixed costs deferred to
the next month by inclusion in the
ending inventory:
30,000 x $2
60,000

13-4


20,000 x $2
Difference in income due to fixed
costs in inventory
13-9 Actual Costing Income Statements

40,000
________
________

$ 60,000
$ 20,000
(15-20 minutes)

1.
Sales, 18,000 x $30, 22,000 x $30
Cost of sales:
Beginning inventory
Production costs:
Variable, 20,000 x $10
Fixed
Total available for sale
Less ending inventory*
Cost of sales
Gross margin
Selling and administrative expenses
Income

January

February

$540,000

$660,000

0

40,000

200,000
200,000
400,000
40,000
360,000
180,000
40,000
$140,000

200,000
200,000
440,000
0
440,000
220,000
40,000
$180,000

Inventory, $400,000/20,000 = $20 per unit, times 2,000 units = $40,000.
There is no inventory at the end of February, so no calculation is needed.
2.
Sales, 18,000 x $30, 22,000 x $30
Cost of sales, variable costs at $10/unit
Contribution margin at $20
Fixed costs, $200,000 + $40,000
Income

January

February

$540,000
180,000
360,000
240,000
$120,000

$660,000
220,000
440,000
240,000
$200,000

The cost of goods sold sections under variable costing appear below.
January
February
Beginning inventory
Variable production costs, 20,000 x $10
Total available for sale
Less ending inventory, 2,000 x $10
Cost of sales

$

0
200,000
200,000
20,000
$180,000

20,000
200,000
220,000
0
$220,000

3.
January

February

Sales, 18,000 x $30, 22,000 x $30
$540,000
Cost of sales, material cost at $6 x production 120,000
Throughput
420,000
Other costs, $80,000 + $200,000 + $40,000
320,000
Income
$100,000
13-10 Standard Fixed Cost and Volume Variance
1.

(15 minutes)

(a)
Normal
$900,000
225,000
$4

Budgeted fixed manufacturing costs
Divided by capacity measure
Equals standard fixed cost per unit

13-5

$660,000
120,000
540,000
320,000
$220,000

(b)
Practical
$900,000
300,000
$3


2.

(a)

Standard fixed cost per unit
Times number of units produced
Fixed overhead applied to production
Less budgeted fixed overhead
Volume variance (unfavorable)

(b)

$4
240,000
$960,000
900,000
$ 60,000

$3
240,000
$720,000
900,000
($180,000)

Alternatively, the calculations could be made using the differences
between actual production and the volume used to set the standard fixed cost.
Volume Used to
Set Standard
(a)
(b)

225,000
300,000

13-11

Relationships

1. (a) $10 per unit
(b) $200,000

2. (b)

$60,000

Actual
Production

Difference

x

Standard
Fixed Cost

(15,000)
60,000

x
x

$4
$3

240,000
240,000

=

Volume
Variance

$ 60,000 F
180,000 U

(20-25 minutes)
$10,000 favorable variance/1,000 units above normal
production
20,000 units x $10
20,000 units x $3

(c) 17,000 units $9,000 unfavorable variance/$3 per unit = 3,000 units
below normal of 20,000
3. (a)
(d)
4. (a)
(c)

$2 per unit

$40,000/20,000

$4,000 unfavorable
$7 per unit

(20,000 - 18,000) x $2

$140,000/20,000

22,000 units $14,000 favorable variance/$7 per unit = 2,000 units
more than normal of 20,000

13-12 Effects of Changes in Production--Standard Variable Costing (15
minutes)
Production
40,000 units
41,000 units
Sales (40,000 x $10)
$400,000
$400,000
Variable cost of goods sold:
Variable production costs
40,000 x $3
$120,000
41,000 x $3
$123,000
Ending inventory
0 x $3
0
1,000 x $3
3,000
Variable cost of goods sold
40,000 x $3
120,000
120,000
Contribution margin
280,000
280,000
Fixed production costs
200,000
200,000
Income

$ 80,000
$ 80,000

13-6


Note to the Instructor: We asked for income statements for both levels
of production to allow you to highlight how increases in variable cost
occurring because of increases in production are deferred in inventory,
therefore having no effect on income. Most students should see that income
will be the same no matter what production is. You might therefore reiterate
that income can be computed as we did as early as Chapter 2.
Sales
- variable costs - fixed costs = income
(40,000 x $10) - (40,000 x $3) - $200,000
= $80,000
13-13 Effects of Changes in Production--Standard Absorption Costing (15-20
minutes)
Production
40,000 units
41,000 units
Sales (40,000 x $10)
$400,000
$400,000
Cost of goods sold:
Variable production costs
$120,000
$123,000
Applied fixed production costs
40,000 x $5

200,000
41,000 x $5
________
205,000
Cost of goods available for sale
320,000
328,000
Ending inventory
0 x $8
0
1,000 x $8
________
8,000
Cost of goods sold (40,000 x $8)
320,000
320,000
Standard gross profit (40,000 x $2)
80,000
80,000
Volume variance, favorable (1,000 x $5)
0
5,000
Income
$ 80,000
$ 85,000
Note to the Instructor: We asked for details of the cost of sales
section so that you can show how increases in production lead to increases in
applied fixed costs with a corresponding increase in ending inventory and a
more favorable (or less unfavorable) volume variance. The 1,000 unit
increase in production leads to an increase in the fixed costs in inventory

of $5,000, which is also the increase in income.
13-14

"Now Wait a Minute Here."

(20 minutes)

This assignment shows the relationships of income to sales and
production.

Sales at $10
Cost of sales at $7
Standard gross margin
Volume variance
Actual gross margin

Sales 10,000
Prod. 10,000

Sales 10,000
Prod. 10,001

Sales 10,001
Prod. 10,001

Sales 9,999
Prod. 10,001

$100,000
70,000

30,000
0
$ 30,000

$100,000
70,000
30,000
6F
$ 30,006

$100,010
70,007
30,003
6F
$ 30,009

$99,990
69,993
29,997
6F
$30,003

The highest profit is with sales and production at 10,001, but the
lowest is with sales and production at 10,000. Sales of 9,999 with
production of 10,001 gives a higher profit than sales of 10,000 with
production of 10,000. Sales of 10,000 with production of 10,001 gives the
second best profit. In other words, production increases income more than
does sales. The company increases its profit by $6 for each additional unit
it produces, while selling an additional unit gains $3 ($10 - $7), and
producing and selling another unit gains $9, the $6 for producing and the $3

for selling.

13-7


13-15

All Fixed Cost Company

(25-30

minutes)

This problem shows the effects on both income and the balance sheet of
the two costing methods. The reconciling factor between incomes in both
years is the $80,000 absorption costing inventory, increase in 20X2, decrease
in 20X3.
1.
20X2
20X3
Sales, 120,000 x $6
Cost of sales:
Beginning inventory
Costs applied at $4
Total available
Ending inventory at $4
Standard cost of sales at $4
Standard gross margin
Volume variance
140,000U

Actual gross margin and profit

$720,000

$720,000

$

0
600,000
600,000
120,000

$120,000
360,000
480,000
0
480,000
240,000
100,000F

480,000
240,000

$340,000

$100,000

Volume variances are $600,000 - $500,000 and $360,000 - $500,000.
2.

Balance sheets
20X2
720,000
120,000
2,000,000
$2,840,000

Cash = cumulative sales
Inventory, 30,000 x $4
Plant, net
Total assets

$

Stockholders' equity ($2,500,000 + $340,000)
($2,840,000 + $100,000)

$2,840,000

20X3
$1,440,000
0
1,500,000
$2,940,000
$2,940,000

3.
Sales
Fixed costs

Profit

$720,000
500,000
$220,000

$720,000
500,000
$220,000

Balance sheets
Cash = cumulative sales
Plant, net
Total assets

$

Stockholders' equity ($2,500,000 + $220,000)
($2,720,000 + $220,000)

$2,720,000

13-16

Basic Absorption Costing

720,000
2,000,000
$2,720,000

$2,940,000

(15-20 minutes)
April

Sales, 9,000 x $100
Standard cost of sales, 9,000 x $65
Standard gross margin, 9,000 x $35
Volume variance*
Actual gross margin
Selling and administrative expenses
Profit

$900,000
585,000
315,000
80,000 F
395,000
280,000
$ 115,000

*

13-8

$1,440,000
1,500,000
$2,940,000

Actual production
Normal activity
Difference
Standard fixed cost
Volume variance, favorable

12,000
10,000
2,000
$40
$80,000

An expanded cost of goods sold section appears as follows.
Beginning inventory
Variable production costs, 12,000 x $25
Fixed production costs, 12,000 x $40
Total, 12,000 x $65
Less ending inventory, 3,000 x $65
Standard cost of sales, 9,000 x $65

$

$

0
300,000
480,000
780,000
195,000
585,000

Note that the volume variance is also the difference between applied
fixed overhead of $480,000 and budgeted fixed overhead of $400,000.
May
Sales, 11,000 x $100
Standard cost of sales, 11,000 x $65
Standard gross margin, 11,000 x $35
Volume variance*
Actual gross margin
Selling and administrative expenses
Profit

$1,100,000
715,000
385,000
40,000 U
345,000
280,000
$
65,000

*
Actual production
Normal activity
Difference
Standard fixed cost
Volume variance, unfavorable

9,000
10,000

1,000
$40
$40,000

Beginning inventory, 3,000 x $65
Variable production costs, 9,000 x $25
Fixed production costs, 9,000 x $40
Available for sale, 12,000 x $65
Less ending inventory, 1,000 x $65
Standard cost of sales, 11,000 x $65

$

$

195,000
225,000
360,000
780,000
65,000
715,000

Note to the Instructor: You might wish to point out that profit dropped
by $50,000, while sales increased 22.1% (from 9,000 to 11,000 units). You
might remind students that Chapter 2 showed how income increases more rapidly
than sales when a company has fixed costs. A manager looking at these
statements must wonder why the increase in income lagged that of sales when
the cost structure remained the same. The next exercise in this series
allows you to show how variable costing alleviates this problem.
13-17

Basic Variable Costing (Continuation of 13-16)

(15-20 minutes)

1.
Sales, 9,000 x $100
Standard variable cost of sales, 9,000 x $25
Contribution margin, 9,000 x $75
Fixed costs:
Manufacturing
$400,000
Selling and administrative
280,000

13-9

$

April
900,000
225,000
675,000


Total fixed costs
Loss

($

680,000
5,000)

An expanded cost of goods sold section shows
Beginning inventory
Variable production costs, 12,000 x $25
Less ending inventory 3,000 x $25
Standard cost of sales 9,000 x $25

$

0
300,000
75,000
$ 225,000
May
$1,100,000
275,000
825,000

Sales, 11,000 x $100
Standard variable cost of sales, 11,000 x $25
Contribution margin, 11,000 x $75
Fixed costs:
Manufacturing
$400,000
Selling and administrative
280,000
Total fixed costs
Profit

$

680,000
145,000

An expanded cost of goods sold section shows
Beginning inventory, 3,000 x $25
Variable production costs, 9,000 x $25
Total, 12,000 x $25
Less ending inventory, 1,000 x $25
Standard cost of sales, 11,000 x $25

$

$

75,000
225,000
300,000
25,000
275,000

2. Jasper should earn about $145,000 per month, the variable costing income.
Absorption costing income does not reflect long-run earning power when
production and sales differ. Over the long-run, sales and production would
have to approximate one another, bringing total income to the variable
costing equilibrium amount.
Note to the Instructor: In connection with the previous exercise, you
might wish to show how income is affected under the two costing methods.

Using variable costing, we see the following.
Loss at 9,000 units
Contribution margin on 2,000 units at $75
Income at 11,000 units

($ 5,000)
150,000
$145,000

Income under absorption costing is more complicated. Both sales and
production affect results. The following analysis might be useful.
Income at 9,000 units
Less inventory effect, (12,000 - 9,000) x $40
Loss at 9,000 units if production equals sales

$115,000
120,000
($ 5,000)

Income at 11,000 units
Plus inventory effect, (11,000 - 9,000) x $40
Income if production equals sales

$ 65,000
80,000
$145,000

13-18

Throughput Costing (Continuation of 13-16)

(15 minutes)

Cost of sales is now the cost of materials used in production, and all other
costs are expensed. Material cost is $15 per unit, so direct labor and
variable overhead are $10 ($25 - $15).
April
Sales, 9,000 x $100
$ 900,000
Cost of sales, 12,000 x $15
180,000

13-10


Margin
Operating expenses:
Direct labor and variable overhead, 12,000 x $10
Fixed manufacturing
Selling and administrative expenses
Loss

Sales, 11,000 x $100
Standard variable cost of sales, 9,000 x $15
Margin
Operating expenses:
Direct labor and variable overhead, 9,000 x $10
Manufacturing
Selling and administrative
Profit

720,000
$120,000
400,000
280,000

800,000
80,000)

($

May
$1,100,000
135,000
965,000
$ 90,000
400,000
280,000
$

770,000
195,000

The differences among the three methods are, as always, differences in
inventories. The table below summarizes the differences. Absorption and
variable costing treat only one element, fixed production costs, differently.
Throughput costing treats all elements differently from the other two methods
except that variable costing also expenses fixed production costs as
incurred.

Absorption costing
Variable costing
Throughput costing

Materials
X
X
Z

Other Variable
Production Costs
X
X
Y

Fixed
Production Costs
X
Y
Y

X = treat as product cost, Y = expense as incurred, Z = expense as used in
production
13-19
Effect of Measure of Activity (Continuation of 13-16)
minutes)

(15-20

Standard fixed cost is $16 per unit, $400,000/25,000, and total standard

cost is $41.
April
Sales, 9,000 x $100
$ 900,000
Standard cost of sales, 9,000 x $41
369,000
Standard gross margin, 9,000 x $59
531,000
Volume variance*
128,000 U
Actual gross margin
403,000
Selling and administrative expenses
280,000
Profit
$ 123,000
* Actual production
Practical capacity
Difference
Standard fixed cost
Volume variance, unfavorable

12,000
20,000
( 8,000)
$16
($128,000)

An expanded cost of goods sold section appears as follows.
Beginning inventory

Variable production costs,

$
12,000 x $25

13-11

0
300,000


Fixed production costs, 12,000 x $16
Total, 12,000 x $41
Less ending inventory, 3,000 x $41
Standard cost of sales, 9,000 x $41

$

192,000
492,000
123,000
369,000

May
Sales, 11,000 x $100
$1,100,000
Standard cost of sales, 11,000 x $41
451,000
Standard gross margin, 11,000 x $59
649,000

Volume variance*
( 176,000)U
Actual gross margin
473,000
Selling and administrative expenses
280,000
Profit
$ 193,000
*
Actual production
9,000
Practical capacity
20,000
Difference
(11,000)
Standard fixed cost
$16
Volume variance, unfavorable
($176,000)
Beginning inventory, 3,000 x $41
Variable production costs, 9,000 x $25
Fixed production costs, 9,000 x $16
Available for sale,
12,000 x $41
Less ending inventory, 1,000 x $41
Standard cost of sales, 11,000 x $41

$

$

123,000
225,000
144,000
492,000
41,000
451,000

The differences are in the standard costs, affecting both inventory and
cost of goods sold. Using practical capacity gives a lower standard cost of
sales because the standard cost is lower, but it gives higher (more
unfavorable) volume variances because the basis for setting the standard is
higher. Income was higher in April, and lower in May, than when the company
used normal capacity. If production exceeds sales, income will be higher for
the method that has the higher unit cost, and vice versa. This relationship
works the same as that between variable costing and absorption costing, and
for the same reason.
13-20

Absorption Costing

(15-20 minutes)

Note to the Instructor: This problem and its sequel include variable
cost variances, a fixed overhead budget variance, and a volume variance.
1.
Sales, 90,000 x $400
Standard cost of sales, 90,000 x $250
Standard gross margin, 90,000 x $150
Volume variance*

Fixed overhead spending variance*
Variable cost variances**
Actual gross margin
Selling and administrative expenses
Profit

$36,000,000
22,500,000
13,500,000
$600,000 U
130,000 F
50,000 F

420,000 U
13,080,000
10,550,000
$ 2,530,000

*
Actual Fixed Overhead
Budgeted Fixed Overhead
Applied Fixed
Overhead
96,000 x
$150
$14,870,000
$15,000,000
$14,400,000
$130,000 F
$600,000 U

Budget variance
Volume variance

13-12


**
Actual Variable Cost

Standard Variable Cost
96,000 x $100
$9,600,000

$9,550,000

$50,000 F
Variable overhead variances
We cannot determine how much of the variable cost variance relates to
spending and how much to efficiency.
An expanded cost of goods sold section appears as follows.

Beginning inventory
Variable production costs, 96,000 x $100
Fixed production costs, 96,000 x $150
Total, 96,000 x $250
Less ending inventory, 6,000 x $250
Standard cost of sales, 90,000 x $250
13-21

Variable Costing

$

0
9,600,000
14,400,000
24,000,000
1,500,000
$22,500,000

(15-20 minutes)

Note to the Instructor: You might wish to ignore the fixed overhead
budget variance. We showed it because it is an economic variance. Moreover,
students tend to forget that companies using variable costing still plan and
control fixed costs.
1.
Sales, 90,000 x $400
$36,000,000
Standard cost of sales, 90,000 x $100
9,000,000
Standard variable manufacturing margin, 90,000 x $300
27,000,000
Variable cost variances
50,000 F
Variable manufacturing margin
27,050,000
Fixed costs:
Budgeted manufacturing costs
$15,000,000

Budget variance
130,000 F
Selling and administrative
10,550,000
Total fixed costs
25,420,000
Profit
$ 1,630,000
An expanded cost of goods sold section appears as follows.
Beginning inventory
Variable production costs, 96,000 x $100
Less ending inventory, 6,000 x $100
Standard cost of sales, 90,000 x $100

$

0
9,600,000
600,000
$9,000,000

The difference in incomes between this and the previous exercise is the
$900,000 fixed costs in the ending inventory (6,000 x $150).
13-22
1.

Interpreting Results

(15 minutes)

February, 35,000 units; March, 16,000 units

Volume variance = $6 x difference between actual
production and 25,000 units
Divided by $6 equals difference between actual
production and 25,000 units (under)

13-13

February
$60,000 F
10,000

March
$54,000 U
(9,000)


Normal capacity
Production

25,000
35,000

25,000
16,000

2. The results that the president believes strange occur because absorption
costing defers fixed production costs in inventory, so that in periods of
high production, profit will be higher than in periods of low production,

sales being the same (or even, as here, with higher sales in the low
production period).
It is not the volume variance per se that causes the results, as
students often think. Rather, it is the deferral of fixed costs in
inventory.
3.

Income statements using variable costing

February
$480,000
48,000
432,000
270,000
$162,000

Sales
Variable cost of sales
Contribution margin
Fixed costs
Income

March
$680,000
68,000
612,000
270,000
$342,000

Variable cost of sales: Unit volumes = 24,000 and 34,000, from revenue/$20

selling price. We can use either month to find standard variable cost of
sales, in several ways. Perhaps the most obvious is
February standard cost of sales
$192,000
Divided by February sales
24,000
Standard cost of sales
$8
Less standard fixed cost of $6 = standard variable cost
$2
Fixed costs = $120,000 selling and administrative plus $150,000 fixed
production costs (25,000 x $6).
The variable costing income statements present the picture much better.
Profits rose by $180,000 ($342,000 - $162,000), accompanying a 10,000 unit
sales increase. Contribution margin is $18 per unit, $20 - $2.
13-23

Income Determination--Absorption Costing

(20-25 minutes)

Standard cost calculations:
Standard fixed cost per unit:
Fixed production costs
Production basis
Standard fixed cost per unit:
Fixed production costs
Production basis

$960,000

80,000

= $12 per unit

$960,000
120,000

= $8 per unit

With the $8 standard variable cost ($880,000/110,000), the total standard
costs are $20 and $16.
80,000-unit
120,000-unit
Basis
Basis
Sales, 90,000 units
Standard cost of sales
Volume variance:
$960,000 - $1,320,000

$2,700,000
1,800,000
360,000 F

13-14

$2,700,000
1,440,000

$960,000 - $880,000
Actual cost of goods sold
Gross profit
Selling and administrative costs
Income

__________
1,440,000
1,260,000
250,000
$1,010,000

80,000 U
1,520,000
1,180,000
250,000
$ 930,000

An expanded cost of sales section shows the following.
Production costs:
Variable (110,000 x $8)
$ 880,000
$ 880,000
Fixed:
110,000 x $12
1,320,000
110,000 x $8
__________
880,000
Total

2,200,000
1,760,000
Less ending inventory:
20,000 x $20
400,000
20,000 x $16
320,000
Standard cost of sales
$1,800,000
$1,440,000
Note to the Instructor: You might wish to show that the $80,000
difference between the two incomes is the $4 difference in standard fixed
cost multiplied by the 20,000 unit change in inventory.
13-24 Income Determination--Variable Costing (Continuation of 13-23)
minutes)
Sales
Cost of goods sold:
Variable production costs (110,000 x $8)
Less ending inventory (20,000 x $8)
Standard cost of sales
Standard variable manufacturing margin
Fixed costs:
Production
Selling and administrative
Income

(15-20

$2,700,000
$880,000

160,000
720,000
1,980,000
$960,000
250,000

1,210,000
$ 770,000

Note to the Instructor: You might wish to show that the difference
between income here and in the previous exercise is the fixed costs in
inventory.
80,000-unit basis
120,000-unit basis
Fixed costs in ending inventory:
20,000 x $12
$ 240,000
20,000 x $8
$160,000
Add variable costing income
770,000
770,000
Absorption costing income
$1,010,000
$930,000
13-25
1.

Relationships

(15-20 minutes)

(c) $240,000
Sales (80,000 x $10)
Variable cost of goods sold (80,000 x $4)
Contribution margin, variable costing ($10 - $4)
Fixed costs
Income, variable costing
(b)

$800,000
320,000
480,000
240,000
$240,000

70,000 units
Income under variable costing (part c)
Income under absorption costing (given)

13-15

$240,000
210,000


Difference in income, absorption costing lower
Divided by per-unit fixed cost used under
absorption costing ($240,000/80,000)
Equals change in inventory

$ 30,000
$3
10,000 units

Because absorption costing income is lower, the inventory change is negative
(inventory declines), so that production must have been 10,000 units lower
than sales.
2.

(a)

50,000 units
Income under variable costing
Add fixed costs
Equals contribution margin
Divided by contribution margin per unit
Equals sales, in units

(b)

$ 60,000
240,000
$300,000
$6
50,000

70,000 units
Income under absorption costing
Less income under variable costing

Equals income difference due to inventory change,
absorption costing higher
Divided by per-unit fixed cost, absorption
Equals inventory change

$120,000
60,000
$ 60,000
$3
20,000 units

Because absorption costing income is higher, the inventory change is positive
(inventory increases), so that production must have been 20,000 units higher
than sales.
3.

(c)

$120,000
Total contribution margin [60,000 x ($10 - $4)]
Less fixed costs
Income, variable costing

(d)

$360,000
240,000
$120,000

$105,000

Income under variable costing
$120,000
Inventory change (60,000 - 55,000)
5,000
Times fixed cost per unit
$3
Equals the difference between income under
variable and under absorption costing
15,000
Absorption costing income
$105,000
(The difference is subtracted because absorption costing income is lower than
variable costing income when inventory decreases, which is the case here.)
Note to the Instructor: Some students have great difficulty with all or
parts of this assignment, but those who understand the two costing methods
and the relationships among sales, production, and income should be able to
complete the problem successfully with little difficulty. A critical step is
to recognize that the difference between incomes under the two costing
methods will relate to changes in inventory and, more specifically, to the
change in fixed costs in inventory. Hence, an important first calculation is
the $3 per-unit fixed cost.
We have found that students who attack the assignment methodically have
taken one of two approaches. One group expresses income under each method in
formula fashion, to see the relationships. Thus,

13-16


Income, variable

costing
Income, absorption
costing

=

(unit sales x unit contribution margin) - fixed costs

=

(unit sales x ($10 - $4)

=

variable costing income
per-unit fixed cost)

=

-

$240,000

+/- (inventory change x

variable costing income +/- (inventory change
x $3)

The second group, perhaps less inventive but with an understanding of the
calculation of the volume variance, will work toward the answers by filling

in the details of income statements reflecting each method.
13-26
1.

All-Fixed Company

(20 minutes)

Absorption costing

Unit sales
Unit production
Sales at $5
Beginning inventory
Applied fixed costs at $2
Available for sale
Less ending inventory at $2
Standard cost of sales at $2
Standard gross margin at $3
Volume variance*
Profit

May
9,000
11,000
$45,000
0
22,000
22,000
4,000

18,000
27,000
2,000 F
$29,000

June
10,000
10,000
$50,000
4,000
20,000
24,000
4,000
20,000
30,000
0
$30,000

July
11,000
9,000
$55,000
4,000
18,000
22,000
0
22,000
33,000
2,000 U
$31,000

* $20,000 - applied fixed production costs or ([actual units - 10,000] x
$2).
Note to the Instructor: This exercise highlights the differences
between absorption costing and variable costing. In the required format,
with simple numbers, it is easy to see several important relationships.
Applied fixed production costs and the volume variance add up to $20,000,
budgeted fixed costs. That is, all fixed costs go through the calculation of
income, with the amounts deferred in inventory (beginning and ending) being
the difference between absorption costing and variable costing. Thus, the
difference in income in the first month will be $4,000 (absorption over
variable), zero in the second month because there is no change in
inventories, and $4,000 in the third month (variable over absorption). It is
also worth noting that total expenses on the income statement equal standard
cost of sales plus/minus the volume variance, $16,000 ($18,000 - $2,000) in
May, $20,000 in June, and $24,000 ($22,000 + $2,000) in July.
2.

Variable costing

Sales at $5
Fixed costs
Profit

May
$45,000
20,000
$25,000

June

$50,000
20,000
$30,000

July
$55,000
20,000
$35,000

Because there are no variable costs, profit is simply sales - $20,000.
13-27

Standard Costing--Absorption and Variable

(20-30 minutes)

1.
$32
$15 + $6 + $11
Variable overhead = $2 x 0.50 = $1. Fixed
overhead = $500,000/50,000 = $10, or ($500,000/25,000 DLH) x 0.50 DLH per

13-17


unit of product.

Total standard variable production costs are $22.

2.

Sales (40,000 x $40)
Standard cost of sales:
Applied variable production costs (45,000 x $22)
Applied fixed production costs (45,000 x $10)
Available for sale (45,000 x $32)
Ending inventory (5,000 x $32)
Standard cost of sales (40,000 x $32)
Standard gross margin [40,000 x ($40 - $32)]
Volume variance [(45,000 - 50,000) x $10]
Actual gross margin
Selling and administrative expenses
Income

$1,600,000
$

990,000
450,000
1,440,000
160,000
1,280,000
320,000
50,000U
270,000
200,000
$
70,000

3.
Sales (40,000 x $40)

Standard variable cost of sales:
Applied variable production costs (45,000 x $22)
$990,000
Ending inventory (5,000 x $22)
110,000
Standard variable cost of sales (40,000 x $22)
Standard variable gross margin [40,000 x ($40 - $22)]
Fixed production costs
$500,000
Selling and administrative expenses
200,000
Total fixed costs
Income

$1,600,000

880,000
720,000

$

700,000
20,000

Alternatively, income is simply [40,000 x ($40 - $22)] - $700,000 = $720,000
- $700,000 = $20,000.
13-28

Absorption Costing and Variable Costing

1.

$40, $600,000/15,000

2.

Income statement

Sales, 14,000 x $90
Standard cost of sales, 14,000 x $65
Standard gross margin, 14,000 x $25
Volume variance*
Actual gross margin
Selling and administrative expenses
Profit

(20-25 minutes)

$1,260,000
910,000
350,000
40,000 F
390,000
160,000
$ 230,000

*
Actual production
16,000
Normal activity

15,000
Difference
1,000
Standard fixed cost (requirement 1)
$40
Volume variance, favorable
$40,000
An expanded cost of goods sold section follows.

13-18


Beginning inventory,
3,000 x $65
Variable production costs, 16,000 x $25
Fixed production costs, 16,000 x $40
Total available, 19,000 x $65
Less ending inventory, 5,000 x $65
Standard cost of sales, 14,000 x $65
3.

$

195,000
400,000
640,000
1,235,000
325,000
$ 910,000

Income statement, variable costing

Sales,
14,000 x $90
Standard variable cost of sales, 14,000 x $25
Contribution margin, 14,000 x $65
Fixed costs:
Manufacturing
$600,000
Selling and administrative
160,000
Total fixed costs
Profit

$1,260,000
350,000
910,000

$

760,000
150,000

An expanded cost of goods sold section follows.

Beginning inventory,
3,000 x $25
Variable production costs, 16,000 x $25
Total available, 19,000 x $25
Less ending inventory, 5,000 x $25

Standard cost of sales, 14,000 x $25
13-29
1.

$ 75,000
400,000
475,000
125,000
$350,000

Absorption Costing and Variable Costing--Variances

(15-20 minutes)

$3 per unit, $900,000/300,000; total standard cost is $9, $3 + $6

2.
Actual Fixed Overhead
Overhead

Budgeted Fixed Overhead

$910,000

Applied Fixed
$3 x 290,000
$870,000

$900,000
$10,000 U

Budget variance

$30,000 U
Volume variance

$40,000 U
Total fixed overhead variances
Total actual variable costs
Total standard variable costs (290,000 x $6)
Variable cost variances
Fixed overhead variances
Total variances

$1,715,000
1,740,000
25,000 F
40,000 U
$
15,000 U

3.
Sales (270,000 x $20)
Standard cost of sales (270,000 x $9)
Variances
Cost of sales
Gross margin
Selling and administrative expenses
Income

$5,400,000

$2,430,000
15,000 U
2,445,000
2,955,000
800,000
$2,155,000

4.
Sales (270,000 x $20)
Standard cost of sales (270,000 x $6)
Variable cost variances

13-19

$5,400,000
$1,620,000
25,000 F

1,595,000


Gross margin and contribution margin
Fixed costs ($800,000 + $910,000)
Income
13-30
1.

Budgeted Income Statements

3,805,000

1,710,000
$2,095,000

(20 minutes)

Absorption costing income statement

Sales, 37,000 x $70
Standard cost of sales, 37,000 x $40
Standard gross margin, 37,000 x $30
Volume variance*
Actual gross margin
Selling and administrative expenses:
Variable, 37,000 x $8
Fixed
Profit
* Budgeted production
Normal activity
Difference
Standard fixed cost
Volume variance, unfavorable

$2,590,000
1,480,000
1,110,000
25,000 U
1,085,000
$296,000
600,000
$

896,000
189,000

39,000
40,000
1,000
$25
$25,000

An expanded cost of goods sold section appears as follows.
Variable production costs, 39,000 x $15
Fixed production costs, 39,000 x $25
Total available, 39,000 x $40
Less ending inventory, 2,000 x $40
Standard cost of sales, 37,000 x $40
2.

585,000
975,000
1,560,000
80,000
$1,480,000

Income statement, variable costing

Sales,
37,000 x $70
Standard variable cost of sales, 37,000 x $15
Variable manufacturing margin, 37,000 x $55

Variable selling and
administrative expenses,
37,000 x $8
Contribution margin, 37,000 x $47*
Fixed costs:
Manufacturing
$1,000,000
Selling and administrative
600,000
Profit
*

$

$2,590,000
555,000
2,035,000
296,000
1,739,000
1,600,000
$ 139,000

$70 - $15 - $8 = $47 contribution margin

An expanded cost of goods sold section follows.
Variable production costs, 39,000 x $15
Less ending inventory, 2,000 x $15
Standard cost of sales, 37,000 x $15

$585,000

30,000
$555,000

The $50,000 difference in income ($189,000 - $139,000) is explained by
the fixed overhead in the ending inventory ($25 x 2,000 pairs).
13-31
1.

Analysis of Results (Continuation of 13-30)

Absorption costing income statement

13-20

(30 minutes)


Sales, 40,000 x $70
Standard cost of sales, 40,000 x $40
Standard gross margin, 40,000 x $30
Volume variance*
Actual gross margin
Selling and administrative expenses:
Variable
40,000 x $8
Fixed
Profit
*
Actual production
Normal activity

Difference
Standard fixed cost
Volume variance, favorable

$2,800,000
1,600,000
1,200,000
25,000
1,225,000
$320,000
600,000
$

F

920,000
305,000

41,000
40,000
1,000
$25
$25,000

An expanded cost of sales section appears below.
Variable production costs, 41,000 x $15
Fixed production costs, 41,000 x $25
Total available, 41,000 x $40
Less ending inventory, 1,000 x $40
Standard cost of sales, 40,000 x $40

2.

$

615,000
1,025,000
1,640,000
40,000
$1,600,000

Income statement, variable costing

Sales,
40,000 x $70
Standard variable cost of sales, 40,000 x $15
Variable manufacturing margin, 40,000 x $55
Variable selling and
administrative expenses,
40,000 x $8
Contribution margin, 40,000 x $47
Fixed costs:
Manufacturing
$1,000,000
Selling and administrative
600,000
Profit

$2,800,000
600,000
2,200,000

320,000
1,880,000
1,600,000
$ 280,000

An expanded cost of goods sold section follows.
Variable production costs, 41,000 x $15
Less ending inventory, 1,000 x $15
Standard cost of sales, 40,000 x $15

$615,000
15,000
$600,000

3. The variable costing income statements provide a better basis for
analyzing results. Income changes purely as a function of the change in
sales. The higher income (actual versus budgeted) under absorption costing
is due in part to increased production, where under variable costing it is
due solely to increased sales. Because goods must be sold to increase profit
(at least at some point they must be sold), variable costing provides a
better basis for evaluating results.
13-32

Analysis of Income Statement--Standard Costs

(25 minutes)

1. (a) 24,000 units, volume variance/application rate = $8,000/$2 = 4,000
units over normal activity of 20,000 units
(b)

$7,000 favorable
Standard use of materials (24,000 x 16)

13-21

384,000


Materials used
Use below standard
Material use variance at $0.50 per pound

370,000
14,000
$ 7,000

(c) $10,000 unfavorable, total unfavorable variance of $3,000 + the
favorable use variance calculated in part b.
(d)

(e)

$12,000 favorable
Standard hours (24,000 x 2 hours/unit)
Actual hours
Hours above standard
Variance at $12 per hour

48,000

47,000
1,000
$12,000

$8,000 unfavorable, total favorable labor variance of $4,000 - the
$12,000 favorable efficiency variance from part d

(f) $1,000 favorable, 1,000 hours under standard from part d x $1
standard
variable overhead rate per hour
(g)

$3,000 unfavorable, total unfavorable variable overhead variance of
$2,000 + the favorable efficiency variance from part f

(h)

2.

$37,000
Total budgeted fixed overhead
$2 standard rate x 20,000 units
Fixed overhead spending variance, favorable
Actual fixed overhead
Variable costing income statement

Sales (20,000 x $50)
Standard variable cost of sales (20,000 x $34)
Standard gross margin
Variances:

Materials
$3,000U
Labor
4,000F
Variable overhead
2,000U
Actual gross margin
Fixed costs:
Production
$ 37,000
Selling and administrative
230,000
Income

$40,000
3,000
$37,000
$1,000,000
680,000
320,000

1,000 U
319,000

$

267,000
52,000

Note that the incomes are easily reconciled:

Increase in inventory (24,000 - 20,000)
4,000
Multiplied by $2 standard fixed cost
$2
Difference in incomes ($60,000 - $52,000)
$8,000
13-33 Conversion of Absorption Costing Statement from Normal to Practical
Capacity (Continuation of 13-32)
(15-20 minutes)
1.

$1.60

($40,000/25,000)

2.
Sales
Standard cost of sales (20,000 x $35.60)*
Standard gross profit
Variances:
Materials
Labor
Variable overhead

13-22

$1,000,000
712,000
288,000
$3,000U

4,000F
2,000U


Fixed overhead--budget
--volume**
Actual gross profit
Selling and administrative expenses
Income

3,000F
1,600U
$

400 F
288,400
230,000
58,400

* $34 + $1.60
** $1.60 x (25,000 - 24,000) = $1,600 unfavorable
Note to the Instructor: You might ask students whether they can
reconcile income here with that in 13-31. The difference in incomes of
$1,600 ($60,000 - $58,400) is the difference in unit fixed costs ($2.00 $1.60) multiplied by the increase of 4,000 units.
Fixed costs in ending inventory at $2 ($2 x 4,000)
Fixed costs in ending inventory at $1.60 ($1.60 x 4,000)
Difference in incomes ($60,000 - $58,400)
13-34

Reconciling Incomes--Absorption Costing

$8,000
6,400
$1,600

(20 minutes)

1.
Sales (214.0 x $20)
Standard cost of sales (214.0 x $9)
Standard gross margin
Volume variance*
Actual gross margin
Selling and administrative expenses
Income
* (220.0 - 210.0) x $5 = $50 U Alternatively,
Budgeted fixed manufacturing cost (220 x $5)
Applied fixed manufacturing cost (210 x $5)
Unfavorable volume variance

$4,280.0
1,926.0
2,354.0
50.0 U
2,304.0
1,800.0
$ 504.0
$1,100
1,050
$

50

There was no fixed overhead budget variance, nor variable cost variances.
Budgeted variable costs for 210,000 units are $840,000, which equalled actual
variable costs.
2.
Memorandum
To:
From:
Subj:
Date:

Lynn Maffett
Student
Operating results
Today

The difficulty with interpreting our results is that we use absorption
costing. Under absorption costing, our income depends partly on production.
The original budget assumed that we would produce 220 thousand units, but we
actually produced only 210 thousand units. We therefore deferred $50
thousand less fixed cost than originally planned [(220 - 210) x $5].
The effect of the change in production is greater than that of the change
in sales. A reconciliation of the incomes is:
Standard gross margin, actual results (214.0 x $11)
Standard gross margin, budgeted results (211.5 x $11)
Difference (2.5 x $11)
Less difference in fixed overhead deferral
Difference in incomes

13-23

$2,354.0
2,326.5
$
27.5
50.0
$
22.5


Note to the Instructor: The difference in volume variances (between
budgeted and actual) equals the actual volume variance because the budgeted
amount was zero. Note that had there been a budgeted volume variance, it
would be necessary to use the differences in volume variances, not the actual
amount.
It is worth pointing out that the budgeted income statement shows income
higher than the company can maintain at that level of sales, which reflects
production in excess of sales. The company cannot continue for long to
produce in excess of sales. The sequel to this assignment uses variable
costing and shows that production does not affect income using that method.
13-35
Reconciling Incomes--Variable Costing (Continuation of 13-34)
minutes)
1.

(15

Budgeted income statement
Sales (211.5 x $20)

Standard cost of sales (211.5 x $4)
Contribution margin
Fixed costs ($1,800 + $1,100)*
Income

$4,230.0
846.0
3,384.0
2,900.0
$ 484.0

* 220 x $5, from 13-33
Actual income statement

Sales (214.0 x $20)
Standard cost of sales (214.0 x $4)
Contribution margin
Fixed costs
Income

$4,280.0
856.0
3,424.0
2,900.0
$ 524.0

2.
The difference in incomes of $40 thousand ($524 - $484) is simply the
additional contribution margin from selling 2,500 more units.
Additional volume

Times contribution margin ($20 - $4)
Additional contribution margin

2,500
$16
$40,000

The change in production is irrelevant, as is the level of production, so
that the variable costing income statements give a clearer picture of the
economic situation than do the absorption costing statements.
13-36

Analyzing Income Statements

(15-20 minutes)

1. Statement A was prepared using variable costing, statement B using
absorption costing. We can determine this several ways: (1) production costs
are higher in statement B because fixed costs are included; (2) ending
inventory is higher in statement B because of the fixed costs included in
inventory; (3) "other costs" are higher in statement A because of the
inclusion of fixed costs as a direct charge-off in the income statement.
2. (a) $900,000, the difference between production costs in the two
statements
(b) $300,000, the amount shown as "other costs" in statement B

13-24


(c) 30,000 units. Since one-third of production costs are included in

ending inventory in both statements and 20,000 units were sold, 20,000 is
two- thirds of production. Also, the variable costing statement shows
$1,800,000 in production costs (must be only variable costs); since variable
cost per unit is $60, production must have been 30,000 units
($1,800,000/$60).
(d) Ending inventory is 10,000 units (production of 30,000 - 20,000
sold). Inventory cost is $60 per unit under variable costing, which is given.
Under absorption costing, $90 per unit is the cost ($900,000/10,000 units).
3.
There is no correct answer to this question. If one accepts the view
that sales managers are most likely to prefer absorption costing because of
the need to "cover" all costs, then the sales manager would probably have
prepared the absorption costing statement, the controller the variable
costing statement. (It might also be argued that the controller would prefer
the simpler and more direct treatment that variable costing affords, though
this is only our opinion.) Others would assume that the absorption costing
statement was prepared by the controller, on the theory that the controller
would be influenced by the demands of financial accounting. Still others
might suggest that the emphasis on "covering all costs" is more likely to
come from the controller, or that the desire to show the best picture would
probably be consistent with the optimism of the sales force rather than the
conservatism of the accounting personnel. Perhaps this is a good place to
discuss (and maybe destroy) some stereotypes.

13-25