7.4 Absorption And Variable Costing

Question 1

How is the fixed portion of manufacturing overhead treated under variable costing?

Answer 1

Fixed manufacturing overhead is expensed as a period cost under variable costing

Question 2

For external reporting purposes, the cost of a product must include all the costs of manufacturing it: direct labor, direct materials, and all factory overhead (both fixed and variable). This method is commonly known as

Answer 2

absorption, full costing, or full absorption costing

Question 3

Under absorption costing, total manufacturing cost per unit includes

Answer 3

both variable and fixed manufacturing costs

Question 4

A corporation had the following unit costs for the recently concluded calendar year:
Variable:
Manufacturing: $8.00
Nonmanufacturing: $2.00

Fixed
Manufacturing: $3.00
Nonmanufacturing: $5.50

Inventory for the sole product totaled 6,000 units on January 1 and 5,200 units on December 31. When compared to variable costing income, absorption costing income is

A. $6,800 higher
B. $2,400 lower
C. $2,400 higher
D. $6,800 lower

Answer 4

B. $2,400 lower.

Since the beginning inventory was 6,000 and ending inventory was 5,200, inventory decreased by 800 units which means sales exceeded production. If production is less than sales, operating income is higher under variable costing. It follows that income is lower under absorption costing.

Fixed manufacturing cost impact = change in inventory x fixed manufacturing cost per unit = 800 x 3 = 2400

Question 5

When comparing absorption costing with variable costing, which of the following statements is false?

A. When sales volume is more than production volume, variable costing will result in higher operating profit.
B. Absorption costing enables managers to increase operating profits in the short run by increasing inventories
C. Under absorption costing, operating profit is a function of both sales volume and production volume.
D. A manger who is evaluated based on variable costing operating profit would be tempted to increase production at the end of a period in order to get more favorable review.

Answer 5

D. A manger who is evaluated based on variable costing operating profit would be tempted to increase production at the end of a period in order to get more favorable review.

Absorption (full) costing is the accounting method that considers all manufacturing costs as product costs. These costs include variable and fixed manufacturing costs whether direct or indirect. Variable (direct) costing considers only variable manufacturing costs to be product costs, i.e., inventoriable. Fixed manufacturing costs are considered period costs and are expensed as incurred. If production is increased without increasing sales, inventories will rise. However, all fixed costs associated with production will be an expense of the period under variable costing. Thus, this action will not artificially increase profits and improve manager’s review.

Question 6

Using absorption costing, fixed manufacturing overhead costs are best described as

A. Direct product costs
B. Indirect period costs
C. Indirect product costs
D. Direct period costs

Answer 6

C. Indirect product costs

Using absorption costing, fixed manufacturing overhead is included in inventoriable (product) costs. Fixed manufacturing costs are indirect costs because they cannot be directly traced to specific units produced.

Question 7

When a firm prepares financial reports by using absorption costing,

A. Profits may decrease with increased sales even if there is no change in selling prices and costs.
B. Profits will always increase with increases in sales.
C. Profits will always decrease with decreases in sales.
D. Decreased output and constant sales result in increased profits.

Answer 7

A. Profits may decrease with increased sales even if there is no change in selling prices and costs.

In an absorption costing system, fixed overhead costs are included in inventory. When sales exceed production, more overhead is expensed under absorption costing due to fixed overhead carried over from the prior inventory. If sales increase over production, more than one period’s overhead is recognized as expense. Accordingly, if the increase in overhead expensed is greater than the contribution margin of the increased units sold, profit may be lower with an increased level of sales.

Question 8

Osawa, Inc., planned and actually manufactured 200,000 units of its single product during its first year of operations. Variable manufacturing costs were $30 per unit of product. Planned and actual fixed manufacturing costs were $600,000, and selling and administrative costs totaled $400,000. Osawa sold 120,000 units of product at a selling price of $40 per unit.

Osawa’s operating income using absorption (full) costing is

A. $200,000
B. $440,000
C. $600,000
D. $840,000

Answer 8

B. $440,000

Absorption costing net income is computed as follows:

Sales (120,000 units × $40): $4,800,000
Variable production costs (200,000 units × $30): $6,000,000
Fixed production costs: 600,000
Total production costs: $6,600,000
Ending inventory (80,000 units × $33): (2,640,000)
Cost of goods sold: (3,960,000)
Gross profit: $ 840,000
Selling and administrative expenses: (400,000)
= Operating income: $ 440,000

Question 9

At the end of its fiscal year, Jubal Manufacturing recorded the data below:

Prime cost: $800,000
Variable manufacturing overhead: 100,000
Fixed manufacturing overhead: 160,000
Variable selling and other expenses: 80,000
Fixed selling and other expenses: 40,000

If Jubal uses variable costing, the inventoriable costs for the fiscal year are

A. $800,000
B. $900,000
C. $980,000
D. $1,060,000

Answer 9

B. $900,000

The only costs capitalized are the variable costs of manufacturing. Prime costs (direct materials and direct labor) are variable.

Prime costs (direct materials and direct labor): $800,000
+Variable manufacturing overhead: 100,000
=Total inventoriable costs: $900,000

Question 10

At the end of its fiscal year, Jubal Manufacturing recorded the data below:

Prime cost: $800,000
Variable manufacturing overhead: 100,000
Fixed manufacturing overhead: 160,000
Variable selling and other expenses: 80,000
Fixed selling and other expenses: 40,000

Using absorption (full) costing, Jubal’s inventoriable costs are

A. $800,000
B. $900,000
C. $1,060,000
D. $1,180,000

Answer 10

C. $1,060,000

The absorption method is required for financial statements prepared according to GAAP. It charges all production costs to inventories. The prime costs of $800,000, variable manufacturing overhead of $100,000, and fixed manufacturing overhead of $160,000 are included. They total $1,060,000.

Question 11

Which one of the following statements is true regarding absorption costing and variable costing?

A. Overhead costs are treated in the same manner under both costing methods.
B. If finished goods inventory increases, absorption costing results in higher income.
C. Variable manufacturing costs are lower under variable costing.
D. Gross margins are the same under both costing methods.

Answer 11

B. If finished goods inventory increases, absorption costing results in higher income.

Under variable costing, inventory is charged only with variable production costs. Fixed manufacturing costs are expensed as period costs. Absorption costing charges all production costs to inventory. If finished goods inventory increases, absorption costing results in higher income because it capitalizes some fixed costs that are expensed under variable costing. When inventory declines, variable costing results in higher income because some fixed costs capitalized under the absorption method in prior periods are expensed in the current period.

Question 12

Absorption costing and variable costing are two different methods of assigning costs to units produced. Of the four cost items listed below, identify the one that is not correctly accounted for as a product cost.

A. Manufacturing supplies
- Absorption Costing: yes
- Variable costing: yes
B. Insurance on factory
- Absorption Costing: yes
- Variable costing: no
C. Direct labor cost
- Absorption Costing: yes
- Variable costing: yes
D. Packaging and shipping costs
- Absorption Costing: yes
- Variable costing: yes

Answer 12

D. Packaging and shipping costs
- Absorption Costing: yes
- Variable costing: yes

Under absorption costing, all manufacturing costs, both fixed and variable, are treated as product costs. Under variable costing, only variable costs of manufacturing are inventoried as product costs. Fixed manufacturing costs are expensed as period costs. Packaging and shipping costs are not product costs under either method because they are incurred after the goods have been manufactured. Instead, they are included in selling and administrative expenses for the period.

Question 13

Which of the following statements is true for a firm that uses variable costing?

A. The cost of a unit of product changes because of changes in number of units manufactured.
B. Profits fluctuate with sales.
C. An idle facility variation is calculated.
D. Product costs include variable administrative costs.

Answer 13

B. Profits fluctuate with sales.

In a variable costing system, only the variable costs are recorded as product costs. All fixed costs are expensed in the period incurred. Because changes in the relationship between production levels and sales levels do not cause changes in the amount of fixed manufacturing cost expensed, profits more directly follow the trends in sales.

Question 14

Osawa, Inc., planned and actually manufactured 200,000 units of its single product during its first year of operations. Variable manufacturing costs were $30 per unit of product. Planned and actual fixed manufacturing costs were $600,000, and selling and administrative costs totaled $400,000. Osawa sold 120,000 units of product at a selling price of $40 per unit.

Osawa’s operating income for the year using variable costing is

A. $200,000
B. $440,000
C. $800,000
D. $600,000

Answer 14

A. $200,000

The contribution margin from manufacturing (Sales – Variable costs) is $10 ($40 – $30) per unit sold, or $1,200,000 (120,000 units × $10). The fixed costs of manufacturing ($600,000) and selling and administrative costs ($400,000) are deducted from the contribution margin to arrive at an operating income of $200,000.

Question 15

Which one of the following considers the impact of fixed overhead costs?

A. Variable costing.
B. Full absorption costing.
C. Direct costing.
D. Marginal costing.

Answer 15

B. Full absorption costing.

Full absorption costing treats fixed factory overhead costs as product costs. Thus, inventory and cost of goods sold include (absorb) fixed factory overhead.

Question 16

A corporation produces and sells smart phones. The following information relates to operations for the last year:

Variable cost per unit: $5.20
Total fixed manufacturing overhead cost: $260,000
Total fixed selling and administrative cost: $180,000
Units produced and sold: 400,000

Using absorption costing, what was the cost per unit last year?

A. $6.30
B. $5.00
C. $4.55
D. $5.85

Answer 16

D. $5.85

Under absorption costing, the fixed portion of manufacturing overhead is “absorbed” into the cost of each unit of product. Product cost thus include all manufacturing costs, both fixed and variable. The total manufacturing cost is equal to $2,340,000 [($5.20 × 400,000) + $260,000]. The cost per unit is thus $5.85 ($2,340,000 ÷ 400,000).

Question 17

At the start of its fiscal year, a company anticipated producing 300,000 units throughout the year. The annual budgeted manufacturing overhead was $150,000 for variable costs and $600,000 for fixed costs. In April, when there was a beginning inventory for finished goods of 5,000 units, the company showed an income of $40,000 using absorption costing. That same month, ending inventory for finished goods was 7,000 units. What amount would the company recognize as income for April using variable costing?

A. $45,000
B. $44,000
C. $36,000
D. $35,000

Answer 17

C. $36,000
The difference between variable costing and absorption costing is the treatment of fixed costs. Under absorption costing, the fixed portion of manufacturing overhead is included in the cost of each product. Under variable costing, product cost includes only variable manufacturing costs and fixed costs are treated as period costs. The rate for assigning fixed overhead costs is $2 per unit ($600,000 budgeted fixed overhead costs ÷ 300,000 budgeted production units). Because the ending inventory in April is 2,000 units greater than the beginning inventory, the company produced more units than it sold. In April, under absorption costing, $4,000 ($2 fixed overhead rate per unit × 2,000 units produced and not sold) of fixed manufacturing overhead costs were still embedded in ending inventory and were not expensed. Under variable costing, these fixed manufacturing overhead costs of $4,000 were expensed. Therefore, the operating income under the absorption costing is $4,000 greater than under the variable costing. Therefore, operating income under variable costing is $36,000 ($40,000 – $4,000).

Question 18

During the month of May, a corporation sold 1,000 units. The cost per unit for May was as follows:

Cost per unit
Direct materials: $ 5.50
Direct labor cost per unit: 3.00
Variable manufacturing overhead: 1.00
Fixed manufacturing overhead: 1.50
Variable administrative costs: .50
Fixed administrative costs: 3.50
Total: $15.00

May’s income using absorption costing was $9,500. The income for May, if variable costing had been used, would have been $9,125. The number of units produced during May was

A. 1,250
B. 1,075
C. 750
D. 925

Answer 18

A. 1,250

The difference between absorption-basis and variable-basis operating income ($9,500 – $9,125 = $375) is equal to the change in inventory for the period (in units) multiplied by fixed manufacturing cost per unit. Stated another way, the difference in operating incomes divided by fixed per-unit manufacturing cost equals the change in ending inventory ($375 ÷ $1.50 = 250 units). Since 1,000 units were sold and ending inventory increased by 250 units, 1,250 units were produced (1,000 + 250).

Question 19

Which of the following costs are generally included in a calculation of operating income when using absorption costing?

I. Fixed direct manufacturing costs
II. Variable direct manufacturing costs
III. Variable manufacturing overhead costs
IV. Fixed manufacturing overhead costs

A. I and IV only.
B. I, II, III, and IV.
C. I, II, and III only.
D. II and III only.

Answer 19

B. I, II, III, and IV.
Under absorption costing, the fixed portion of manufacturing overhead is absorbed into the cost of each unit product. Product cost thus includes all manufacturing costs, both fixed and variable.

Question 20

Huron Industries has developed two new products but has only enough plant capacity to introduce one product during the current year. The following data will assist management in deciding which product should be selected.
Huron’s fixed overhead includes rent and utilities, equipment depreciation, and supervisory salaries. Selling and administrative expenses are not allocated to products.

*Raw materials
Product A: $ 44.00
Product B: $ 36.00
*Machining @ $12/hour
Product A: 18.00
Product B: 15.00
*Assembly @ $10/hour
Product A: 30.00
Product B: 10.00
*Variable overhead @ $8/hour
Product A: 36.00
Product B: 18.00
*Fixed overhead @ $4/hour
Product A: 18.00
Product B: 9.00
*Total cost
Product A: $ 146.00
Product B: $ 88.00
*Suggested selling price
Product A: $ 169.95
Product B: $ 99.98
*Actual research & development costs
Product A: $240,000
Product B: $175,000
*Proposed advertising & promotion costs
Product A: $500,000
Product B: $350,000

The difference between the $99.98 suggested selling price for Huron’s Product B and its total unit cost of $88.00 represents the unit’s

A. Contribution.
B. Contribution margin ratio.
C. Gross profit margin ratio.
D. Gross profit.

Answer 20

D. Gross profit

Gross profit is the difference between sales price and the full absorption cost of goods sold.

Question 21

The costing method that is properly classified for both external and internal reporting purposes is

A. Job-order costing
- External Reporting: No
- Internal Reporting: Yes
B. Process Costing
- External Reporting: No
- Internal Reporting: No
C. Variable Costing
- External Reporting: No
- Internal Reporting: Yes
D. Activity-based costing
- External Reporting: No
- Internal Reporting: Yes

Answer 21

C. Variable Costing
- External Reporting: No
- Internal Reporting: Yes

Activity-based costing, job-order costing, process costing, and standard costing can all be used for both internal and external purposes. Variable costing is not acceptable under GAAP for external reporting purposes.

Question 22

During the first month of its operations, a company manufactured a product with variable production costs of $50 per unit. Fixed manufacturing overhead totaled $1,800,000 and is allocated based upon units produced. During the month, the company completed 15,000 units, sold 12,000 units, and incurred no variances. If the company’s operating income under absorption costing was $400,000, its operating income (loss) under variable costing was

A. $(110,000)
B. $760,000
C. $(50,000)
D. $40,000

Answer 22

D. $40,000

The key difference between variable costing and absorption costing in this circumstance is the treatment of fixed overhead. Absorption costing treats all manufacturing costs as product costs, while variable costing considers only variable manufacturing costs to be product costs. Under absorption costing, only $1,440,000 [($1,800,000 ÷ 15,000 units produced) × 12,000 units sold] of fixed overhead costs are recognized in the period; under variable costing, all $1,800,000 of fixed overhead costs are recognized. Thus, there is an increase in cost and a resulting decrease in operating income of $360,000 ($1,800,000 – $1,440,000), which leads to an operating income under variable costing of $40,000.