Chapter 7

Question 1

What are inventoriable costs

Answer 1

expenses that are directly related to the production of goods and are included in the value of inventory.

Question 2

What is variable costing?

Answer 2

Variable costing is a method where all variable manufacturing costs are included as inventoriable costs. Fixed manufacturing costs are excluded from inventoriable costs and are treated as period costs.

Question 3

What is absorption costing

Answer 3

Absorption costing includes all variable and fixed manufacturing costs as inventoriable costs. In absorption costing, stock ‘absorbs’ all manufacturing costs.

Question 4

How are fixed manufacturing costs accounted for under absorption costing?

Answer 4

Fixed manufacturing costs are initially treated as stock-based costs and become an expense in the form of cost of goods sold when sales occur.

Question 5

How are fixed manufacturing costs accounted for under variable costing?

Answer 5

Fixed manufacturing costs are deducted as a period cost in the period in which they are incurred.

Question 6

What is the focus of the variable-costing income statement?

Answer 6

The variable-costing income statement differentiates between fixed and variable costs and calculates a contribution margin, which equals sales minus variable costs. This format is called the contribution format.

Question 7

What does the absorption-costing income statement focus on?

Answer 7

The absorption-costing income statement calculates a gross margin, which equals sales less cost of goods sold. It highlights the distinction between manufacturing and non-manufacturing costs.

Question 7

What is the difference between fixed and variable costs in the context of variable costing?

Answer 7

The distinction between fixed and variable costs is central to variable costing, and it is highlighted through the contribution format.

Question 8

Why is the term “Direct Costing” misleading for variable costing? (3)

Answer 8

1. Variable costing does not include all direct costs as inventoriable costs. It includes only direct variable manufacturing costs
2. Variable costing includes some indirect costs, specifically variable indirect manufacturing costs, as inventoriable costs, not just direct costs.

Question 9

What happens to operating profit under variable costing when stock levels increase?

Answer 9

When stock levels increase, absorption costing reports higher operating profit than variable costing, as some fixed manufacturing costs are included in stock rather than expensed immediately

Question 10

What happens to operating profit under variable costing when stock levels decrease?

Answer 10

When stock levels decrease, variable costing shows higher operating profit than absorption costing because more fixed manufacturing costs are released from stock in absorption costing, increasing expenses.

Question 11

What causes the difference in operating profit between variable and absorption costing?

Answer 11

The difference in operating profit is due to the movement of fixed manufacturing costs into stock as stock increases, and out of stock as it decreases.

Question 12

How can you calculate the difference in operating profit between absorption and variable costing?

Answer 12

The difference can be calculated using a formula that accounts for the movement of fixed manufacturing costs into or out of stock, assuming manufacturing overhead variances are prorated.

Question 13

formulas page 29

Question 14

Explain profit and absorption costing

Answer 14

Managers can increase profits by producing more units, even if customer demand isn’t increasing. This is because producing more means fixed costs (like rent or salaries) are spread over more units, reducing the cost per unit and increasing reported profits

Question 15

Negative effects of increasing production without demand (absorping costing) (3)

Answer 15

1. Managers might cherry-pick orders that absorb the most fixed costs rather than prioritizing customer demand, which could lead to missed delivery deadlines.
2. A manager might accept an order that isn’t suited for their plant, causing inefficiencies.
3. They might delay maintenance to keep production high in the current period, but this could lead to higher repair costs and reduced efficiency in the future.

Question 16

Criticism of absorption costing

Answer 16

creates incentives for managers to focus on short-term profit boosts rather than long-term efficiency and customer satisfaction.

Question 17

What are their proposals for changing this system:

Answer 17

1. Change the accounting system
2. Change the time period for evaluating performance
3. Careful budgeting and stock planning
4. Include non-financial measures

Question 18

What does “capacity” mean in the context of denominator-level concepts?

Answer 18

Capacity means a constraint or upper limit.

Question 19

What is theoretical capacity?

Answer 19

Theoretical capacity is based on the production of output at full efficiency for all of the time.

Question 20

How does practical capacity differ from theoretical capacity?

Answer 20

Practical capacity reduces theoretical capacity for unavoidable operating interruptions.

Question 21

What do theoretical capacity and practical capacity measure?

Answer 21

They measure the denominator level in terms of what a plant can supply.

Question 22

What do utilization and master-budget utilization measure?

Answer 22

hey measure the denominator level in terms of demand for the output of the plant.

Question 23

What is normal utilization?

Answer 23

Normal utilization is based on the level of capacity utilization that satisfies average customer demand over a period that includes seasonal, cyclical, or other trend factors.

Question 24

What is master-budget utilization?

Answer 24

Master-budget utilization is based on the anticipated level of capacity utilization for the next budget period.

Question 25

Why might master-budget utilization be preferred over normal utilization?

Answer 25

Because forecasting normal utilization can be difficult in industries with long-run cyclical patterns.

Question 26

How does the choice of denominator level affect financial statements?

Answer 26

It affects the production-volume variance, stock, operating profit amounts, pricing, and contract reimbursement. The smaller the denominator level, the higher the fixed manufacturing overhead cost per output unit that is inventoriable.