Planning and Measurement - Part 2

Question 1

Dough Distributors has decided to increase its daily muffin purchases by 100 boxes. A box of muffins costs $2 and sells for $3 through regular stores. Any boxes not sold through regular stores are sold through Dough’s thrift store for $1. Dough assigns the following probabilities to selling additional boxes:

Additional sales 	Probability
60 	.6
100 	.4
What is the expected value of Dough's decision to buy 100 additional boxes of muffins?
	A.  	$28.
	B.  	$40.
	C.  	$52.
	D.  	$68.

Answer 1

C. $52.

Income or net cash inflow is expected to increase:

$52 = .6[60($3-$2) + 40($1-$2)] + .4[100($3-$2)].

The .6[ ] term reflects the expected sales of 60 units at regular price less their cost, and 40 at the reduced price less their cost. The .4[ ] term reflects the expected sales all at regular prices less their cost.

Question 2

The coefficient of determination, r squared, in a multiple regression equation is the
A. Percentage of variation in the independent variables explained by the variation in the dependent variable.
B. Percentage of variation in the dependent variable explained by the variation in the independent variables.
C. Measure of the proximity of actual data points to the estimated data points.
D. Coefficient of the independent variable divided by the standard error of regression coefficient.

Answer 2

B. Percentage of variation in the dependent variable explained by the variation in the independent variables.

The definition of r squared reflects the overall model’s explanatory power of the independent variables in predicting the dependent variable.

Question 3

Johnson Co., distributor of candles, has reported the following budget assumptions for year 1: No change in candles inventory level; cash disbursement to candle manufacturer, $300,000; target accounts payable ending balance for year 1 is 150% of accounts payable beginning balance; and sales price is set at a markup of 20% of candle purchase price. The candle manufacturer is Johnson's only vendor, and all purchases are made on credit. The accounts payable has a balance of $100,000 at the beginning of year 1. What is the budgeted gross margin for year 1?
	A.  	$60,000
	B.  	$70,000
	C.  	$75,000
	D.  	$87,500

Answer 3

B. $70,000

Gross Profit ($70,000) is determined by subtracting Cost of Goods Sold ($350,000) from Sales ($420,000). Sales is calculated by multiplying a markup of 20% based on cost of goods sold (i.e., $420,000 = 1.2($350,000). Cost of Goods Sold is easily determined by using an accounts payable T-account to calculate purchases of $350,000 by using the cash paid of $300,000 and the beginning and ending balances of accounts payable ($100,000 and $150,000, respectively).

Question 4

Which of the following would be most impacted by the use of the percentage of sales forecasting method for budgeting purposes?
	A.  	Accounts payable.
	B.  	Mortgages payable.
	C.  	Bonds payable.
	D.  	Common stock.

Answer 4

A. Accounts payable.

The percentage of sales forecasting method is used to define operating costs such as cost of goods sold, supplies expense, sales discounts, etc. It also defines the percentage of sales that are collected in cash and the percentage of purchases that are paid for in cash and, consequently, accounts payable.

Question 5

A flexible budget is appropriate for a
	  Marketing budget  	  Direct material usage budget  
	 No 	 No 
	 No 	 Yes 
	 Yes 	 Yes 
	 Yes 	 No

Answer 5

Marketing budget Direct material usage budget

 Yes 	 Yes 

Flexible budgets are budgets produced at different activity levels. Direct material usage budgets are commonly prepared for different activity levels to indicate the level of cost that should be incurred at those levels. The actual cost is then compared with the budget for the level of activity actually attained. The comparison is much more relevant for evaluation purposes than would be the comparison between the actual and the master or static budgets if the level of activity in the master and static budgets were not the same.

The same idea applies for marketing cost, although there typically is less “flex” in this type of budgeted cost. A good proportion of the marketing cost is fixed. Other portions are variable (e.g., commissions). Both costs, however, can be expressed as part of a flexible budget. Many flexible budgets include fixed components. The term “flexible” budget does not imply the exclusion of fixed costs.

Question 6

What is the required unit production level given the following factors?

	Units
Projected sales 	1,000
Beginning inventory 	85
Desired ending inventory 	100
Prior-year beginning inventory 	200
	A.  	915.
	B.  	1,015.
	C.  	1,100.
	D.  	1,215.

Answer 6

B. 1,015.

Since the desired ending inventory is 15 units more than the beginning inventory, production must be 15 units greater than the projected sales level of 1,000 units.

Question 7

A Year 1 cash budget is being prepared for the purchase of Toyi, a merchandise item. The budgeted data are as follows:

Cost of goods sold for Year 1 	$300,000
Accounts payable 1/1/Year 1 	20,000
Inventory - 1/1/Year 1 	30,000
12/31/05 	42,000
Purchases will be made in 12 equal monthly amounts and paid for in the following month. What is the Year 1 budgeted cash payment for the purchase of Toyi?
	A.  	$295,000.
	B.  	$300,000.
	C.  	$306,000.
	D.  	$312,000.

Answer 7

C. $306,000.

First, the budgeted annual purchases of the item must be determined, and then the budgeted payment amount is calculated.

Beginning inventory + purchases = ending inventory + cost of goods sold
$30,000 + purchases = $42,000 + $300,000
purchases = $312,000

Budgeted cash payment = accounts payable at 1/1/Year 1 + (11/12)purchases for purchases in Year 1
=$20,000 + (11/12)($312,000)
= $306,000
Only 11/12 of the Year 1 purchases, i.e., the purchases made in the first eleven months, will be paid for in Year 1 under the company’s policy of payment for purchases.

Question 8

A static budget contains which of the following amounts?
A. Actual costs for actual output.
B. Actual costs for budgeted output.
C. Budgeted costs for actual output.
D. Budgeted costs for budgeted output.

Answer 8

D. Budgeted costs for budgeted output.

A static budget is a comprehensive financial plan produced at the beginning of the year for the entire enterprise and does not change (or flex) during the year. Thus, it uses budgeted costs based on budgeted output.

Question 9

Lon Co.’s budget committee is preparing its master budget on the basis of the following projections:

Sales $2,800,000
Decrease in inventories 70,000
Decrease in accounts payable 150,000
Gross margin 40%

What are Lon's estimated cash disbursements for inventories?
	A.  	$1,040,000.
	B.  	$1,200,000.
	C.  	$1,600,000.
	D.  	$1,760,000.

Answer 9

D. $1,760,000.

First, purchases must be computed, and then the estimated payments to be made on accounts payable. With inventory declining, purchases must equal cost of sales less the decline in inventory. In other words, purchases are less than cost of sales if inventory declines. If the gross margin is 40% of sales, then cost of sales is 60% of sales.
Purchases = cost of sales - inventory decline
= (.60)($2,800,000) - $70,000
= $1,610,000

If accounts payable (AP) is to decrease, payments on AP must exceed purchases. Estimated payments on AP = $1,610,000 + $150,000 decrease in AP = $1,760,000.

Question 10

State College is using cost-volume-profit analysis to determine tuition rates for the upcoming school year. Projected costs for the year are as follows:

Contribution margin per student $ 1,800
Variable expenses per student 1,000
Total fixed expenses 360,000

Based on these estimates, what is the approximate break-even point in number of students?
	A.  	129
	B.  	200
	C.  	360
	D.  	450

Answer 10

B. 200

This answer satisfies the basic breakeven quantity formula of fixed costs divided by contribution margin per unit (i.e., $360,000/$1,800).

Question 11

State College is using cost-volume-profit analysis to determine tuition rates for the upcoming school year. Projected costs for the year are as follows:

Contribution margin per student $ 1,800
Variable expenses per student 1,000
Total fixed expenses 360,000

Based on these estimates, what is the approximate break-even point in number of students?
	A.  	129
	B.  	200
	C.  	360
	D.  	450

Answer 11

B. 200

This answer satisfies the basic breakeven quantity formula of fixed costs divided by contribution margin per unit (i.e., $360,000/$1,800).

Question 12

Trendy Co. produced and sold 30,000 backpacks during the last year at an average price of $25 per unit. Unit variable costs were the following:

Variable manufacturing costs $9
Variable selling and administrative costs 6
Total $15

Total fixed costs were $250,000. There was no year-end work-in-process inventory. If Trendy had spent an additional $15,000 on advertising, then sales would have increased by $30,000. If Trendy had made this investment, what change would have occurred in Trendy's pretax profit?
	A.  	$3,000 increase.
	B.  	$4,200 increase.
	C.  	$3,000 decrease.
	D.  	$4,200 decrease.

Answer 12

C. $3,000 decrease.

This problem compares the increase in revenue due to the possible increased spending on advertising. The $15,000 for advertising is just another fixed cost. The contribution margin ratio is used to determine 40% of the new revenue of $780,000 = $312,000 resulting in only $12,000 more in contribution margin as compared to a new fixed advertising cost $15,000. The difference between the $15,000 and the $12,000 is a $3,000 decrease in income.

Question 13

In Year 1, Thor Lab supplied hospitals with a comprehensive diagnostic kit for $120. At a volume of 80,000 kits, Thor had fixed costs of $1,000,000 and a profit before income taxes of $200,000. Due to an adverse legal decision, Thor’s Year 2 liability insurance increased by $1,200,000 over Year 1.

Assuming the volume and other costs are unchanged, what should the Year 2 price be if Thor is to make the same $200,000 profit before income taxes?
	A.  	$120.00.
	B.  	$135.00.
	C.  	$150.00.
	D.  	$240.00.

Answer 13

B. $135.00.

The problem first requires that the variable cost per unit (V) be computed so that the price can then be made a variable. V does not change in the question.

80,000($120 - V) - $1,000,000 = $200,000
V = $105

Now to solve for the new selling price S

80,000(S - $105) - $2,200,000 = $200,000
S = $135

Question 14

Del Co. has fixed costs of $100,000 and breakeven sales of $800,000.
What is its projected profit at $1,200,000 sales?
A. $50,000.
B. $150,000.
C. $200,000.
D. $400,000.

Answer 14

A. $50,000.

The objective is to determine the contribution margin ratio and apply it to the sales figure. This results in the total contribution margin because the contribution margin ratio is (sales - variable costs)/sales. Then subtract fixed cost to find the projected profit.

Breakeven sales = fixed cost/contribution margin ratio
$800,000 = $100,000/cmr
.125 = cmr
Projected profit = .125($1,200,000) - $100,000 = $50,000

Question 15

Cott Company has sales of $200,000, a contribution margin of 20%, and a margin of safety of $80,000. What is Cott's fixed cost?
	A.  	$16,000.
	B.  	$24,000.
	C.  	$80,000.
	D.  	$96,000.

Answer 15

B. $24,000.

The margin of safety is the difference between current sales and breakeven sales. Thus, breakeven sales are $120,000 ($200,000 - $80,000).

In other words, the firm has breathing room of $80,000 of sales. Sales could fall by this amount before the firm would dip below breakeven.

breakeven sales = Fixed cost/contribution margin percentage
$120,000 = Fixed cost/.20
$24,000 = Fixed cost

Question 16

Selected costs associated with a product are as follows:

Total standard hours for units produced 5,000
Total actual direct labor cost $111,625.00
Actual per hour labor rate $23.50
Standard per hour labor rate $24.00

What amount is the total direct labor price variance?
	A.  	$2,375 unfavorable.
	B.  	$2,375 favorable.
	C.  	$2,500 unfavorable.
	D.  	$2,500 favorable.

Answer 16

B. $2,375 favorable.

To solve this we would use the formula (SP - AP) AQ. We are given SP and AP, but not AQ. We can find the AQ by dividing the actual total cost of $111,625 by the AP of $23.50 to get 4,750 hours. Now we multiply AQ of 4,750 by the $0.50 difference between the SP of $24 and the AP of $23.50 to get the price variance of $2,375. Since the actual price of $23.50 is less than the expected standard cost of $24, the variance is favorable.

Question 17

Relevant information for material A follows:

Actual quantity purchased 6,500 lbs.
Standard quantity allowed 6,000 lbs.
Actual price $3.80
Standard price $4.00

What was the direct material quantity variance for material A?
	A.  	$2,000 favorable.
	B.  	$1,900 favorable.
	C.  	$1,900 unfavorable.
	D.  	$2,000 unfavorable.

Answer 17

D. $2,000 unfavorable.

Quantity variances are calculated as the actual quantity less standard quantity, multiplied by standard price: (AQ - SQ) SP. Thus, (6,500 lbs. - 6,000 lbs.) $4.00 = $2,000. The variance is unfavorable since actual quantity required of 6,500 lbs. was more than the planned level of 6,000 lbs.

Question 18

Yola Co. manufactures one product with a standard direct labor cost of four hours at $12.00 per hour. In June, 1,000 units were produced using 4,100 hours at $12.20 per hour. The unfavorable direct labor efficiency variance was
	A.  	$1,220.
	B.  	$1,200.
	C.  	$820.
	D.  	$400.

Answer 18

B. $1,200.

The DL efficiency variance =
(actual labor hours)(standard wage rate) - (standard labor hours)(standard wage rate) =
(4,100)($12) - (1,000 units x 4 hours)($12) =
$49,200 - $48,000 = $1,200

Question 19

Virgil Corp. uses a standard cost system. In May, Virgil purchased and used 17,500 pounds of materials at a cost of $70,000. The materials usage variance was $2,500 unfavorable, and the standard materials allowed for May production was 17,000 pounds. What was the materials price variance for May?

A.  	$17,500 favorable.
B.  	$17,500 unfavorable.
C.  	$15,000 favorable.
D.  	$15,000 unfavorable.

Answer 19

A. $17,500 favorable.

This answer is correct. Using the model suggested in the study text to perform the calculations:

Units 	Price/Unit 	Total Standard Costs 	17,000 lbs. 	x Std. Price 	= ??? Actual Costs 	17,500 lbs. 	x $4.00* 	= $70,000 Differences 	(500) lbs. 	??? 	??? *Actual Price = $70,000/17,500 lbs. = $4.00

Usage variance = ($2,500) = Difference in Units x Std. Price
= (500) x Std. Price
Std. Price = ($2,500) / (500) = $5.00 per unit

Substituting the standard price into the previous calculation, we now have:

Units 	Price/Unit 	Total Standard Costs 	17,000 lbs. 	x $5.00 	= $85,000 Actual Costs 	17,500 lbs. 	x $4.00* 	= $70,000 Differences 	(500) lbs. 	$1.00 	$15,000

Price variance = Difference in Price x Actual Quantity Used =
$1.00 x 17,500 = 17,500 favorable various
Check: Usage Variance + Price Variance = Total Difference in Costs
($2,500) + $17,500 = $15,000

Question 20

In Year 1, a department’s three-variance overhead standard costing system reported unfavorable spending and volume variances. The activity level selected for allocating overhead to the product was based on 80% of practical capacity.

If 100% of practical capacity had been selected instead, how would the reported unfavorable spending and volume variances have been affected?
Spending variance Volume variance
A. Increased Unchanged
B. Increased Increased
C. Unchanged Increased
D. Unchanged Unchanged

Answer 20

C. Unchanged Increased

The spending variance is unaffected by the volume used for allocating the fixed overhead. The spending variance for the variable overhead is the difference between the actual overhead and the budgeted overhead based on actual direct labor hours. The spending variance for the fixed overhead is the difference between the actual overhead and the master budget for the fixed overhead. Neither variance is affected by the denominator used for allocating the fixed overhead.

However, the volume variance (computed for fixed overhead only) is the difference between the master budgeted fixed overhead and the allocated fixed overhead. The allocated fixed overhead is the product of the predetermined overhead rate per direct labor hour, and standard direct labor hours. An increase in the denominator of the predetermined fixed overhead rate from 80% to 100% of capacity would cause the predetermined overhead rate to decline, along with the allocated fixed overhead. This would increase the volume variance because the master budgeted fixed overhead would remain unchanged.

Question 21

The most likely strategy to reduce the breakeven point would be to
A. Increase both the fixed costs and the contribution margin.
B. Decrease both the fixed costs and the contribution margin.
C. Decrease the fixed costs and increase the contribution margin.
D. Increase the fixed costs and decrease the contribution margin.

Answer 21

C. Decrease the fixed costs and increase the contribution margin.

Question 22

Breakeven analysis assumes that over the relevant range
	A.  	Unit revenues are nonlinear.
	B.  	Unit variable costs are constant.
	C.  	Total costs are constant.
	D.  	Total fixed costs are nonlinear.

Answer 22

B. Unit variable costs are constant.

In a graph with the Y-axis being cost and the X-axis being activity level, total variable cost begins at the origin and is an upward sloping line. The slope of this curve is variable cost per unit of activity and is a constant. If variable cost were not assumed to be a constant in the relevant range, breakeven analysis would not be possible.

Question 23

Allen Harvey, an accounting major, is considering a full-time internship during the spring semester of his junior year. The internship opportunity is located in the town where he attends school, so he would be able to continue to live in his apartment that costs $600 per month.
The internship would pay $1,200 per month for January through May. If he does not take the internship, he will attend school at a cost of $4,000 for the semester.

If Harvey decides to stay in school full-time during the spring semester, which one of the following would be the amount of his opportunity cost and the amount of his incremental (or differential) cost?
Opportunity Cost Incremental Cost
A. $6,000 $6,000
B. $6,000 $10,000
C. $10,000 $10,000
D. $10,000 $13,000

Answer 23

B. $6,000 $10,000

Opportunity cost comprises the benefits associated with an alternative that is given up as a result of choosing another alternative. In this case, by choosing to stay in school, Harvey foregoes the pay he would have received from the internship, or $1,200 x 5 months (January - May) = $6,000.

Incremental cost (also called differential cost) is the difference in total cost between two decision alternatives; in this case, between going to school and going to work.

Going to school would cost $4,000 for the semester. Going to work would have provided a benefit of $6,000 (5 months x $1,200 per month). Thus, the total difference between the two alternatives is $10,000.
By going to school, Harvey incurs a total economic cost of $10,000. Or, put another way, if Harvey goes to work, he earns $6,000 and does not have the $4,000 cost of going to school.

Question 24

Which of the following items is never relevant to a sell or process further decision?
A. Incremental revenue after the split-off point.
B. Incremental cost after the split-off point.
C. Joint costs.
D. Additional contribution margin realized if processed further.

Answer 24

C. Joint costs.

Joint costs are sunk costs that are unavoidable, regardless of whether the item is sold at split-off or processed further.

Question 25

Which of the following performance measures is nonfinancial?
	A.  Percentage of defective products.
	B.  Return on investment.
	C.  Gross profit margin.
	D.  Economic value-added.

Answer 25

A. Percentage of defective products.

“Percentage of defective products” is not an expression of money. All other answer choices are expressed in dollars or a return metric that is comprised of dollars.

Question 26

Under the balanced scorecard concept developed by Kaplan and Norton, employee satisfaction and retention are measures used under which of the following perspectives?
	A.  Customer.
	B.  Internal business.
	C.  Learning and growth.
	D.  Financial.

Answer 26

C. Learning and growth.

This answer is correct. Measures of learning and growth are related to the quality, vitality, and productivity of the workforce and include such things as employee turnover, new product development, product improvements, employee satisfaction levels, and personnel training and education

Question 27

A cost leadership strategy, in addition to focusing on the company’s ability to sell a large volume of low-cost products, is often aided by all of the following characteristics except
A. Proprietary production technology.
B. Access to low-cost production inputs (raw materials, labor, etc.).
C. More highly desirable product features.
D. Access to low-cost capital.

Answer 27

C. More highly desirable product features.

Having more highly desirable product features is a characteristic of a differentiation strategy, not a cost leadership strategy.

Question 28

Which of the following statements correctly describes the structural differences between mass and lean manufacturing?
A. Mass production usually has lower setup times than lean production.
B. Mass production usually has dedicated equipment and highly skilled laborers.
C. Mass production usually has flexible equipment and highly skilled laborers.
D. Mass production usually has higher setup times and dedicated equipment.

Answer 28

D. Mass production usually has higher setup times and dedicated equipment.

Mass production is typically characterized by higher setup times, dedicated equipment, and low-skilled workers with a high degree of specialization. In contrast, lean production is characterized by lower setup times, flexible equipment, and highly skilled, cross-trained workers.

Question 29

What tools does Six Sigma commonly use to achieve quality control?
A. Demand flow technology tools (e.g., continuous flow planning).
B. Tools common to TQM (e.g., control charts).
C. Constraint management optimization tools (e.g., capacity analysis).
D. Push-model tools (e.g., forecasting using regression).

Answer 29

B. Tools common to TQM (e.g., control charts).

Six Sigma is very similar to total quality management (TQM) and uses TQM tools such as control charts, run charts, pareto histograms, and Isikawa (fish-bone) diagrams.

Question 30

Jago Co. has two products that use the same manufacturing facilities and cannot be subcontracted. Each product has sufficient orders to utilize the entire manufacturing capacity.

For short-run profit maximization, Jago should manufacture the product with the
A. Lower total manufacturing costs for the manufacturing capacity.
B. Lower total variable manufacturing costs for the manufacturing capacity.
C. Greater gross profit per hour of manufacturing capacity.
D. Greater contribution margin per hour of manufacturing capacity.

Answer 30

D. Greater contribution margin per hour of manufacturing capacity.

This is a short run situation. In the long run, the firm should expand to take advantage of the market for its products. But given that capacity cannot be increased in the short run, the product that produces the highest contribution margin per hour should be produced. There are only so many hours of production capacity available. Maximizing the contribution margin per hour also maximizes profits and cash flow, as fixed costs remain unchanged.

Question 31

Which type of project risk is related to managing people, time, cost restrictions, and the interrelationships among activities?
	A.  	Planning risk.
	B.  	Implementing risk.
	C.  	Monitoring risk.
	D.  	Forecasting risk.

Answer 31

B. Implementing risk.

Managing people, time, cost restrictions, and the interrelationships among activities is a function of implementing risk.

Question 32

When using PERT or CPM, activity slack is calculated as
A. The maximum amount of time that an activity can be delayed without delaying the entire project.
B. The difference between the estimated activity time and the actual time once the actual completion time is known.
C. The extra time the project manager adds to the most probable activity time estimate to ensure that the completion time is met.
D. The time difference between the shortest and longest paths in the network.

Answer 32

A. The maximum amount of time that an activity can be delayed without delaying the entire project.

Slack time is always calculated as the maximum amount of time that an activity can be delayed without delaying the entire project.

Question 33

When using PERT, project completion times are measured by a pessimistic, optimistic, and most probable estimate…
A. And assigning equal weight to each of the estimates to calculate an average.
B. And assigning a weight of one for the pessimistic and optimistic estimates and a weight of two for the most probable estimate and dividing by four.
C. And assigning a weight of one for the pessimistic and optimistic estimates and a weight of four for the most probable estimate and dividing by six.
D. And assigning weights for the estimates based on the judgment of the project manager as to the probabilities of each of the outcomes.

Answer 33

C. And assigning a weight of one for the pessimistic and optimistic estimates and a weight of four for the most probable estimate and dividing by six.

Project completion time is measured by assigning a weighting of one for each of the optimistic and pessimistic estimates, a weighting of four for the most probable estimate, adding them together, and then dividing by six.

Question 34

Lynn Manufacturing Co. prepares income statements using both standard absorption and standard variable costing methods. For Year 2, unit standard costs were unchanged from Year 1. In Year 2, the only beginning and ending inventories were finished goods of 5,000 units.

How would Lynn’s ratios using absorption costing compare with those using variable costing?
Current ratio Return on stockholders’ equity
Same Same
Same Smaller
Greater Same
Greater Smaller

Answer 34

Greater Smaller

Current ratio = current assets/current liabilities. Return on stockholders’ equity = net income/average owners’ equity. Absorption costing allocates both variable and fixed manufacturing costs to inventory. Variable costing assigns only variable manufacturing cost to inventory and expenses fixed manufacturing overhead as a period cost. Therefore, ending inventory, and thus, current assets, are higher under absorption costing by the amount of fixed overhead allocated to ending inventory. The current ratio under absorption costing is, therefore, higher than under variable costing. Income in the current period is the same under both absorption costing and variable costings because the fixed overhead allocation rate has not changed, and ending inventory quantities have not changed. Therefore, total expenses recognized for the life of the firm for absorption costing are less than for variable costing by the amount of fixed overhead remaining in those 5,000 units at the end of Year 2. Thus, retained earnings are higher for absorption costing, causing the denominator of return on stockholders’ equity to be greater, and finally causing the ratio to be smaller for absorption costing

Question 35

A single-product company prepares income statements using both absorption and variable costing methods. Manufacturing overhead cost applied per unit produced in Year 2 was the same as in Year 1.

The Year 2 variable costing statement reported a profit, whereas the Year 2 absorption costing statement reported a loss.
The difference in reported income could be explained by the units produced in Year 2 being
A. Less than the units sold in Year 2.
B. Less than the activity level used for allocating overhead to the product.
C. In excess of the activity level used for allocating overhead to the product.
D. In excess of the units sold in Year 2.

Answer 35

A. Less than the units sold in Year 2.

Absorption costing includes fixed manufacturing costs as part of product costs; direct costing expenses fixed manufacturing costs as a period expense. Because of this, inventory valuation under absorption costing is more than inventory valuation under direct costing. When a firm sells more than it produces, it must use some of its existing inventory. Since absorption costing has a higher inventory valuation, the cost of goods sold under absorption costing will be higher (and income lower) than under direct costing.

Question 36

A manufacturing company prepares income statements using both absorption and variable costing methods.
At the end of a period, actual sales revenues, total gross profit, and total contribution margin approximated the budgeted figures, whereas income was substantially below the budgeted amount. There were no beginning or ending inventories.

The most likely explanation for the income shortfall is that, compared to budget, actual
A. Sales prices and variable costs had declined proportionately.
B. Sales prices had declined proportionately more than variable costs.
C. Manufacturing fixed costs had increased.
D. Selling and administrative fixed expenses had increased.

Answer 36

D. Selling and administrative fixed expenses had increased.

Gross profit is the difference between sales and the cost of goods sold. The cost of goods sold includes the fixed and variable manufacturing costs assigned to the units sold. Contribution margin equals sales less variable costs.
Both the gross profit and the contribution margin are approximately as expected, which implies that sales, variable manufacturing costs, variable selling and administrative expenses, and fixed manufacturing costs are as expected.
The only remaining component, fixed selling and administrative expenses, must be responsible for the variation in income.

Question 37

Which of the following are characteristic of Book’s activity-based costing approach?

I. Cost drivers are used as a basis for cost allocation.

II. Costs are accumulated by department or function for the purposes of product costing.

III. Activities that do not add value to the product are identified and reduced to the extent possible.
	A.  	I only.
	B.  	I and II.
	C.  	I and III.
	D.  	II and III.

Answer 37

C. I and III.

Both I. and III. are common characteristics of the ABC approach.

For the purpose of cost estimation and allocation. Single variables such as direct labor hours or machine hours are not used, but rather, multiple variables are identified (which could include the latter two), in an effort to identify the underlying relationship between cost and its causes. Also, nonvalue-added activities are identified and eliminated or reduced. Inventories are typically reduced along with the related storage and security activities, and paperwork and other activities that do not add value to the product are minimized. However, II. is not a characteristic of ABC systems. II. is a statement of the way overhead costs are allocated in traditional costing systems. ABC disaggregates overhead costs into specific activities or drivers, computes overhead rates for each driver, and then allocates overhead to products based on their consumption or the use of the driver. Thus, ABC first allocates overhead to activities and then to products, rather than to departments and then to products, as is the case with traditional systems.

Question 38

In an activity-based costing system, what should be used to assign a department’s manufacturing overhead costs to products produced in varying lot sizes?
A. A single cause and effect relationship.
B. Multiple cause and effect relationships.
C. Relative net sales values of the products.
D. A product’s ability to bear cost allocations.

Answer 38

B. Multiple cause and effect relationships.

Activity-based costing seeks multiple cost drivers to explain the behavior of cost. The technique recognizes that there is no single independent variable to explain how a cost behaves. Breaking down costs into lower levels of aggregation also helps to identify the factors that are relevant in explaining cost, and to exclude other factors.

Question 39

Using the variable costing method, which of the following costs are assigned to inventory?
Variable selling and administrative costs Variable factory overhead costs
Yes Yes
Yes No
No No
No Yes

Answer 39

No Yes

Variable costing assigns only variable manufacturing costs to inventory. Variable manufacturing costs include direct materials, direct labor, and variable factory overhead. Fixed factory overhead is treated as a period expense. Variable selling and administrative costs, although deducted to arrive at a contribution margin, are not included as inventoriable costs, but are expensed in full each period.