Sec D 1 Absorption and Variable Costing – Theory Flashcards
.1Which method of inventory costing treats direct manufacturing costs and manufacturing overhead
costs, both variable and fixed, as inventoriable costs?
A. Direct costing.
B. Variable costing.
C. Absorption costing.
D. Conversion costing.
Answer (C) is correct.
Absorption (full) costing considers all manufacturing costs to be inventoriable as product costs. These
costs include variable and fixed manufacturing costs, whether direct or indirect. The alternative to
absorption is known as variable (direct) costing
2Which 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 (B) is correct.
Under variable costing, inventories are charged only with the variable costs of production. Fixed
manufacturing costs are expensed as period costs. Absorption costing charges to inventory all costs of
production. If finished goods inventory increases, absorption costing results in higher income because
it capitalizes some fixed costs that would have been expensed under variable costing. When inventory
declines, variable costing results in higher income because some fixed
3Absorption 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.
Part of Product Cost Under
Absorption Variable
Costing Costing
A. Manufacturing supplies Yes Yes
B. Insurance on factory Yes No
C. Direct labor cost Yes Yes
D. Packaging and shipping costs Yes Yes
Answer (D) is correct.
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.
4When a firm prepares financial reports by using absorption costing,
A. Profits will always increase with increases in sales.
B. Profits will always decrease with decreases in sales.
C. Profits may decrease with increased sales even if there is no change in selling prices and costs.
D. Decreased output and constant sales result in increased profits.
Answer (C) is correct.
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.
5The contribution margin is the excess of revenues over
A. Cost of goods sold.
B. Manufacturing cost.
C. Direct cost.
D. All variable costs
Answer (D) is correct.
Contribution margin is the excess of revenues over all variable costs (including both manufacturing
and nonmanufacturing variable costs) that vary with an output-related cost driver. The contribution
margin equals the revenues that contribute toward covering the fixed costs and providing a net income.
6A company pays bonuses to its managers based on operating income. The company uses absorption
costing, and overhead is applied on the basis of direct labor hours. To increase bonuses, the managers may do all of
the following except
A. Produce those products requiring the most direct labor.
B. Defer expenses such as maintenance to a future period.
C. Increase production schedules independent of customer demands.
D. Decrease production of those items requiring the most direct labor.
Answer (D) is correct.
Under an absorption costing system, income can be manipulated by producing more products than are
sold because more fixed manufacturing overhead will be allocated to the ending inventory. When
inventory increases, some fixed costs are capitalized rather than expensed. Decreasing production,
however, will result in lower income because more of the fixed manufacturing overhead will be
expensed in the current period.
7Which one of the following is an advantage of using variable costing?
A. Variable costing complies with the U.S. Internal Revenue Code.
B. Variable costing complies with generally accepted accounting principles.
C. Variable costing makes cost-volume relationships more easily apparent.
D. Variable costing is more relevant to long-run pricing strategies.
Answer (C) is correct.
Under variable costing, only the variable costs of manufacturing attach to the units of output; fixed
costs are expensed in the period in which they are incurred. Thus, the variations in cost directly
attributable to changes in production level are immediately apparent under variable costing.
8A corporation pays bonuses to its managers based on operating income, as calculated under variable
costing. It is now 2 months before year end, and earnings have been depressed for some time. Which one of the
following actions should the production manager definitely implement to maximize the bonus for this year?
A. Step up production so that more manufacturing costs are deferred into inventory.
B. Cut $2.3 million of advertising and marketing costs.
C. Postpone $1.8 million of discretionary equipment maintenance until next year.
D. Implement, with the aid of the controller, an activity-based costing and activity-based management
system.
Answer (C) is correct.
Because the production manager wishes to maximize the bonus for the coming year, the action the
manager must take will necessarily have most of its effect in the short run. The action the manager
should take to achieve this goal is to defer costs under the manager’s control until the following period.
9When comparing absorption costing with variable costing, which of the following statements
is not true?
A. Absorption costing enables managers to increase operating profits in the short run by increasing
inventories.
B. When sales volume is more than production volume, variable costing will result in higher operating
profit.
C. A manager 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 a more favorable review.
D. Under absorption costing, operating profit is a function of both sales volume and production volume.
Answer (C) is correct.
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 the manager’s review.
10Which one of the following is the best reason for using variable costing?
A. Fixed factory overhead is more closely related to the capacity to produce than to the production of
specific units.
B. All costs are variable in the long term.
C. Variable costing is acceptable for income tax reporting purposes.
D. Variable costing usually results in higher operating income than if a company uses absorption costing.
Answer (A) is correct.
Because fixed factory overhead is more closely related to the capacity to produce than to the
production of specific units, variable costing more accurately depicts the variations in cost resulting
from changes in the level of output
11If a manufacturing company uses variable costing to cost inventories, which of the following costs
are considered inventoriable costs?
A. Only raw material, direct labor, and variable manufacturing overhead costs.
B. Only raw material, direct labor, and variable and fixed manufacturing overhead costs.
C. Only raw material, direct labor, variable manufacturing overhead, and variable selling and administrative
costs.
D. Only raw material and direct labor costs.
Answer (A) is correct.
Under variable costing, only variable costs (direct materials, direct labor, and variable overhead) are
considered product costs.
12An airline is in the process of preparing a contribution margin income statement that will allow a
detailed look at its variable costs and profitability of operations. Which one of the following cost combinations
should be used to evaluate the variable cost per flight of the company’s flights along a specific route?
A. Flight crew salary, fuel, and engine maintenance.
B. Fuel, food service, and airport landing fees.
C. Airplane depreciation, baggage handling, and airline marketing.
D. Communication system operation, food service, and ramp personnel.
Answer (B) is correct.
Fuel, food service, and airport landing fees are all variable and traceable to individual flights
13A firm uses direct (variable) costing for internal reporting and absorption costing for the external
financial statements. A review of the firm’s internal and external disclosures will likely find
A. A difference in the treatment of fixed selling and administrative costs.
B. A higher inventoriable unit cost reported to management than to the shareholders.
C. A contribution margin rather than gross margin in the reports released to shareholders.
D. Internal income figures that vary closely with sales and external income figures that are influenced by
both units sold and productive output.
Answer (D) is correct.
Under variable costing, only costs that vary with the level of production are treated as product costs.
Thus, internal income figures will vary closely with sales. Under absorption costing, all production
costs (both variable and fixed) are treated as product costs. Thus, external income figures are
influenced by both units sold and productive output.
14Which of the following correctly shows the treatment of (1) factory insurance, (2) direct labor, and
(3) finished goods shipping costs under absorption costing and variable costing?
Absorption Costing Variable Costing
Product Period Product Period
Cost Cost Cost Cost
A. 1, 2 3 2 1, 3
B. 2 1, 3 1, 2 3
C. 1, 2 3 1 2, 3
D. 1 2, 3 2, 3 1
Answer (A) is correct.
Factory insurance (item 1) is a factory operating cost, one of the three components of manufacturing
overhead (the other two being indirect materials and indirect labor). Since it is a manufacturing cost, it
must be treated as a product cost under absorption costing, and since it is fixed over the relevant range,
it must be treated as a period cost under variable costing. Direct labor (item 2) is treated as a product
cost under both systems. Finished goods shipping (item 3) is a variable selling and administrative cost,
and, as such, is treated as a period cost under both systems.
15When comparing absorption costing with variable costing, the difference in operating income can
be explained by the difference between the
A. Units sold and the units produced, multiplied by the unit sales price.
B. Ending inventory in units and the beginning inventory in units, multiplied by the budgeted fixed
manufacturing cost per unit.
C. Ending inventory in units and the beginning inventory in units, multiplied by the unit sales price.
D. Units sold and the units produced, multiplied by the budgeted variable manufacturing cost per unit.
Answer (B) is correct.
Absorption and variable costing differ in their treatment of fixed overhead: It is capitalized as
inventory under absorption costing and not under variable costing. Thus, the difference in operating
income between the two can be explained by the difference between the ending inventory in units and
the beginning inventory in units, multiplied by the budgeted fixed manufacturing cost per unit