Week 3 Important Flashcards
- PREPARE a numerical reconciliation and explanation of the difference between operating profit for each month under variable costing and absorption costing.
Absorption costing operating income - variable costing operating income
=
fixed manufacturing costs in ending inventory - fixed manufacturing costs in beginning inventory
- Prepare a numerical reconciliation and EXPLANATION of the difference between operating profit for each month under variable costing and absorption costing.
The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May).
- Explain the difference in operating profit as calculated in requirements 1 and 2.
The absorption-costing operating income exceeds the variable costing figure by A$7000 because of the increase of A$7000 during 2014 of the amount of fixed manufacturing costs in ending inventory vis-à-vis beginning inventory.
- Critics have claimed that a widely used accounting system has led to undesirable build-ups of inventory levels. (a) Is variable costing or absorption costing more likely to lead to such build-ups? Why?
- Absorption costing is more likely to lead to build-ups of inventory than does variable costing. Absorption costing enables managers to increase reported operating income by building up inventory which reduces the amount of fixed manufacturing overhead included in the current period’s cost of goods sold.
- Critics have claimed that a widely used accounting system has led to undesirable build-ups of inventory levels. (a) Is variable costing or absorption costing more likely to lead to such build-ups? Why?
(b) What can be done to counteract undesirable inventory build-ups?
Ways to reduce this incentive include:
(a) Careful budgeting and inventory planning.
(b) Change the accounting system to variable costing or throughput costing.
(c) Incorporate a carrying charge for carrying inventory.
(d) Use a longer time period to evaluate performance than a quarter or a year.
(e) Include nonfinancial as well as financial measures when evaluating management performance.
Distinguish between the single-rate and the dual-rate methods
The single-rate (cost-allocation) method makes no distinction between fixed costs and variable costs in the cost pool. It allocates costs in each cost pool to cost objects using the same rate per unit of the single allocation base. The dual-rate (cost-allocation) method classifies costs in each cost pool into two pools—a variable-cost pool and a fixed-cost pool-with each pool using a different cost-allocation base.
Describe how the dual-rate method is useful to division managers in decision making
The dual-rate method provides information to division managers about cost behaviour. Knowing how fixed costs and variable costs behave differently is useful in decision making.
How do budgeted cost rates motivate the support-department manager to improve efficiency?
Budgeted cost rates motivate the manager of the supplier department to improve efficiency because the supplier department bears the risk of any unfavourable cost variances.
Give examples of allocation bases used to allocate support-department cost pools to operating departments.
Examples of bases used to allocate support department cost pools to operating departments include the number of employees, square metres of space, number of hours and machine-hours.
The use of budgeted indirect cost allocation rates rather than actual indirect rates has several attractive features to the manager of a user department:
a. The user knows the costs in advance and can factor them into ongoing operating choices,
b. The cost allocated to a particular user department does not depend on the amount of resources used by other user departments
c. Inefficiencies at the department providing the service do not affect the costs allocated to the user department.
‘To ensure unbiased cost allocations, fixed costs should be allocated on the basis of estimated
long-run use by user-department managers.’ Do you agree? Why?
Disagree. Allocating costs on ‘the basis of estimated long-run use by user department managers’ means department managers can lower their cost allocations by deliberately underestimating their long-run use (assuming all other managers do not similarly underestimate their usage).
Distinguish between the three methods of allocating the costs of support departments to operating departments
The three methods differ in how they recognise reciprocal services among support departments:
a. The direct (allocation) method ignores any services rendered by one support department to another; it allocates each support department’s costs directly to the operating departments.
b. The step-down (allocation) method allocates support-department costs to other support departments and to operating departments in a sequential manner that partially recognises the mutual services provided among all support departments.
c. The reciprocal (allocation) method allocates support-department costs to operating departments by fully recognising the mutual services provided among all support departments.
What is conceptually the most defensible method for allocating support-department costs? Why?
The reciprocal method is theoretically the most defensible method because it fully recognises the mutual services provided among all departments, irrespective of whether those departments are operating or support departments.
What approach should be used to decide the sequence in which to allocate support departments
when using the step-down method?
Allocate support departments on a ranking of the percentage of their total services provided to other support departments. This approach typically better approximates the theoretically preferred reciprocal method. It results in a higher percentage of support-department costs provided to other support departments being incorporated into the step-down process.
