ACCT 215 Problems Solutions, Fall 2011

Chapter 06 Variable Costing and Segment Reporting: Tools for Management Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-1 (15 minutes) 1. Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs. (All currency values are in thousands of rupees, denoted by R.) Direct materials........................................................................ R120 Direct labor................................................................................ 140 Variable manufacturing overhead......................................... 50 Fixed manufacturing overhead (R600,000 ÷ 10,000 units)....................................................................................... 60 Absorption costing unit product cost.................................... R370 2. Under variable costing, only the variable manufacturing costs are included in product costs. (All currency values are in thousands of rupees, denoted by R.) Direct materials..................................... R120 Direct labor............................................ 140 Variable manufacturing overhead...... 50 Variable costing unit product cost...... R310 Note that selling and administrative expenses are not treated as product costs under either absorption or variable costing. These expenses are always treated as period costs and are charged against the current period’s revenue. 6-1 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-2 (20 minutes) 1. 2,000 units in ending inventory × R60 fixed manufacturing overhead per unit = R120,000. 2. The variable costing income statement appears below: Sales....................................................... R4,000,000 Variable expenses: Variable cost of goods sold (8,000 units × R310 per unit)......... R2,480,000 Variable selling and administrative (8,000 units × R20 per unit)........... 160,000 2,640,000 Contribution margin............................ 1,360,000 Fixed expenses: Fixed manufacturing overhead........ 600,000 Fixed selling and administrative...... 400,000 1,000,000 Net operating income.......................... R     360,000 The difference in net operating income between variable and absorption costing can be explained by the deferral of fixed manufacturing overhead cost in inventory that has taken place under the absorption costing approach. Note from part (1) that R120,000 of fixed manufacturing overhead cost has been deferred in inventory to the next period. Thus, net operating income under the absorption costing approach is R120,000 higher than it is under variable costing 6-2 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-3 (20 minutes) 1. Year 1 Year 2 Year 3 Beginning inventories......... 180 150 160 Ending inventories............... 150 160 200 Change in inventories......... (30) 10 40 Fixed manufacturing overhead in beginning inventories (@$450 per unit).................................... $ 81,000 $ 67,500 $72,000 Fixed manufacturing overhead in ending inventories (@$450 per unit).................................... 67,500 72,000 90,000 Fixed manufacturing overhead deferred in (released from) inventories (@$450 per unit).................................... $(13,500) $     4,500 $   18,000 Variable costing net operating income.............. $292,400 $269,200 $251,800 Add (deduct) fixed manufacturing overhead cost deferred in (released from) inventory under absorption costing................................ (13,500 ) 4,500 18,000 Absorption costing net operating income.............. $278,900 $273,700 $269,800 2. Because absorption costing net operating income was greater than variable costing net operating income in Year 4, inventories must have increased during the year and hence, fixed manufacturing overhead was deferred in inventories. The amount of the deferral is just the difference between the two net operating incomes or $27,000 = $267,200 – $240,200. 6-3 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-4 (10 minutes) Total CD DVD Sales*..................................................... $750,000 $300,000 $450,000 Variable expenses**............................ 435,000 120,000 315,000 Contribution margin............................ 315,000 180,000 135,000 Traceable fixed expenses..................... 183,000 138,000 45,000 Product line segment margin............. 132,000 $ 42,000 $ 90,000 Common fixed expenses not traceable to products........................ 105,000 Net operating income.......................... $ 27,000 * ** CD: 37,500 packs × $8.00 per pack = $300,000; DVD: 18,000 packs × $25.00 per pack= $450,000. CD: 37,500 packs × $3.20 per pack = $120,000; DVD: 18,000 packs × $17.50 per pack= $315,000. Exercise 6-5 (10 minutes) Sales were above the company’s break-even sales and yet the company sustained a loss. The apparent contradiction is explained by the fact that the CVP analysis is based on variable costing, whereas the income reported to shareholders is prepared using absorption costing. Because sales were above the breakeven, the variable costing net operating income would have been positive. However, the absorption costing net operating income was negative. Ordinarily, this would only happen if inventories decreased and fixed manufacturing overhead deferred in inventories was released to the income statement on the absorption costing income statement. This added fixed manufacturing overhead cost resulted in a loss on an absorption costing basis even though the company operated at its breakeven on a variable costing basis. Exercise 6-6 (20 minutes) 1. The company is using variable costing. The computations are: 6-4 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Variable Costing Absorption Costing Direct materials................................ $10 $10 Direct labor....................................... 5 5 Variable manufacturing overhead. 2 2 Fixed manufacturing overhead ($90,000 ÷ 30,000 units)............... — 3 Unit product cost............................. $17 $20 Total cost, 5,000 units...................... $85,000 $100,000 2. a. No, $85,000 is not the correct figure to use, because variable costing is not generally accepted for external reporting purposes or for tax purposes. b. The finished goods inventory account should be stated at $100,000, which represents the absorption cost of the 5,000 unsold units. Thus, the account should be increased by $15,000 for external reporting purposes. This $15,000 consists of the amount of fixed manufacturing overhead cost that is allocated to the 5,000 unsold units under absorption costing (5,000 units × $3 per unit fixed manufacturing overhead cost = $15,000). 6-5 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-7 (30 minutes) 1. a. The unit product cost under absorption costing would be: Direct materials...................................................................... $18 Direct labor.............................................................................. 7 Variable manufacturing overhead....................................... 2 Total variable manufacturing costs...................................... 27 Fixed manufacturing overhead ($200,000 ÷ 20,000 units)..................................................................................... 10 Absorption costing unit product cost.................................. $37 b. The absorption costing income statement: Sales (16,000 units × $50 per unit).............................. $800,000 Cost of goods sold (16,000 units × $37 per unit)...... 592,000 Gross margin................................................................. 208,000 Selling and administrative expenses [(16,000 units × $2 per unit) + $110,000]................ 142,000 Net operating income.................................................. $   66,000 2. a. The unit product cost under variable costing would be: Direct materials.................................. $18 Direct labor.......................................... 7 Variable manufacturing overhead... 2 Variable costing unit product cost... $27 b. The variable costing income statement: Sales (16,000 units × $50 per unit)............... $800,000 6-6 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Less variable expenses: Variable cost of goods sold (16,000 units × $27 per unit)................... $432,000 Variable selling expense (16,000 units × $2 per unit)...................... 32,000 464,000 Contribution margin...................................... 336,000 Less fixed expenses: Fixed manufacturing overhead................. 200,000 Fixed selling and administrative................     110,000 310,000 Net operating income.................................... $   26,000 6-7 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-7 (continued) 3. The price increase appears to be a good idea from an absorption costing perspective because it increases net operating income by $4,000, but a variable costing income statement reveals that the price increase would actually decrease net operating income by $6,000. The income statements are shown below: The absorption costing income statement: Sales (15,000 units × $51 per unit).............................. $765,000 Cost of goods sold (15,000 units × $37 per unit)...... 555,000 Gross margin................................................................. 210,000 Selling and administrative expenses [(15,000 units × $2 per unit) + $110,000]................ 140,000 Net operating income.................................................. $   70,000 The variable costing income statement: Sales (15,000 units × $51 per unit)............... $765,000 Less variable expenses: Variable cost of goods sold (15,000 units × $27 per unit)................... $405,00 0 Variable selling expense (15,000 units × $2 per unit)...................... 30,000 435,000 Contribution margin...................................... 330,000 Less fixed expenses: Fixed manufacturing overhead................. 200,000 Fixed selling and administrative................   110,000 310,000 Net operating income.................................... $   20,000 6-8 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-8 (10 minutes) The completed segmented income statement should appear as follows: Divisions Total Company East Wes Amount % Amount % Amount Sales..................................................... $600,000 100.0 $400,000 100.0 $200,00 0 Variable expenses.............................. 300,000 50.0 250,000 62.5 50,000 Contribution margin.......................... 300,000 50.0 150,000 37.5 150,000 Traceable fixed expenses.................. 190,000 31.7 80,000 20.0 110,000 Territorial segment margin.............. 110,000 18.3 $ 70,000       17.5 $40,000 Common fixed expenses................... 60,000 10.0 Net operating income....................... $   50,000 8.3 6-9 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-9 (30 minutes) 1. Under variable costing, only the variable manufacturing costs are included in product costs. Direct materials....................................... $ 60 Direct labor.............................................. 30 Variable manufacturing overhead........ 10 Variable costing unit product cost........ $100 Note that selling and administrative expenses are not treated as product costs; that is, they are not included in the costs that are inventoried. These expenses are always treated as period costs. 2. The variable costing income statement appears below: Sales....................................................... $1,800,000 Variable expenses: Variable cost of goods sold (9,000 units × $100 per unit).......... $900,000 Variable selling and administrative (9,000 units × $20 per unit)............ 180,000 1,080,000 Contribution margin............................ 720,000 Fixed expenses: Fixed manufacturing overhead........ 300,000 Fixed selling and administrative...... 450,000 750,000 Net operating loss................................ $       (30,000 ) 3. The break-even point in units sold can be computed using the contribution margin per unit as follows: Selling price per unit..................... $200 Variable cost per unit.................... 120 Contribution margin per unit....... $ 80 Break-even unit sales = Fixed expenses ÷ Unit contribution margin = $750,000 ÷ $80 per unit = 9,375 units Exercise 6-10 (20 minutes) 1. Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs. Direct materials.................................... $ 60 6-10 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Direct labor............................................ 30 Variable manufacturing overhead..... 10 Fixed manufacturing overhead ($300,000 ÷ 10,000 units).................. 30 Unit product cost.................................. $130 2. The absorption costing income statement appears below: Sales (9,000 units × $200 per unit).................................. $1,800,000 Cost of goods sold (9,000 units × $130 per unit)...........   1,170,000 Gross margin..................................................................... 630,000 Selling and administrative expenses (9,000 units × $20 per unit) + $450,000....................... 630,000 Net operating income....................................................... $                         0 Note: The company apparently has exactly zero net operating income even though its sales are below the break-even point computed in Exercise 6-9. This occurs because $30,000 of fixed manufacturing overhead has been deferred in inventory and does not appear on the income statement prepared using absorption costing. 6-11 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-11 (20 minutes) 1. Total Geographic Market Company South Central North Sales.................................... $1,500,000 $400,000 $600,000 $500,000 Variable expenses............. 588,000 208,000 180,000 200,000 Contribution margin......... 912,000 192,000 420,000 300,000 Traceable fixed expenses. 770,000 240,000 330,000 200,000 Geographic market segment margin............. 142,000 $(48,000) $ 90,000 $100,000 Common fixed expenses not traceable to geographic markets*..... 175,000 Net operating income (loss)................................. $     (33,000 ) *$945,000 – $770,000 = $175,000. 2. Incremental sales ($600,000 × 15%)...................... $90,000 Contribution margin ratio ($420,000 ÷ $600,000)............................................................... ×     70% Incremental contribution margin.......................... 63,000 Less incremental advertising expense.................. 25,000 Incremental net operating income....................... $38,000 Yes, the advertising program should be initiated. Exercise 6-12 (30 minutes) 1 a. Under variable costing, only the variable manufacturing costs are included in product costs. Year 1 Year 2 Direct materials....................................... $20 $20 Direct labor.............................................. 12 12 Variable manufacturing overhead........ 4 4 Variable costing unit product cost........ $36 $36 Note that selling and administrative expenses are not treated as product costs; that is, they are not included in the costs that are inventoried. These expenses are always treated as period costs. 1 b. 6-12 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Year 1 Year 2 Sales................................................................. $2,000,000 $2,500,000 Variable expenses: Variable cost of goods sold @ $36 per unit............................................................. 1,440,000 1,800,000 Variable selling and administrative @ $3 per unit...................................................... 120,000 150,000 Total variable expenses................................. 1,560,000 1,950,000 Contribution margin...................................... 440,000 550,000 Fixed expenses: Fixed manufacturing overhead................. 200,000 200,000 Fixed selling and administrative................ 80,000 80,000 Total fixed expenses...................................... 280,000 280,000 Net operating income (loss).......................... $     160,000 $       270,000 2 a. The unit product costs under absorption costing: 6-13 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Year 1 Year 2 Direct materials....................................... $20 $20 Direct labor.............................................. 12 12 Variable manufacturing overhead........ 4 4 Fixed manufacturing overhead............. *4 **5 Absorption costing unit product cost... $40 $41 * $200,000 ÷ 50,000 units = $4 per unit. ** $200,000 ÷ 40,000 units = $5 per unit. Exercise 6-12 (continued) 2 b. The absorption costing income statements appears below: Year 1 Year 2 Sales............................................................ $2,000,000 $2,500,000 Cost of goods sold..................................... *1,600,000 **2 ,040,000 Gross margin............................................. 400,000 460,000 Selling and administrative expenses.................................................. 200,000 2 30,000 Net operating income............................... $     200,000 $     230,000 * 40,000 units × $40 per unit = $1,600,000 ** (40,000 units × $41 per unit) + (10,000 units × $40 per unit) = $2,040,000 3. The net operating incomes are reconciled as follows: Year 1 Year 2 Variable costing net operating income (loss).............................................................. $   160,000 $   270,000 6-14 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing (10,000 units × $4 per unit).......... 40,000 Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing (10,000 units × $4 per unit)........................................................ (40,000 ) Absorption costing net operating income.. $         200,000 $       230,000 Exercise 6-13 (20 minutes) 1. Sales (40,000 units × $33.75 per unit)............ $1,350,000 Variable expenses: Variable cost of goods sold (40,000 units × $16 per unit*)................... $640,000 Variable selling and administrative expenses (40,000 units × $3 per unit)....................... 120,000 760,000 Contribution margin........................................ 590,000 Fixed expenses: Fixed manufacturing overhead................... 250,000 Fixed selling and administrative expenses 300,000 550,000 Net operating income...................................... $         40,000 * Direct materials................................. $10 Direct labor........................................ 4 Variable manufacturing overhead.. 2 Total variable manufacturing cost.. $16 2. The difference in net operating income can be explained by the $50,000 in fixed manufacturing overhead deferred in inventory under the absorption costing method: Variable costing net operating income.......................... $40,000 Add fixed manufacturing overhead cost deferred in inventory under absorption costing (10,000 units × $5 per unit in fixed manufacturing overhead cost)... 50,000 Absorption costing net operating income..................... $90,000 6-15 Chapter 06 Variable Costing and Segment Reporting: Tools for Management 6-16 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-14 (20 minutes) 1. $75,000 × 40% CM ratio = $30,000 increased contribution margin in Dallas. Because the fixed costs in the office and in the company as a whole will not change, the entire $30,000 would result in increased net operating income for the company. It is incorrect to multiply the $75,000 increase in sales by Dallas’ 25% segment margin ratio. This approach assumes that the segment’s traceable fixed expenses increase in proportion to sales, but if they did, they would not be fixed. 2. a. The segmented income statement follows: Segments Total Company Houston Dallas Amount % Amount % Amount % Sales.......................... $800,000 100.0 $200,000 100 $600,000 100 Variable expenses................  420,000 52.5 60,000 30 360,000 60 Contribution margin....................380,000 47.5 140,000 70 240,000 40 Traceable fixed expenses................  168,000 21.0 78,000 39 90,000 15 Office segment margin....................212,000 26.5 $ 62,000 31 $150,000 25 Common fixed expenses not traceable to segments...............  120,000 15.0 Net operating income............... $ 92,000 11.5 b. The segment margin ratio rises and falls as sales rise and fall due to the presence of fixed costs. The fixed expenses are spread over a larger base as sales increase. In contrast to the segment ratio, the contribution margin ratio is stable so long as there is no change in either variable expenses or the selling price of a unit of service. 6-17 Chapter 06 Variable Costing and Segment Reporting: Tools for Management Exercise 6-15 (15 minutes) 1. The company should focus its campaign on Landscaping Clients. The computations are: Construction Clients Landscaping Clients Increased sales..................................... $70,000 $60,000 Market CM ratio.................................... ×  35% ×  50% Incremental contribution margin....... $24,500 $30,000 Less cost of the campaign................... 8,000 8,000 Increased segment margin and net operating income for the company as a whole........................................... $16,500 $22,000 2. The $90,000 in traceable fixed expenses in the previous exercise is now partly traceable and partly common. When we segment Dallas by market, only $72,000 remains a traceable fixed expense. This amount represents costs such as advertising and salaries that arise because of the existence of the construction and landscaping market segments. The remaining $18,000 ($90,000 – $72,000) is a common cost when Dallas is segmented by market. This amount would include such costs as the salary of the manager of the Dallas office that could not be avoided by eliminating either of the two market segments. 6-18