Chapter 3-

Predetermined Overhead Rates,

Flexible Budgets, and Absorption/Variable Costing

TRUE/FALSE

1. Absorption costing is commonly used for external reporting.

ANS: T

2. Absorption costing is commonly used for internal reporting.

ANS: F

3. Variable costing is commonly used for internal reporting.

ANS: T

4. Variable costing is commonly used for external reporting.

ANS: F

5. In an actual cost system, factory overhead is assigned directly to products and services.

ANS: T

6. In a normal cost system, factory overhead is assigned directly to products and services.

ANS: F

7. In a normal cost system, factory overhead is assigned to an overhead control account and then
allocated to products and services.

ANS: T

8. In an actual cost system, factory overhead is assigned to an overhead control account and then
allocated to products and services.

ANS: F

9. A debit to the factory overhead account represents actual overhead costs.

ANS: T

10. A debit to the factory overhead account represents applied overhead costs.

ANS: F

11. A credit to the factory overhead account represents actual overhead costs.

ANS: F

12. A credit to the factory overhead account represents applied overhead costs.

ANS: T
13. If actual overhead exceeds applied overhead, factory overhead is said to be overapplied.

ANS: F

14. If actual overhead exceeds applied overhead, factory overhead is said to be underapplied.

ANS: T

15. If overapplied factory overhead is immaterial, the account is closed by a credit to Cost of Goods Sold.

ANS: T

16. If overapplied factory overhead is material, the account is closed by a credit to Cost of Goods Sold.

ANS: F

17. If overapplied factory overhead is immaterial, the account is closed by a debit to Cost of Goods Sold.

ANS: F

18. If underapplied factory overhead is immaterial, the account is closed by a debit to Cost of Goods Sold.

ANS: T

19. If underapplied factory overhead is immaterial, the account is closed by a credit to Cost of Goods Sold.

ANS: F

20. If underapplied factory overhead is material, it is prorated among Work in Process Inventory, Finished
Goods Inventory, and Cost of Goods Sold.

ANS: T

21. The estimated maximum potential activity for a specified time is known as theoretical capacity.

ANS: T

22. Practical capacity does not adjust for routine downtime in a production process.

ANS: F

23. Normal capacity considers present and future production levels and cyclical fluctuations.

ANS: T

24. Expected capacity is a long-run measure of activity.

ANS: F

25. Practical capacity is the capacity that can be achieved during normal working hours.

ANS: T

26. The regression equation y = a+ bX assumes that the function is curvilinear in nature.
 ANS: F

27. The regression equation y = a+ bX assumes that the function is linear in nature.

ANS: T

28. The slope of a regression line is determined by dividing the change in activity level by the change in
total cost.

ANS: F

29. The slope of a regression line is determined by dividing the change in total cost by the change in
activity level.

ANS: T

30. The high-low method excludes outliers from the calculation of the slope of a regression line.

ANS: F

31. When using the high-low method, fixed costs are computed before the variable component is
computed.

ANS: F

32. When using the high-low method, the variable component is computed before the fixed component is.

ANS: T

33. A flexible budget is a planning document that presents expected variable and fixed overhead costs at
different activity levels.

ANS: T

34. A master budget is a planning document that presents expected variable and fixed overhead costs at
different activity levels.

ANS: F

35. Plantwide overhead rates provide a more accurate computation of factory overhead than departmental
overhead rates

ANS: F

36. Plantwide overhead rates provide a less accurate computation of factory overhead than departmental
overhead rates

ANS: T

37. Absorption costing conforms with generally accepted accounting principles.

ANS: T

38. Direct costing conforms with generally accepted accounting principles.

 ANS: F

39. The Internal Revenue Service allows the use of both variable and absorption costing.

ANS: F

40. Sales minus cost of goods sold is referred to as variable contribution margin.

ANS: F

41. Phantom profits result when absorption costing is used and sales exceed production.

ANS: F

42. Phantom profits result when absorption costing is used and production exceeds sales.

ANS: T

43. If production exceeds sales, absorption costing net income exceeds variable costing net income.

ANS: T

44. If production exceeds sales, absorption costing net income is less than variable costing net income.

ANS: F

45. If sales exceed production, absorption costing net income is less than variable costing net income.

ANS: T

46. If sales exceed production, absorption costing net income exceeds variable costing net income.

ANS: F

COMPLETION

1. In a(n) _________ cost system, factory overhead is assigned directly to products and services.

ANS: actual
2. In a(n) _________ cost system, factory overhead is assigned to an overhead control account and then
allocated to products and services.

ANS: normal

3. The dollar amount of overhead assigned to work-in-process inventory using a predetermined rate is
known as __________________ overhead.

ANS: applied

4. If actual overhead exceeds applied overhead, factory overhead is said to be ______________.

ANS: underapplied

5. If actual overhead is less than applied overhead, factory overhead is said to be ______________.

ANS: overapplied

6. If underapplied or overapplied factory overhead is material, it is prorated among

______________________, _________________________, and _______________________.

ANS: Work in Process Inventory, Finished Goods Inventory, Cost of Goods Sold

7. If underapplied or overapplied factory overhead is immaterial, it is charged to

_______________________.

ANS: Cost of Goods Sold

8. The performance measure that considers routine interruptions is known as ___________________

capacity.

ANS: practical
 9. A performance measure that encompasses a firm’s long-run average activity is referred to as
__________________ capacity.

ANS: normal

10. A performance measure that assumes all production factors are operating perfectly is referred to as
___________________ capacity.

ANS: theoretical

11. A performance measure that is short-run in nature and represents a firm’s anticipated activity level for
the upcoming period is ____________________ capacity.

ANS: expected

12. Consider the regression equation y = a + bX. The portion of the equation that represents fixed costs is
________.

ANS: a

13. Consider the regression equation y = a + bX. The portion of the equation that represents the variable
rate is ________.

ANS: b

14. Consider the regression equation y = a + bX. The portion of the equation that represents the activity
base is ________.

ANS: X

15. An observation that is found outside the relevant range is referred to as a(n) ______________.

ANS: outlier
16. When a relationship between several independent variables and one dependent variable is analyzed,
the regression is referred to as _____________.

ANS: multiple

17. When a relationship between one independent variable and one dependent variable is analyzed, the
regression is referred to as _____________.

ANS: simple

18. A __________________________ is a planning document that presents expected variable and fixed
overhead costs at different activity levels.

ANS: flexible budget

19. The costing technique that treats manufacturing overhead as a period cost is referred to as
_________________ costing.

ANS: variable or direct

20. The costing technique that treats all manufacturing costs as inventoriable is referred to as
_________________ costing.

ANS: absorption or full

21. Sales less variable cost of goods sold is referred to as _________________________________.

ANS: product contribution margin

22. Temporary profits that result when absorption costing is used and production exceeds sales are
referred to as _________________________________.

ANS: phantom profits

MULTIPLE CHOICE

1. Since overhead costs are indirect costs,

a. they require some process of allocation.
b. they can be easily traced to production.
c. a predetermined overhead rate is not advantageous.
d. they cannot be allocated.
ANS: A

2. Cost allocation is the assignment of ______ costs to one or more products using a reasonable basis.

direct indirect

a. yes yes
b. yes no
c. no no
d. no yes
ANS: D

3. An actual cost system differs from a normal cost system in that an actual cost system
a. assigns overhead as it occurs during the manufacturing cycle.
b. assigns overhead at the end of the manufacturing process.
c. does not assign overhead at all.
d. does not use an Overhead Control account.
ANS: B

4. In a normal cost system, which of the following is used?

Actual direct materials Actual direct labor Actual overhead

a. yes no yes
b. yes yes yes
c. yes yes no
d. no yes no

ANS: C

5. Predetermined overhead rates are computed based on

estimated overhead costs estimated level of activity

a. yes yes
b. yes no
c. no yes
d. no no

ANS: A

6. One reason annual overhead application rates are used is

a. because of seasonal variability of overhead costs.
b. to help budget overhead costs.
c. to minimize the overhead cost assigned to products.
 d. to maximize the overhead cost assigned to products.
ANS: A

7. Which of the following is not a reason to use predetermined overhead rates?

a. to overcome the problems of assigning overhead to diverse types of products
b. to compensate for fluctuations in monthly overhead costs
c. to provide a means for assigning overhead during the period rather than at the end of the
period
d. to smooth out the amount of overhead cost assigned to products when monthly production
activity differs
ANS: A

8. When a manufacturing company has a highly automated manufacturing plant producing many
different products, which of the following is the more appropriate basis of applying manufacturing
overhead costs to work in process?
a. direct labor hours
b. direct labor dollars
c. machine hours
d. cost of materials used
ANS: C

9. A mixed cost has which of the following components?

Variable component Fixed component

a. yes no
b. yes yes
c. no no
d. no yes

ANS: B

10. In the formula y = a + bX, y represents

a. fixed costs.
b. total cost.
c. variable costs.
d. mixed costs.
ANS: B

11. In the formula y = a + bX, a represents

a. mixed cost.
b. variable cost.
c. total cost.
d. fixed cost.
ANS: D
12. In relationship to changes in activity, variable overhead changes

in total per unit

a. no no
b. no yes
c. yes yes
d. yes no

ANS: D

13. In relationship to changes in activity, fixed overhead changes

in total per unit

a. yes yes
b. no no
c. no yes
d. yes no

ANS: C

14. If the level of activity increases,

a. variable cost per unit and total fixed costs increase.
b. fixed cost per unit and total variable cost increase.
c. total cost will increase and fixed cost per unit will decrease.
d. variable cost per unit and total cost increase.
ANS: C

15. Weaknesses of the high-low method include all of the following except
a. only two observations are used to develop the cost function.
b. the high and low activity levels may not be representative.
c. the method does not detect if the cost behavior is nonlinear.
d. the mathematical calculations are relatively complex.
ANS: D

16. If there is no "a" value in a linear cost equation, this is an indication that the cost is
a. fixed.
b. mixed.
c. variable.
d. either fixed or mixed.
ANS: C

17. An outlier is
a. something that happens outside the organization that does not affect production.
b. always used in analyzing a mixed cost.
c. something that happens inside the organization that does not affect production.
d. never used in analyzing a mixed cost.
ANS: D
18. Applied overhead consists of which of the following?
a. actual activity times predetermined overhead rate
b. estimated activity times predetermined overhead rate
c. actual activity times actual overhead rate
d. estimated activity times actual overhead rate
ANS: A

19. If a company used two overhead accounts (actual overhead and applied overhead), the one that would
receive the most debits would be
a. actual overhead.
b. applied overhead.
c. both would receive an equal number of debits.
d. impossible to determine without additional information.
ANS: A

20. If underapplied overhead is considered to be immaterial, it is closed to which of the following

accounts?

Work in Process Finished Goods Cost of Goods Sold

a. yes yes yes

b. no yes yes
c. yes no no
d. no no yes

ANS: D

21. All other things being equal, if actual cost per unit is greater than budgeted cost per unit, variable
overhead will be
a. overapplied.
b. the same as fixed overhead.
c. underapplied.
d. applied to Finished Goods.
ANS: C

22. Overapplied overhead will result if

a. the plant is operated at less than expected capacity.
b. overhead costs incurred were greater than estimated overhead costs.
c. overhead costs incurred were less than overhead costs charged to production.
d. overhead costs incurred were greater than overhead charged to production.
ANS: C
23. Actual overhead exceeds applied overhead and the amount is immaterial. Which of the following will
be true? Upon closing,

Overhead is Cost of Goods Sold will

a. underapplied increase
b. overapplied decrease
c. overapplied increase
d. underapplied decrease
ANS: A

24. If actual overhead is less than applied overhead, which of the following will be true? Upon closing,

Overhead is Cost of Goods Sold is

a. underapplied credited
b. underapplied debited
c. overapplied debited
d. overapplied credited
ANS: D

25. The estimated maximum potential activity for a specified time is:
a. theoretical capacity c. normal capacity
b. practical capacity d. expected capacity
ANS: A

26. The measure of activity that allows for routine variations in manufacturing activity is:
a. theoretical capacity c. normal capacity
b. practical capacity d. expected capacity
ANS: B

27. The measure of production that considers historical and estimated future production levels and cyclical
fluctuations is referred to as:
a. theoretical capacity c. normal capacity
b. practical capacity d. expected capacity
ANS: C

28. A short-run measure of activity that represents a firm’s anticipated activity level for an upcoming
period based upon expected demand is referred to as:
a. theoretical capacity c. normal capacity
b. practical capacity d. expected capacity
ANS: D
29. An item or event that has a cause-effect relationship with the incurrence of a variable cost is called a
a. mixed cost.
b. predictor.
c. direct cost.
d. cost driver.
ANS: D

30. Furman Tailors has gathered information on utility costs for the past year. The controller has decided
that utilities are a function of the hours worked during the month. The following information is
available and representative of the company’s utility costs:

Hours worked Utility cost incurred

Low point 1,300 $ 903
High point 1,680 1,074

If 1,425 hours are worked in a month, total utility cost (rounded to the nearest dollar) using the high-
low method should be
a. $947.
b. $954.
c. $959.
d. $976.
ANS: C
Variable portion:

Fixed Portion
903 - 0.45 ( 1,300) = $318

Y = $318 + $0.45(1,425) = $959

31. Reno Corporation uses a predetermined overhead application rate of $.30 per direct labor hour. During
the year it incurred $345,000 dollars of actual overhead, but it planned to incur $360,000 of overhead.
The company applied $363,000 of overhead during the year. How many direct labor hours did the
company plan to incur?
a. 1,150,000
b. 1,190,000
c. 1,200,000
d. 1,210,000
ANS: C
$360,000 / .30 = 1,200,000 direct labor
hours
32. Birmingham Machine Works had the following data regarding monthly power costs:

Month Machine hours Power cost

Jun 300 $680
Jul 600 720
Aug 400 695
Sept. 200 640

Assume that management expects 500 machine hours in October. Using the high-low method,
calculate October’s power cost using machine hours as the basis for prediction.
a. $700
b. $705
c. $710
d. $1,320
ANS: A
Variable portion:

Fixed portion:

$640 - (200 *$0 .20) = $600

$600 + (500*$0.20) = $700

33. Gary Corporation has developed the following flexible budget formula for monthly overhead:

For output of less than 200,000 units: $36,600 + $.80(units)

For output of 200,000 units or more: $43,000 + $.80(units)

How much overhead should Gary expect if the firm plans to produce 200,000 units?
a. $52,600
b. $59,000
c. $196,600
d. $203,000
ANS: D
$43,000 + $0.80(200,000) = $43,000 + $160,000 =
$203,000
34. Walton Corporation wishes to develop a single predetermined overhead rate. The company's expected
annual fixed overhead is $340,000 and its variable overhead cost per machine hour is $2. The
company's relevant range is from 200,000 to 600,000 machine hours. Walton expects to operate at
425,000 machine hours for the coming year. The plant's theoretical capacity is 850,000. The
predetermined overhead rate per machine hour should be
a. $2.40.
b. $2.57.
c. $2.80.
d. $2.85.
ANS: C

Fixed component:

Variable component = $2.00 per unit

Total predetermined overhead = $2.80 per unit

Burke Corporation

Burke Corporation has the following data for use of its machinery

Month Usage Cost

Jun 600 $750
Jul 650 775
Aug 420 550
Sept 500 650
Oct 450 570

35. Refer to Burke Corporation. Using the high-low method, compute the variable cost element.
a. $1.02
b. $.98
c. $1.31
d. $1.19
ANS: B
36. Refer to Burke Corporation. Using the high-low method, compute the fixed cost element (to the
nearest whole dollar).
a. $225
b. $138
c. $411
d. $364
ANS: B
$775 - 650(.98) = $775 - 637 = $138

Zenith Corporation

The records of Zenith Corporation revealed the following data for the current year.

Work in Process $ 73,150

Finished Goods 115,000
Cost of Goods Sold 133,650
Direct Labor 111,600
Direct Material 84,200

37. Refer to Zenith Corporation. Assume, for this question only, actual overhead is $98,700 and applied
overhead is $93,250. Manufacturing overhead is:
a. overapplied by $12,900.
b. underapplied by $18,350.
c. overapplied by $5,450.
d. underapplied by $5,450.
ANS: D
$98,700 - $93,250 = $5,450 underapplied

38. Refer to Zenith Corporation. Assume that Zenith has underapplied overhead of $37,200 and that this
amount is material. What journal entry is needed to close the overhead account? (Round decimals to
nearest whole percent.)
a. Debit Work in Process $8,456; Finished Goods $13,294; Cost of Goods Sold $15,450 and
credit Overhead $37,200
b. Debit Overhead $37,200 and credit Work in Process $8,456; Finished Goods $13,294;
Cost of Goods Sold $15,450
c. Debit Work in Process $37,200 and credit Overhead $37,200
d. Debit Cost of Goods Sold $37,200 and credit Overhead $37,200
ANS: A
WIP: 73,150/321,800 = $ 8,456
FG: 115,000/321,800 = $13,294
EI: 133,650/321,800 = $15,450

39. Refer to Zenith Corporation. Assume that Zenith has underapplied overhead of $10,000 and that this
amount is immaterial. What is the balance in Cost of Goods Sold after the underapplied overhead is
closed?
a. $133,650
b. $123,650
c. $143,650
 d. $137,803
ANS: C

COGS + Underapplied Overhead = Adjusted COGS

$133,650 + $ 10,000 = $143,650

40. Refer to Zenith Corporation. Assume that Zenith has overapplied overhead of $25,000 and that this
amount is material. What is the balance in Cost of Goods Sold after the overapplied overhead is
closed?
a. $123,267
b. $144,033
c. $158,650
d. $108,650
ANS: A
$133,650/$321,800 * $25,000 = $10,383

$133,650-$10,383 = $123,267

41. Aztec Company is relocating its facilities. The company estimates that it will take three trucks to move
office contents. If the per truck rental charge is $1,000 plus 25 cents per mile, what is the expected cost
to move 800 miles?
a. $1,000
b. $1,200
c. $2,400
d. $3,600
ANS: D
3 trucks * ($1,000 + $0.25(800)) = 3 * $1,200 = $3,600
42. Aquatic Motor Company is exploring different prediction models that can be used to forecast indirect
labor costs. One independent variable under consideration is machine hours. Following are matching
observations on indirect labor costs and machine hours for the past six months:

Month Machine hours Indirect labor costs

1 300 $20,000
2 400 $24,000
3 240 $17,000
4 370 $22,000
5 200 $13,000
6 225 $14,000

In a high-low model, which months' observations would be used to compute the model's parameters?

a. 2 and 5
b. 1 and 6
c. 2 and 6
d. 4 and 5
ANS: A

43. Consider the following three product costing alternatives: process costing, job order costing, and
standard costing. Which of these can be used in conjunction with absorption costing?
a. job order costing
b. standard costing
c. process costing
d. all of the above
ANS: D

44. Another name for absorption costing is

a. full costing.
b. direct costing.
c. job order costing.
d. fixed costing.
ANS: A

45. If a firm produces more units than it sells, absorption costing, relative to variable costing, will result in
a. higher income and assets.
b. higher income but lower assets.
c. lower income but higher assets.
d. lower income and assets.
ANS: A

46. Under absorption costing, fixed manufacturing overhead could be found in all of the following except
the
a. work-in-process account.
b. finished goods inventory account.
c. Cost of Goods Sold.
d. period costs.
ANS: D

47. If a firm uses absorption costing, fixed manufacturing overhead will be included
a. only on the balance sheet.
 b. only on the income statement.
c. on both the balance sheet and income statement.
d. on neither the balance sheet nor income statement.
ANS: C

48. Under absorption costing, if sales remain constant from period 1 to period 2, the company will report a
larger income in period 2 when
a. period 2 production exceeds period 1 production.
b. period 1 production exceeds period 2 production.
c. variable production costs are larger in period 2 than period 1.
d. fixed production costs are larger in period 2 than period 1.
ANS: A

49. The FASB requires which of the following to be used in preparation of external financial statements?
a. variable costing
b. standard costing
c. activity-based costing
d. absorption costing
ANS: D

50. An ending inventory valuation on an absorption costing balance sheet would

a. sometimes be less than the ending inventory valuation under variable costing.
b. always be less than the ending inventory valuation under variable costing.
c. always be the same as the ending inventory valuation under variable costing.
d. always be greater than or equal to the ending inventory valuation under variable costing.
ANS: D

51. Absorption costing differs from variable costing in all of the following except
a. treatment of fixed manufacturing overhead.
b. treatment of variable production costs.
c. acceptability for external reporting.
d. arrangement of the income statement.
ANS: B

52. Which of the following is not associated with absorption costing?

a. functional format
b. gross margin
c. period costs
d. contribution margin
ANS: D
53. Unabsorbed fixed overhead costs in an absorption costing system are
a. fixed manufacturing costs not allocated to units produced.
b. variable overhead costs not allocated to units produced.
c. excess variable overhead costs.
d. costs that cannot be controlled.
ANS: A

54. Profit under absorption costing may differ from profit determined under variable costing. How is this
difference calculated?
a. Change in the quantity of all units in inventory times the relevant fixed costs per unit.
b. Change in the quantity of all units produced times the relevant fixed costs per unit.
c. Change in the quantity of all units in inventory times the relevant variable cost per unit.
d. Change in the quantity of all units produced times the relevant variable cost per unit.
ANS: A

55. What factor, related to manufacturing costs, causes the difference in net earnings computed using
absorption costing and net earnings computed using variable costing?
a. Absorption costing considers all costs in the determination of net earnings, whereas
variable costing considers fixed costs to be period costs.
b. Absorption costing allocates fixed overhead costs between cost of goods sold and
inventories, and variable costing considers all fixed costs to be period costs.
c. Absorption costing "inventories" all direct costs, but variable costing considers direct costs
to be period costs.
d. Absorption costing "inventories" all fixed costs for the period in ending finished goods
inventory, but variable costing expenses all fixed costs.
ANS: B

56. The costing system that classifies costs by functional group only is
a. standard costing.
b. job order costing.
c. variable costing.
d. absorption costing.
ANS: D

57. A functional classification of costs would classify "depreciation on office equipment"

as a
a. product cost.
b. general and administrative expense.
c. selling expense.
d. variable cost.
ANS: B

58. The costing system that classifies costs by both functional group and behavior is
a. process costing.
b. job order costing.
c. variable costing.
d. absorption costing.
ANS: C

59. Under variable costing, which of the following are costs that can be inventoried?
a. variable selling and administrative expense
b. variable manufacturing overhead
 c. fixed manufacturing overhead
d. fixed selling and administrative expense
ANS: B

60. Consider the following three product costing alternatives: process costing, job order costing, and
standard costing. Which of these can be used in conjunction with variable costing?
a. job order costing
b. standard costing
c. process costing
d. all of them
ANS: D

61. Another name for variable costing is

a. full costing.
b. direct costing.
c. standard costing.
d. adjustable costing.
ANS: B

62. If a firm uses variable costing, fixed manufacturing overhead will be included
a. only on the balance sheet.
b. only on the income statement.
c. on both the balance sheet and income statement.
d. on neither the balance sheet nor income statement.
ANS: B

63. Under variable costing,

a. all product costs are variable.
b. all period costs are variable.
c. all product costs are fixed.
d. product costs are both fixed and variable.
ANS: A

64. How will a favorable volume variance affect net income under each of the following methods?

Absorption Variable

a. reduce no effect
b. reduce increase
c. increase no effect
d. increase reduce

ANS: C
65. Variable costing considers which of the following to be product costs?

Fixed Fixed Variable Variable

Mfg. Costs Selling & Adm. Mfg. Costs Selling & Adm.

a. yes no yes no
b. yes no yes yes
c. no no yes yes
d. no no yes no

ANS: D

66. The variable costing format is often more useful to managers than the absorption costing format
because
a. costs are classified by their behavior.
b. costs are always lower.
c. it is required for external reporting.
d. it justifies higher product prices.
ANS: A

67. The difference between the reported income under absorption and variable costing is attributable to the
difference in the
a. income statement formats.
b. treatment of fixed manufacturing overhead.
c. treatment of variable manufacturing overhead.
d. treatment of variable selling, general, and administrative expenses.
ANS: B

68. Which of the following costs will vary directly with the level of production?
a. total manufacturing costs
b. total period costs
c. variable period costs
d. variable product costs
ANS: D

69. On the variable costing income statement, the difference between the "contribution margin" and
"income before income taxes" is equal to
a. the total variable costs.
b. the Cost of Goods Sold.
c. total fixed costs.
d. the gross margin.
ANS: C

70. For financial reporting to the IRS and other external users, manufacturing overhead costs are
a. deducted in the period that they are incurred.
b. inventoried until the related products are sold.
c. treated like period costs.
d. inventoried until the related products have been completed.
ANS: B

71. In the application of "variable costing" as a cost-allocation process in manufacturing,

a. variable direct costs are treated as period costs.
b. nonvariable indirect manufacturing costs are treated as product costs.
 c. variable indirect manufacturing costs are treated as product costs.
d. nonvariable direct costs are treated as product costs.
ANS: C

72. A basic tenet of variable costing is that period costs should be currently expensed. What is the
rationale behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific product.
b. Period costs are generally immaterial in amount and the cost of assigning the amounts to
specific products would outweigh the benefits.
c. Allocation of period costs is arbitrary at best and could lead to erroneous decision by
management.
d. Because period costs will occur whether production occurs, it is improper to allocate these
costs to production and defer a current cost of doing business.
ANS: D

73. Which of the following is a term more descriptive of the term "direct costing"?
a. out-of-pocket costing
b. variable costing
c. relevant costing
d. prime costing
ANS: B

74. What costs are treated as product costs under variable (direct) costing?
a. only direct costs
b. only variable production costs
c. all variable costs
d. all variable and fixed manufacturing costs
ANS: B

75. Which of the following must be known about a production process in order to institute a variable
costing system?
a. the variable and fixed components of all costs related to production
b. the controllable and non-controllable components of all costs related to production
c. standard production rates and times for all elements of production
d. contribution margin and break-even point for all goods in production
ANS: A

76. Why is variable costing not in accordance with generally accepted accounting principles?
a. Fixed manufacturing costs are treated as period costs under variable costing.
b. Variable costing procedures are not well known in industry.
c. Net earnings are always overstated when using variable costing procedures.
d. Variable costing ignores the concept of lower of cost or market when valuing inventory.
ANS: A
77. Which of the following is an argument against the use of direct (variable) costing?
a. Absorption costing overstates the balance sheet value of inventories.
b. Variable factory overhead is a period cost.
c. Fixed manufacturing overhead is difficult to allocate properly.
d. Fixed manufacturing overhead is necessary for the production of a product.
ANS: D

78. Which of the following statements is true for a firm that uses variable costing?
a. The cost of a unit of product changes because of changes in the number of units
manufactured.
b. Profits fluctuate with sales.
c. An idle facility variation is calculated.
d. None of the above.
ANS: B

79. An income statement is prepared as an internal report. Under which of the following methods would
the term contribution margin appear?

Absorption costing Variable costing

a.   no no
b.   no yes
c.   yes no
d.   yes yes

ANS: B

80. In an income statement prepared as an internal report using the variable costing method, fixed
manufacturing overhead would
a. not be used.
b. be used in the computation of operating income but not in the computation of the
contribution margin.
c. be used in the computation of the contribution margin.
d. be treated the same as variable manufacturing overhead.
ANS: B

81. Variable costing has an advantage over absorption costing for which of the following purposes?
a. analysis of profitability of products, territories, and other segments of a business
b. determining the CVP relationship among the major factors of selling price, sales mix, and
sales volume
c. minimizing the effects of inventory changes on net income
d. all of the above
ANS: D

82. In the variable costing income statement, which line separates the variable and fixed costs?
a. selling expenses
b. general and administrative expense
c. product contribution margin
d. total contribution margin
ANS: D

83. A firm presently has total sales of $100,000. If its sales rise, its
a. net income based on variable costing will go up more than its net income based on
 absorption costing.
b. net income based on absorption costing will go up more than its net income based on
variable costing.
c. fixed costs will also rise.
d. per unit variable costs will rise.
ANS: A

Langley Corporation

Langley Corporation has the following standard costs associated with the manufacture and sale of one
of its products:

Direct material $3.00 per unit

Direct labor 2.50 per unit
Variable manufacturing overhead 1.80 per unit
Fixed manufacturing overhead 4.00 per unit (based on an estimate
of 50,000 units per year)
Variable selling expenses .25 per unit
Fixed SG&A expense $75,000 per year

During its first year of operations Langley manufactured 51,000 units and sold 48,000. The
selling price per unit was $25. All costs were equal to standard.

84. Refer to Langley Corporation. Under absorption costing, the standard production cost per unit for the
current year was
a. $11.30.
b. $ 7.30.
c. $11.55.
d. $13.05.
ANS: A
DM + DL + VFOH + FFOH = Standard Cost per Unit
$3.00 + $2.50 + $1.80 + $4.00 = $11.30

85. Refer to Langley Corporation. The volume variance under absorption costing is
a. $8,000 F.
b. $4,000 F.
c. $4,000 U.
d. $8,000 U.
ANS: B

1,000 favorable units production variance * $4.00 fixed factory overhead = $4,000 F
86. Refer to Langley Corporation. Under variable costing, the standard production cost per unit for the
current year was
a. $11.30.
b. $7.30.
c. $7.55.
d. $11.55.
ANS: B

DM + DL + VOH = Standard Production Cost per Unit

$3.00 + $2.50 + $1.80 = $7.30

87. Refer to Langley Corporation. Based on variable costing, the income before income taxes for the year
was
a. $570,600.
b. $560,000.
c. $562,600.
d. $547,500.
ANS: C
Sales: $1,200,000
Variable Expenses 362,400
Contribution Margin $ 837,600
Fixed Expenses
Overhead $ 200,000
75,000
Net Income $ 562,600
=========
 Ford Company

The following information is available for Ford Company for its first year of operations:

Sales in units 5,000

Production in units 8,000
Manufacturing costs:
Direct labor $3 per unit
Direct material 5 per unit
Variable overhead 1 per unit
Fixed overhead $100,000
Net income (absorption method) $30,000
Sales price per unit $40

88. Refer to Ford Company. If Ford Company had used variable costing, what amount of income before
income taxes would it have reported?
a. $30,000
b. ($7,500)
c. $67,500
d. can't be determined from the information given
ANS: B

Net Income--Absorption Costing $ 30,000

Fixed OH in Ending Inventory:
$100,000 * (3,000/8,000) ($37,500)
Net Loss--Variable Costing ($ 7,500)
=======

89. Refer to Ford Company. What was the total amount of Selling,General and Administrative expense
incurred by Ford Company?
a. $30,000
b. $62,500
c. $6,000
d. can't be determined from the information given
ANS: B
Sales $200,000
COGS 107,500
Gross Profit 92,500
SG&A X
Net Income $ 30,000

X = $62,500

90. Refer to Ford Company. If Ford Company were using variable costing, what would it show as the
value of ending inventory?
a. $120,000
 b. $64,500
c. $27,000
d. $24,000
ANS: C
3,000 units * $9.00/unit = $27,000

Clinton Corporation

The following information has been extracted from the financial records of Clinton Corporation for its
first year of operations:

Units produced 10,000

Units sold 7,000
Variable costs per unit:
Direct material $8
Direct labor 9
Manufacturing overhead 3
SG&A 4
Fixed costs:
Manufacturing overhead $70,000
SG&A 30,000

91. Refer to Clinton Corporation. Based on absorption costing, Clinton Corporation's income in its first
year of operations will be
a. $21,000 higher than it would be under variable costing.
b. $70,000 higher than it would be under variable costing.
c. $30,000 higher than it would be under variable costing.
d. higher than it would be under variable costing, but the exact difference cannot be
determined from the information given.
ANS: A
3,000 unsold units * $7.00 fixed overhead/unit = $21,000 higher under absorption costing.
92. Refer to Clinton Corporation. Based on absorption costing, the Cost of Goods Manufactured for
Clinton Corporation's first year would be
a. $200,000.
b. $270,000.
c. $300,000.
d. $210,000.
ANS: B
COGM = Variable Overhead + Fixed Overhead
COGM = (100,000 units * $20/unit) + $70,000
COGM = $270,000

93. Refer to Clinton Corporation. Based on absorption costing, what amount of period costs will Clinton
Corporation deduct?
a. $70,000
b. $79,000
c. $30,000
d. $58,000
ANS: D
Period costs = Variable SG&A + Fixed SG&A
$58,000 = (7,000 * $4) + $30,000

94. For its most recent fiscal year, a firm reported that its contribution margin was equal to 40 percent of
sales and that its net income amounted to 10 percent of sales. If its fixed costs for the year were
$60,000, how much were sales?
a. $150,000
b. $200,000
c. $600,000
d. can't be determined from the information given
ANS: B
Let S = Sales
Let CM = .40S
Let NI = .10S

FC = .30S
$60,000 = .30S
S = $200,000
95. At its present level of operations, a small manufacturing firm has total variable costs equal to 75
percent of sales and total fixed costs equal to 15 percent of sales. Based on variable costing, if sales
change by $1.00, income will change by
a. $0.25.
b. $0.10.
c. $0.75.
d. can't be determined from the information given.
ANS: A
Let S = 1.00
Let VC = .75S
Let CM = .25S

Under variable costing every dollar of sales will increase net income by $0.25.

96. The following information regarding fixed production costs from a manufacturing firm is available for
the current year:

Fixed costs in the beginning inventory $ 16,000

Fixed costs incurred this period 100,000

Which of the following statements is not true?

a. The maximum amount of fixed production costs that this firm could deduct using
absorption costs in the current year is $116,000.
b. The maximum difference between this firm's the current year income based on absorption
costing and its income based on variable costing is $16,000.
c. Using variable costing, this firm will deduct no more than $16,000 for fixed production
costs.
d. If this firm produced substantially more units than it sold in the current year, variable
costing will probably yield a lower income than absorption costing.
ANS: C

Enigma Corporation

The following information was extracted from the first year absorption-based accounting records of
Enigma Corporation

Total fixed costs incurred $100,000

Total variable costs incurred 50,000
Total period costs incurred 70,000
Total variable period costs incurred 30,000
Units produced 20,000
Units sold 12,000
Unit sales price $12
97. Refer to Enigma Corporation. What is Cost of Goods Sold for Enigma Corporation's first year?
a. $80,000
b. $90,000
c. $48,000
d. can't be determined from the information given
ANS: C
Total variable manufacturing costs = $50,000 - 30,000 = $20,000
Total fixed period costs incurred = $70,000 - 30,000 = $40,000
Total fixed manufacturing costs = $100,000 - 40,000 = $60,000
Total manufacturing costs = $60,000 + $20,000 = $80,000
Percent of goods sold: 12,000/20,000 = 60%
$80,000 * 60% = $48,000

98. Refer to Enigma Corporation. If Enigma Corporation had used variable costing in its first year of
operations, how much income (loss) before income taxes would it have reported?
a. ($6,000)
b. $54,000
c. $26,000
d. $2,000
ANS: D
Sales $144,000
Less: Variable Costs
Manufacturing $20,000 * 60% 12,000
Period Costs $30,000 30.000
Contribution Margin $102,000
Fixed Costs 100,000
Variable Costing Net Income 2,000
======

99. Refer to Enigma Corporation. Based on variable costing, if Enigma had sold 12,001 units instead of
12,000, its income before income taxes would have been
a. $9.50 higher.
b. $11.00 higher.
c. $8.50 higher.
d. $8.33 higher.
ANS: C
Sales Price per Unit: $12.00
Variable Costs per Unit ($50,000 / 20,000) 2.50
Contribution Margin $ 8.50
======
 King Corporation

King Corporation produces a single product. The following cost structure applied to its first year of
operations:

Variable costs:
SG&A $2 per unit
Production $4 per unit
Fixed costs (total cost incurred for the year):
SG&A $14,000
Production $20,000

100. Refer to King Corporation. Assume for this question only that during the current year King
Corporation manufactured 5,000 units and sold 3,800. There was no beginning or ending work-in-
process inventory. How much larger or smaller would King Corporation's income be if it uses
absorption rather than variable costing?
a. The absorption costing income would be $6,000 larger.
b. The absorption costing income would be $6,000 smaller.
c. The absorption costing income would be $4,800 larger.
d. The absorption costing income would be $4,000 smaller.
ANS: C

Add back fixed manufacturing portion of units unsold (1,200/5,000) * $20,000 = $4,800.

101. Refer to King Corporation. Assume for this question only that King Corporation manufactured and
sold 5,000 units in the current year. At this level of activity it had an income of $30,000 using variable
costing. What was the sales price per unit?
a. $16.00
b. $18.80
c. $12.80
d. $14.80
ANS: B
Sales--5,000 units * $18.80/unit $94,000
Variable Costs:
Manufacturing 20,000
SG&A 10,000
Contribution Margin $64,000
Fixed Costs
Manufacturing 14,000
SG&A 20,000
Net Income $30,000
=====
102. Refer to King Corporation. Assume for this question only that King Corporation produced 5,000 units
and sold 4,500 units in the current year. If King uses absorption costing, it would deduct period costs
of
a. $24,000.
b. $34,000.
c. $27,000.
d. $23,000.
ANS: D
Variable SG&A Costs (4,500 units * $2/unit) $ 9,000
Fixed SG&A Costs 14,000
Total period costs to be deducted $23,000
======

103. Refer to King Corporation. Assume for this question only that King Corporation manufactured 5,000
units and sold 4,000 in the current year. If King employs a costing system based on variable costs, the
company would end the current year with a finished goods inventory of
a. $4,000.
b. $8,000.
c. $6,000.
d. $5,000.
ANS: A
1,000 units * $4.00 variable cost per unit = $4,000

Companies R, S, and T

Three new companies (R, S, and T) began operations on January 1 of the current year. Consider the
following operating costs that were incurred by these companies during the complete calendar year:

Company R Company S Company T

Production in units 10,000 10,000 10,000
Sales price per unit $10 $10 $10
Fixed production costs $10,000 $20,000 $30,000
Variable production costs $30,000 $20,000 $10,000
Variable SG&A $10,000 $20,000 $30,000
Fixed SG&A $30,000 $20,000 $10,000

104. Refer to Companies R, S, and T. Based on sales of 7,000 units, which company will report the greater
income before income taxes if absorption costing is used?
a. Company R
b. Company S
c. Company T
d. All of the companies will report the same income.
ANS: D
Under absorption costing, the net income for all three companies is the same.

105. Refer to Companies R, S, and T. Based on sales of 7,000 units, which company will report the greater
income before income taxes if variable costing is used?
 a. Company R
b. Company S
c. Company T
d. All of the companies will report the same income.
ANS: A
Since Company R has the largest variable manufacturing costs, income will increase by the
amount that was held in finished goods inventory.

106. Refer to Companies R, S, and T. Based on sales of 10,000 units, which company will report the greater
income before income taxes if variable costing is used?
a. Company R
b. Company S
c. Company T
d. All of the companies will report the same income before income taxes.
ANS: D
Since all the companies have the same net income and all had the same amount of sales, all
three companies would have the same net income under variable costing.

107. A firm has fixed costs of $200,000 and variable costs per unit of $6. It plans on selling 40,000 units in
the coming year. To realize a profit of $20,000, the firm must have a sales price per unit of at least
a. $11.00.
b. $11.50.
c. $10.00.
d. $10.50.
ANS: B
Sales--40,000 units * $11.50/unit $460,000
Variable Costs:
Manufacturing 240,000
Contribution Margin $220,000
Fixed Costs 200,000
Net Income $ 20,000
=====
 Bennett Corporation

Bennett Corporation produces a single product that sells for $7.00 per unit. Standard capacity is
100,000 units per year; 100,000 units were produced and 80,000 units were sold during the year.
Manufacturing costs and selling and administrative expenses are presented below.

There were no variances from the standard variable costs. Any under- or overapplied overhead is
written off directly at year-end as an adjustment to cost of goods sold.

Fixed costs Variable costs

Direct material $0 $1.50 per unit produced
Direct labor 0 1.00 per unit produced
Manufacturing overhead $150,000 0.50 per unit produced
Selling & Administration expense 80,000 0.50 per unit sold

Bennett Corporation had no inventory at the beginning of the year.

108. Refer to Bennett Corporation. In presenting inventory on the balance sheet at December 31, the unit
cost under absorption costing is
a. $2.50.
b. $3.00.
c. $3.50.
d. $4.50.
ANS: D

DM + DL + VOH + FOH = Absorption Cost per Unit

$1.50 + $1.00 + $0.50 + $(150,000/100,000) = $4.50 / Unit

109. Refer to Bennett Corporation. What is the net income under variable costing?
a. $50,000
b. $80,000
c. $90,000
d. $120,000
ANS: A
Sales $560,000
Variable Costs:
Materials $120,000
Labor 80,000
Overhead 40,000
Selling and Administrative 40,000
Contribution Margin $280,000
Fixed Costs
Overhead 150,000
Selling and Administrative 80,000
Net Income $ 50,000
=======
110. Refer to Bennett Corporation. What is the net income under absorption costing?
a. $50,000
b. $80,000
c. $90,000
d. $120,000
ANS: B
Sales $560,000
Cost of Goods Sold:
Materials $120,000
Labor 80,000
Overhead (Variable and Fixed) 160,000
Gross Profit $200,000
Fixed Costs:
Selling and Administrative $120,000
Net Income $ 80,000
=======
SHORT ANSWER

1. What are three reasons that overhead must be allocated to products?

ANS:
Overhead must be allocated because it is necessary to (1) determine fill cost, (2) it can motivate
managers, and (3) it allows managers to compare alternative courses of action.

2. Why should predetermined overhead rates be used?

ANS:
Predetermined overhead rates should be used for three reasons: (1) to assign overhead to Work in
Process during the production cycle instead of at the end of the period; (2) to compensate for
fluctuations in actual overhead costs that have no bearing on activity levels; and (3) to overcome
problems of fluctuations in activity levels that have no impact on actual fixed overhead costs.

3. What are the primary reasons for using a predetermined overhead rate?

ANS:
1. A predetermined overhead rate allows overhead to be assigned during a period and therefore
improves the timeliness of information.
2. A predetermined overhead rate adjusts for variations in actual overhead costs that are unrelated to
activity.
3. A predetermined overhead rate overcomes the problem of fluctuations in activity levels that have
no impact on actual fixed overhead costs.
4. Using a predetermined overhead rate often allows managers to be more aware of individual product
or product line profitability as well as the profitability of doing business with a particular customer or
vendor.

4. Discuss underapplied and overapplied overhead and its disposition at the end of the period.

ANS:
During the course of the production cycle, actual overhead costs are incurred. When overhead is
applied to Work in Process, it is commonly applied using a predetermined rate. Overhead application
at a predetermined rate may cause overhead to be under- or overapplied. If actual overhead is greater
than applied overhead, then underapplied overhead results and a debit balance exists in the overhead
account. If applied overhead is greater than actual overhead, then overapplied overhead results and a
credit balance exists in the overhead account. If the amount of under- or overapplied overhead is
immaterial, it is closed directly to Cost of Goods Sold. If the amount is material, it must be allocated
among Work in Process, Finished Goods, and Cost of Goods Sold.
5. List and explain the four alternative measures of capacity.

ANS:
Theoretical capacity--This is the estimated maximum potential activity for a specified time. It assumes
that all production factors are operating perfectly. It disregards such factors as machinery breakdowns
and reduced plant operations.
Practical capacity--This measure reduces theoretical capacity by ongoing regular operating
interruptions. It represents the capacity that could realistically be achieved during normal working
hours.
Normal capacity--This measure considers historical and estimated future production levels and cyclical
fluctuations.
Expected capacity--This is a short-run capacity measure that represents the firm’s anticipated activity
level for the upcoming period based upon projected product demand.

6. Discuss the high-low method.

ANS:
The high-low method is a technique for analyzing mixed costs. The high-low method analyzes changes
at two levels of activity (the high end and the low end) within the relevant range. The changes in cost
and activity are calculated for these two levels of activity. Dividing the change in cost by the change in
activity determines the variable cost element portion of the mixed cost. Once this is determined, the
fixed portion is computed by subtracting the variable element times either the high or low level of
activity from respectively, total cost at either the high or low level of activity.

7. Why do managers frequently prefer variable costing to absorption costing for internal use?

ANS:
Managers may prefer variable costing because it classifies costs both by their function and their
behavior. When costs are classified by behavior, managers can more accurately predict how total costs
will change when volume changes. With more accurate information, managers can make better
production and pricing decisions.

8. Why is variable costing not used extensively in external reporting?

ANS:
Variable costing is not used extensively outside of the firm because absorption costing is required by
GAAP and the IRS.
 9. How can a company produce both variable and absorption costing information from a single
accounting system?

ANS:
Firms only have one accounting information system. This system will be based on either variable or
absorption costing. If the system needs to provide information in both the variable and absorption
formats, the system's accounting information can be converted from one format to the other. The
conversion requires an adjustment to the product inventory accounts and the amount of product costs
charged against the period's income. The conversion is typically easier if standard costing is employed.

10. What are the major differences between variable and absorption costing?

ANS:
The major difference between variable costing and absorption costing is in the way each defines
product cost. While absorption costing includes fixed manufacturing overhead as a product cost,
variable costing treats it as a cost of the period. A secondary difference between the two methods is the
format of the income statement. Absorption costing utilizes the traditional income statement format
that categorizes costs by their function only. Variable costing uses an income statement format that
categorizes costs by both their function and behavior.

11. Why is absorption costing not used for CVP analysis?

ANS:
Absorption costing is not used in break-even analysis because it presents a classification of costs by
function rather than by behavior. Without a behavioral classification of costs, it is impossible to predict
how total costs change as volume changes.

12. How do differences in sales and production level affect net income computed under absorption costing
and variable costing?

ANS:
If production equals sales, absorption costing net income equals variable costing net income.

If production exceeds sales, absorption costing net income exceeds variable costing net income,
because some fixed manufacturing overhead is deferred as inventory cost on the balance sheet.

If production is less than sales, absorption costing net income is less than variable costing net income,
because some fixed manufacturing overhead that had been deferred as inventory cost is now expensed.
PROBLEM

1. Hume Corporation has the following data for the current year:

Direct Labor $220,000

Direct Material 137,800
Actual Overhead 320,000
Applied Overhead 395,000
Raw Material 51,394
Work in Process 101,926
Finished Goods 111,192
Cost of Goods Sold 250,182

What is the amount of under- or overapplied overhead? Prepare the necessary journal entry to dispose
of under- or overapplied overhead.

ANS:

Applied Overhead $395,000

Actual Overhead 320,000
$ 75,000 overapplied

WIP $101,926/$463,300=.22 x $75,000 = $16,500

FG $111,192/$463,300=.24 x $75,000 = $18,000
CGS $250,182/$463,300=.54 x $75,000 = $40,500

Manufacturing Overhead $75,000

Work in Process $16,500
Finished Goods 18,000
Cost of Goods Sold 40,500

2. Leon Corporation has the following data relating to its power usage for the first six months of the
current year.

Month Usage (Kw)Cost

Jan. 500 $450
Feb. 550 455
Mar. 475 395
Apr. 425 310
May 450 380
June 725 484

Assume usage is within the relevant range of activity.

Required:

a. Using the high-low method, compute the cost formula.

b. Leon Corporation estimates its power usage for July at 660 watts. Compute the total
power cost for July.
 ANS:

Usage Cost
High 725 $484
Low 425  310
300 $174

$174/300 = $.58 x 425 = $246.50 Total variable cost

$310 (TC) - $246.50 (TVC) = $63.50 Fixed cost

TC = $63.50 + $0.58(VC)

At 660 kw, the total cost would be

TC = $63.50 + $0.58(660 kwh)

TC = $446.30

3. Miller Corporation applies overhead at the rate of 70 percent of direct labor. Miller incurred $450,000
of direct labor during the current year. Miller incurred actual overhead of $367,000.

(a) Compute the amount of under- or overapplied overhead for Miller Corporation for the current year
(b) Prepare the necessary journal entry to dispose of the under- or overapplied overhead (assuming that
the amount is immaterial).

ANS:

a. $450,000 x 70% = $315,000 applied overhead

367,000 actual overhead
$ 52,000 underapplied overhead

b. Cost of Goods Sold $52,000

Manufacturing Overhead $52,000

4. Action Trainers provides a personalized training program that is popular with many companies. The
number of programs offered over the last five months, and the costs of offering these programs are as
follows:

Programs Offered Costs Incurred

Jan 55 $15,400
Feb 45 14,050
Mar 60 18,000
April 50 14,700
May 75 19,000

a. Using the high-low method, compute the variable cost per program and the total fixed cost
per month.
b. Using the least squares regression method, compute the variable cost per program and the
total fixed cost per month.
 ANS:

a. Variable cost per program:

Change in costs $19,000 - $14,050 = $165 per program

Change in activity 75 - 45

Fixed cost:
At high activity = $19,000 - (75 x $165) = $6,625 per month
At low activity = $14,050 - (45 x $165) = $6,625 per month

b. x y xy x2
55 $15,400 $ 847,000 3,025
45 14,050 632,250 2,025
60 18,000 1,080,000 3,600
50 14,700 735,000 2,500
 75  19,000  1,425,000  5,625
285 $81,150 $4,719,250 16,775

= 57

= 16,230

b = 4,719,250 - (5 57 16,230) (16,775 - (5 57 )

b = 176.79
a = 16,230 - (176.79 57)
a = 6,152.97

5. The facility manager of Bello Corporation asked the systems analyst for information to help in
forecasting handling costs. The following printout was generated using the least squares regression
method.

Fixed cost $2550

Variable cost per unit 1.85
Activity variable units of production volume

a. Using the information from the printout, develop a cost function that can be used to estimate
handling costs at different volume levels.
b. Estimate handling costs if expected production for next month is 20,000 units.

ANS:

a. Total handling costs = $2,550 + $1.85 (unit production)

Total handling costs = $2,550 + ($1.85 x 20,000) = $39,550
b.

6. The McAlister Co. has the following information available regarding costs and revenues for two recent
months. Selling price is $20.
 March April
Sales revenue $60,000 $100,000
Cost of goods sold -36,000 - 60,000
Gross profit $24,000 $ 40,000
Less other expenses:
Advertising $   600 $    600
Utilities 4,200 5,600
Salaries and commissions 3,200 4,000
Supplies (bags, cleaning supplies etc.) 320 400
Depreciation 2,300 2,300
Administrative costs   1,900   1,900
Total -12,520 -14,800
Net income $11,480 $25,200

Required:

a. Identify each of the company's expenses (including cost of goods sold) as being either
variable, fixed, or mixed.
b. By use of the high-low method, separate each mixed expense into variable and fixed
elements. State the cost formula for each mixed expense.
c. What is the total cost equation?
d. Estimate total cost if sales = $75,000.

ANS:

a. Cost April May Behavior

COGS 36,000/60,000=60% 60,000/100,000=60% V
Advertising 600 600 F
Utilities 4,200/60,000= 7% 5,600/100,000=5.6% M
Salaries, Etc. 4,000/100,000=4% M
3,200/60,000=5.3%
Supplies 320/60,000 .53% 400/100,000=.4% M
Depreciation 2,300 2,300 F
Administration 1,900 1,900 F

b. Utilities $1,400 = 3.5% Sales

$40,000

FC = $4,200 - (3.5% x 60,000) = $2,100

Salaries $800/$40,000 = 2% Sales

FC = $3,200 - (2% x 60,000) = $2,000

Supplies $80/$40,000 = .2% sales

FC = $320 - (.2% x $60,000) = $200

c. Total FC = $600 + $2,300 + $1,900 + $2,100 + $2,000 + $200 = $9,100

Total VC = 60% + 3.5% + 2% + .2% = 65.7% sales
TC = $9,100 + 65.7% sales

d. TC = $9100 + (65.7% x $75,000) = $58,375

7. Browning Company owns two luxury automobiles that are used by employees on company business.
Mileage and expenses, excluding depreciation, by quarters for the most recent year are presented
below:

Quarter Mileage Expenses

First 3,000 $  550
Second 3,500 560
Third 2,000 450
Fourth  3,500    600
12,000 $2,160

Required: Determine the variable cost per mile (nearest tenth of a cent) and the fixed costs per
quarter, using the method of least squares.

ANS:

X Y XY X2
1 ST 3,000 $550 $1,650,000 9,000,000
2ND 3,500 560 1,960,000 12,250,000
3RD 2,000 450 900,000 4,000,000
4TH 3,500 600 2,100,000 12,250,000
12,000 $2,160 $6,610,000 37,500,000

_
X = 12,000/4 = 3,000/miles per quarter
_
Y = $2,160/4 = $540

b = $6,610,000 - 4 (3,000) ($540) = $130,000 = $.087/mile

$37,500,000 - 4 (3,000) (3,000) $1,500,000

a = $540 - ($.087) (3,000) = $279

TC = $279 + .087/mile

8. On December 30, a fire destroyed most of the accounting records of the Adams Division, a small one-
product manufacturing division that uses standard costs and flexible budgets. All variances are written
off as additions to (or deductions from) income; none are pro-rated to inventories. You have the task of
reconstructing the records for the year. The general manager informs you that the accountant has been
experimenting with both absorption costing and variable costing.

The following information is available for the current year:

a. Cash on hand, December 31 $10

b. Sales $128,000
c. Actual fixed indirect manufacturing costs 21,000
d. Accounts receivable, December 31 20,000
e. Standard variable manufacturing costs per unit 1
f. Variances from standard of all variable manufacturing costs $5,000 U
g. Operating income, absorption-costing basis $14,400
h. Accounts payable, December 31 18,000
i. Gross profit, absorption costing at standard (before deducting
 variances) 22,400
j. Total liabilities 100,000
k. Unfavorable budget variance, fixed manufacturing costs 1,000 U
l. Notes receivable from chief accountant 4,000
m. Contribution margin, at standard (before deducting variances) 48,000
n. Direct-material purchases, at standard prices 50,000
o. Actual selling and administrative costs (all fixed) 6,000

Required:

Compute the following items (ignore income tax effects).

1. Operating income on a variable-costing basis.

2. Number of units sold.
3. Number of units produced.
4. Number of units used as the denominator to obtain fixed indirect cost application rate
per unit on absorption-costing basis.
5. Did inventory (in units) increase or decrease? Explain.
6. By how much in dollars did the inventory level change (a) under absorption costing,
(b) under variable costing?
7. Variable manufacturing cost of goods sold, at standard prices.
8. Manufacturing cost of goods sold at standard prices, absorption costing.

ANS:

1. CM 48,000  Actual fix mfg $21,000 

- FC (26,000) - unfavorable VAR  (1,000)
Operating Income (STD) $22,000  fix cost @STD $20,000 
- unfavorable variances (6,000)
Operating Income (actual) $16,000 

2. Sales  $128,000 
- CM   (48,000)
= VC  $ 80,000 /$1 UNIT = 80,000 units sold

3. Sales  $128,000 
- GM   (22,400)
COGS  $105,600 /80,000 = $1.32

Difference in OI = (P - S)  fix mfg/unit

$(1,600) = (P - 80,000)  $.32 P = 75,000

4. OI - absorption cost = $22,400 - $6,000 = $ 16,400  OI STD

 (14,400) OI ACT
variances $ 2,000  UNF
- other VAR    6,000  UNF
VOL VAR $ 4,000  FAV

$4,000 F = (75,000 - X)  $.32

X = 62,500 units produced

5. Inventory decreased. OI absorption is less than OI variable.

6. Absorption cost 5,000 units  $1.32 = $6,600

Variable cost 5,000 units  $1 = $5,000
 7. 80,000 units  $1 = $80,000

8. 80,000  $1.32 = $105,600

9. Sports Innovators has developed a new design to produce hurdles that are used in track and field
competition. The company's hurdle design is innovative in that the hurdle yields when hit by a runner
and its height is extraordinarily easy to adjust. Management estimates expected annual capacity to be
90,000 units; overhead is applied using expected annual capacity. The company's cost accountant
predicts the following 2001 activities and related costs:

Standard unit variable manufacturing costs $12

Variable unit selling expense $5
Fixed manufacturing overhead $480,000
Fixed selling and administrative expenses $136,000
Selling price per unit $35
Units of sales 80,000
Units of production 85,000
Units in beginning inventory 10,000

Other than any possible under- or overapplied fixed overhead, management expects no variances from
the previous manufacturing costs. Under- or overapplied fixed overhead is to be written off to Cost of
Goods Sold.

Required:
1. Determine the amount of under- or overapplied fixed overhead using (a) variable
costing and (b) absorption costing.

2. Prepare projected income statements using (a) variable costing and (b) absorption
costing.

3. Reconcile the incomes derived in part 2.

ANS:

1. a. $0

b. (90,000 - 85,000)  $5.33 = $26,650 U

2. a. Sales (80,000  $35) = $2,800,000 

- VC (80,000  $17) = (1,360,000)
CM $1,440,000 
- FC   (616,000)
Income before income taxes $ 824,000 

b. Sales (80,000  $35) $2,800,000 

- COGS ($17.33  80,000) (1,386,400)
GM $1,413,600 
- S&A   (536,000)
Income before income (STD) $ 877,600 
- VOL VAR    (26,650)
Income before income taxes $ 850,950 

3. 5,000  $5.33 = $26,650.

10. Sherrill Corporation produces a single product. The following is a cost structure applied to its first year
of operations.

Sales price $15 per unit

Variable costs:
SG&A $2 per unit
Production $4 per unit
Fixed costs (total cost incurred for the year):
SG&A $14,000
Production $20,000

During the first year, Sherrill Corporation manufactured 5,000 units and sold 3,800. There was no
beginning or ending work-in-process inventory.

a. How much income before income taxes would be reported if Stanley uses absorption
costing?
b. How much income before income taxes would be reported if variable costing was
used?
c. Show why the two costing methods give different income amounts.

ANS:

a. Income under absorption costing is:

Sales $15  3,800 = $57,000 
COGS 3,800  ($4 + $20,000/5,000)  30,400 
GM $26,600 
Oper. Exp.
VSE $2  3,800 = $ 7,600
FSE  14,000 (21,600)
Absorption income before income taxes $ 5,000 

b. Income under variable costing:

CMU = SP - VProd.Cost - VSGA = $15 - $4 - $2 = $9
 Vol. sold 3,800
CM $34,200 
Less: FC - Production (20,000)
SG&A (14,000)
Variable costing income before income taxes $ 200 

c. Reason for difference in income:

Fixed costs expensed under absorp. costing
COGS 3,800  $20,000/5,000 units $15,200 
Fixed SG&A  14,000 
Total $29,200 
Fixed costs expensed under variable costing
Fixed SG&A $14,000 
Fixed Production  20,000 
Total FC $34,000 
Difference in FC expensed under two methods $ 4,800 

This is also the difference in income amounts.

11. Trent Johnson Company used least squares regression analysis to obtain the following
output:

Personnel Department Cost

Explained by Number of
Employees

Constant $5,800
Standard error of Y estimate $630
R - squared 0.8924
No. of observations 20
Degrees of freedom 18

X coefficient(s) 1.902
Standard error of coefficient(s) 0.0966

a. What is the total fixed cost?

b. What is the variable cost per employee?

c. Prepare the linear cost function.

d. What is the coefficient of determination? Comment on the goodness

of fit.

ANS:
a. The constant or intercept is the total fixed cost of $5,800.

b. The variable cost per employee is the X coefficient of $1.902.

c. Personnel department cost = $5,800 + $1.902 * (number of employees).

d. The coefficient of determination is the R - squared of 0.8924. This

represents a very high goodness of fit. The closer to 1.0, the
better the cost driver explains the dependent variable. Therefore, the
conclusion can be drawn that there is a significant relationship
between the cost of the personnel department and the number of
employees.