Chapter 20 (5) Variable Costing for Management Analysis Study Guide Solutions 1. Variable cost of goods sold 2. Manufacturing margin 3. Income from operations 4. Contribution margin ratio Fill-in-the-Blank Equations Exercises 1. Determine if each description relates to the variable or absorption costing method. a. Variable costing b. Absorption costing c. Variable costing 2. Finnegan s management is deciding between the absorption costing and variable costing method. The company would like to treat the fixed and variable overhead costs the same, as a product cost. Which method should the company use? Absorption costing 3. In order to calculate income from operations, a company deducts the fixed costs from the contribution margin. Which type of costing method does management use in calculating income from operations? Variable costing Strategy: Under variable costing, only the variable manufacturing overhead is included in the cost of goods manufactured. Fixed manufacturing overhead is deducted as a period expense. Absorption costing includes variable and fixed manufacturing overhead when determining cost of goods manufactured. Since fixed manufacturing overhead is included, it is only expensed when the goods are sold. 1
2 Chapter 20 (5) 4. Use the information shown to calculate Finnegan s manufacturing margin, contribution margin, and income from operations. The company uses a variable costing system. Assume that the company sold all units produced. Sales $890,000 Direct materials 54,000 Direct labor 120,000 Variable overhead 18,000 Fixed overhead 23,500 Variable selling and administrative 12,400 Fixed selling and administrative 35,750 Manufacturing margin: $698,000 = $890,000 $54,000 $120,000 $18,000 Contribution margin: $685,600 = $698,000 $12,400 Income from operations: $626,350 = $685,600 $23,500 $35,750 5. For the month of August, Purple Sun generated sales of $400,000. The company s variable cost of goods sold for the month totaled $175,000, including variable overhead of $25,600. Total overhead for the month was $56,200. The company also incurred variable selling and administrative costs of $13,200 and fixed selling and administrative costs of $45,000. a. $225,000 = $400,000 $175,000 b. $211,800 = $225,000 $13,200 c. $136,200 = $211,800 $30,600 $45,000 6. During the month of May, Rosie s Shoe Supply incurs the following costs: variable cost of goods sold, $18,000; fixed manufacturing costs, $4,000; variable selling and administrative, $1,400; and fixed selling and administrative, $2,200. The sales for the month totaled $43,000. Determine the company s manufacturing margin, contribution margin, and income from operations for the month. Manufacturing margin: $25,000 = $43,000 $18,000 Contribution margin: $23,600 = $25,000 $1,400 Income from operations: $17,400 = $23,600 $4,000 $2,200 Strategy: First, calculate the manufacturing margin by subtracting the variable cost of goods sold from sales, which are expenses incurred to manufacture the products. Next, calculate the contribution margin by subtracting variable selling and administrative expenses from the manufacturing margin. To calculate the income from operations, subtract all fixed costs from the contribution margin.
Variable Costing for Management Analysis 3 7. Finnegan s produces 400 units for the month of September but only sells 325 units. Each unit incurs fixed manufacturing costs of $10 and variable manufacturing costs of $25. Determine the difference in variable costing and absorption costing, indicating which income will be higher. Income from operations using absorption costing will be higher than using variable costing by $750 (75 units $10/unit). 8. Purple Sun produced 15,500 units of product during the last quarter. Due to a decrease in sales, the company sold only 13,600 of these products. To manufacture each unit, the company incurs fixed manufacturing costs of $12. Under absorption costing, the income from operations totals $72,900. Determine the income from operations under variable costing. Difference in income: $22,800 = (15,500 13,600) units $12/unit Income from operations (variable costing): $50,100 = $72,900 $22,800 9. The Rarebit incurs fixed manufacturing costs of $600,000 to produce 150,000 units during the year. The company sold 142,400 of these units during the year to produce income from operations of $164,000, using the variable costing method. Determine the company s income from operations using the absorption costing method. Fixed manufacturing costs: $4/unit = $600,000/150,000 units Difference in income: $30,400 = (150,000 142,400) units $4/unit Income from operations (absorption costing): $194,400 = $164,000 + $30,400 Strategy: If units produced exceed unit sales, the income from operations using the absorption method will be higher, since some of the fixed costs will need to be allocated to the ending inventory. The difference between the incomes from operations under the methods is due to the fixed manufacturing costs. To calculate the difference, multiply the fixed manufacturing costs per unit times the difference between the units produced and the units sold. The difference is the amount that is allocated to ending inventory under the absorption method, while it is expensed under the variable costing method. 10. Rosie s Shoe Supply produces and sells 30,000 units during the year. The company also sells 2,000 of the beginning inventory. To produce each unit, Rosie s Shoe Supply incurs fixed manufacturing costs of $12 per unit. Determine if income from operations will be higher under the variable or absorption costing method and the difference. Income from operations will be higher using variable costing than absorption costing by $24,000 (2,000 units $12/unit).
4 Chapter 20 (5) 11. Poe s Candles has inventory of 4,000 units at the beginning of the year. The company produced 22,000 units during the year and had no units on hand at the end of the year. The company incurred fixed manufacturing costs of $8 per unit. Income from operations using the variable costing system totaled $92,700. Determine the income from operations using the absorption method. Difference in income: $32,000 = 4,000 units $8/unit Income from operations: $60,700 = $92,700 $32,000 12. Cutty s Scissors generated an income from operations of $71,600 using the absorption costing method. The company sold 41,000 units, although it produced 39,200 units. The fixed manufacturing costs totaled $9 per unit, while variable manufacturing costs totaled $15 per unit. Determine the income from operations using the variable costing method. Difference in income: $16,200 = (41,000 39,200) units $9/unit Income from operations: $87,800 = $71,600 + $16,200 Strategy: If unit sales exceed the units produced, the variable costing method will generate a higher income from operations. The difference in income from operations is calculated the same as when the units produced exceeded the unit sales. The variable costing method produces a higher income from operations because only fixed manufacturing costs for the period are expensed, unlike the absorption costing method, which must also expense the fixed manufacturing costs of the units sold that were in beginning inventory.
Variable Costing for Management Analysis 5 13. Management of The Rarebit expects to sell 14,000 units for $12 each in the upcoming year and is deciding between producing 14,000 or 16,000 units. The company will incur variable costs of $4 per unit and total fixed costs of $21,000. The company also incurs fixed selling costs of $12,000 annually and incurs variable selling costs of $2 per unit. Prepare absorption costing income statements for the two options to determine how many units the company should produce to generate the highest income from operations. Round fixed manufacturing costs per unit to two decimal places. The Rarebit Absorption Costing Income Statements 14,000 units 16,000 units Sales $168,000 $168,000 Cost of goods sold: Cost of goods manufactured: 14,000 units $5.50 $ 77,000 16,000 units $5.31 $ 84,960 Less ending inventory: 2,000 units $5.31 10,620 Cost of goods sold $ 77,000 $ 74,340 Gross profit $ 91,000 $ 93,660 Selling and administrative expenses 40,000 40,000 Income from operations $ 51,000 $ 53,660 The income from operations using the absorption costing method will be higher for 16,000 units.
6 Chapter 20 (5) 14. Use the information in Exercise 13 to determine how many units the company should produce to generate the highest income from operations using variable costing income statements. The Rarebit Variable Costing Income Statements 14,000 units 16,000 units Sales $168,000 $168,000 Variable cost of goods sold: Variable cost of goods manufactured: 14,000 units $4 $ 56,000 16,000 units $4 $64,000 Less ending inventory: 0 units $4 0 2,000 units $4 8,000 Variable cost of goods sold $ 56,000 $ 56,000 Manufacturing margin $112,000 $112,000 Variable selling and administrative expenses 28,000 28,000 Contribution margin $ 84,000 $ 84,000 Fixed costs: Fixed manufacturing costs $ 21,000 $ 21,000 Fixed selling and administrative expenses 12,000 12,000 Total fixed costs $ 33,000 $ 33,000 Income from operations $ 51,000 $ 51,000 The income from operations will be the same for both production levels using the variable costing method.
Variable Costing for Management Analysis 7 15. Finnegan s expects to sell 53,000 units in the upcoming year. The production manager has decided the company can produce 53,000 products to meet the demand, or 58,000 products. The company will sell the units for $50 each and incur variable costs of $14 per unit. The company will also incur a variable selling expense of $5 per unit sold. Fixed costs include manufacturing costs of $41,000 and selling and administrative costs of $22,000. Using the absorption costing method, prepare the income statement for both situations to determine the number of units to produce if the company would like to generate the highest income from operations. Round fixed manufacturing overhead per unit to two decimal places. Finnegan's Absorption Costing Income Statements 53,000 units 58,000 units Sales $2,650,000 $2,650,000 Cost of goods sold: Cost of goods manufactured: 53,000 units $14.77 $ 782,810 58,000 units $14.71 $ 853,180 Less ending inventory: 5,000 units $14.71 73,550 Cost of goods sold $ 782,810 $ 779,630 Gross profit $1,867,190 $1,870,370 Selling and administrative expenses 287,000 287,000 Income from operations $1,580,190 $1,583,370 Using the absorption costing method, income from operations will be higher if the company produces 58,000 units.
8 Chapter 20 (5) 16. Assume the same information as Exercise 15, except that the company uses the variable costing method to determine income from operations. Finnegan s Variable Costing Income Statements 53,000 units 58,000 units Sales $2,650,000 $2,650,000 Variable cost of goods sold: Variable cost of goods manufactured: 53,000 units $14 $ 742,000 58,000 units $14 $ 812,000 Less ending inventory: 0 units $14 0 5,000 units $14 70,000 Variable cost of goods sold $ 742,000 $ 742,000 Manufacturing margin $1,908,000 $1,908,000 Variable selling and administrative expenses 265,000 265,000 Contribution margin $1,643,000 $1,643,000 Fixed costs: Fixed manufacturing costs $ 41,000 $ 41,000 Fixed selling and administrative expenses 22,000 22,000 Total fixed costs $ 63,000 $ 63,000 Income from operations $1,580,000 $1,580,000 Using the variable costing method, income from operations will be the same if the company produces 53,000 or 58,000 units.
Variable Costing for Management Analysis 9 17. After estimating unit sales to be 32,000 units for $35 each, Rosie s Shoe Supply is trying to decide whether to produce 32,000 units or 36,000 units. The company will incur variable costs of $22 per unit and fixed manufacturing costs of $67,000. Each unit sold has a variable selling and administrative cost of $4.50. The fixed selling and administrative expenses will be $25,000. Use absorption costing income statements to determine the number of units to produce that will result in the highest income from operations. Round fixed manufacturing overhead per unit to two decimal places. Rosie's Shoe Supply Absorption Costing Income Statements 32,000 units 36,000 units Sales $1,120,000 $1,120,000 Cost of goods sold: Cost of goods manufactured: 32,000 units $24.09 $ 770,880 36,000 units $23.86 $ 858,960 Less ending inventory: 4,000 units $23.86 95,440 Cost of goods sold $ 770,880 $ 763,520 Gross profit $ 349,120 $ 356,480 Selling and administrative expenses 169,000 169,000 Income from operations $ 180,120 $ 187,480 The company will produce a higher income from operations under the absorption costing method if it produces 36,000 units. Strategy: To prepare the absorption costing income statement, first determine the sales revenue. Next, calculate the cost of goods manufactured, which will include all manufacturing costs, such as direct materials, direct labor, and variable and fixed manufacturing overhead. If the company will have ending inventory on hand, the cost of the units should be deducted from the cost of goods manufactured to calculate the cost of goods sold. The gross profit is equal to the sales revenue less the cost of goods sold. Income from operations is the gross profit less the variable and fixed selling and administrative expenses.
10 Chapter 20 (5) 18. Use the information in Exercise 17 for Rosie s Shoe Supply assuming the company calculates income from operations using the variable costing method to determine the number of units to produce. Rosie's Shoe Supply Variable Costing Income Statements 32,000 units 36,000 units Sales $1,120,000 $1,120,000 Variable cost of goods sold: Variable cost of goods manufactured: 32,000 units $22 $ 704,000 36,000 units $22 $ 792,000 Less ending inventory: 0 units $22 0 4,000 units $22 88,000 Variable cost of goods sold $ 704,000 $ 704,000 Manufacturing margin $ 416,000 $ 416,000 Variable selling and administrative expenses 144,000 144,000 Contribution margin $ 272,000 $ 272,000 Fixed costs: Fixed manufacturing costs 67,000 67,000 Fixed selling and administrative expenses 25,000 25,000 Total fixed costs $ 92,000 $ 92,000 Income from operations $ 180,000 $ 180,000 The income from operations using the variable costing method will be the same for both production levels. Strategy: To prepare a variable costing income statement, calculate the sales revenue. Next, determine the variable manufacturing costs for the number of units produced. The variable cost of goods sold is equal to the variable manufacturing costs incurred less the variable manufacturing costs for the goods remaining in ending inventory. Sales revenue less the variable cost of goods sold is called the manufacturing margin. Subtract the variable selling and administrative expenses from the manufacturing margin to determine the contribution margin. Finally, subtract the total fixed costs from the contribution margin to determine the income from operations. Income from operations will remain the same, since all fixed manufacturing costs are expensed in the period incurred.
Variable Costing for Management Analysis 11 19. The sales manager of a company is determining the best selling price for its new product. The manager expects that all costs incurred to make the product should be included in the decision. Should the manager use the variable or absorption costing method to determine the selling price? Variable costing method 20. In the past few years, a manufacturer has not produced sufficient units in order to meet the year s sales. Management would like to produce enough products to meet demand and have an ending inventory. The company expects to incur additional fixed costs due to the increase in production. Should management use the variable or absorption costing method to determine the production planning for the upcoming years? Absorption costing method, since management will be expanding in order to meet the demand 21. A manufacturing company promises a bonus to its production managers if they can increase profit in their department. Since the selling price is fixed, the managers must determine a way to decrease the costs to manufacture each unit. Would the variable or absorption costing method be more helpful to the managers? Variable costing method Strategy: When deciding whether to use the variable or absorption costing method, users should determine if the fixed manufacturing costs per unit would be relevant. If the fixed manufacturing costs per unit should be considered, the absorption costing method allows for an easier understanding. However, if the fixed manufacturing costs per unit should not be considered or are noncontrollable by the user, the variable costing method should be used.
12 Chapter 20 (5) 22. Use the information below to calculate the contribution margin for the dog food and the Southern region. Pet Supply North South Sales volume (units): Dog food 15,000 19,200 Cat food 14,300 16,750 Sales price: Dog food $4.65 $4.50 Cat food $3.80 $3.95 Variable cost per unit: Dog food $2.80 $2.75 Cat food $1.15 $1.20 Dog Food: $61,350 = [15,000 units ($4.65 $2.80)] + [19,200 units ($4.50 $2.75)] Southern region: $79,662.50 = [19,200 units ($4.50 $2.75)] + [16,750 units ($3.95 $1.20)] 23. Using the information below, determine the contribution margin ratio for the highlighters and Ross Thompson. Sales commissions are paid based on a percentage of total sales. Round the contribution margin ratio to two decimal places. Study Better Supply Ross Thompson Sherry Zink Anna Mills Sales volume (units): Highlighters 12,600 14,750 14,900 Pens 17,800 14,300 18,150 Sticky Notes 12,300 11,980 12,500 Sales price: Highlighters $4.90 $4.90 $4.90 Pens $4.50 $4.50 $4.50 Sticky Notes $5.25 $5.25 $5.25 Variable cost per unit: Highlighters $1.85 $1.85 $1.85 Pens $1.50 $1.50 $1.50 Sticky Notes $2.15 $2.15 $2.15 Sales commission 5.00% 5.00% 5.00%
Variable Costing for Management Analysis 13 Highlighters (contribution margin): $118,511.25 = [(12,600 + 14,750 + 14,900) units $4.90 (100% 5%)] [(12,600 + 14,750 + 14,900) units $1.85)] Highlighters (contribution margin ratio): 57.24% = $118,511.25/$207,025 Ross Thompson (contribution margin): $119,639.25 = [12,600 units ($4.90 $1.85)] + [17,800 units ($4.50 $1.50)] + [12,300 units ($5.25 $2.15)] ($206,415 5%) Ross Thompson (contribution margin ratio): 57.96% = $119,639.25/$206,415 24. With the information below, calculate the contribution margin for the Western region and the water bottles. Thirst Killers East West Sales volume (units): Water bottles 82,500 85,000 Energy drinks 65,000 61,800 Sports drinks 58,750 54,300 Sales price: Water bottles $10.50 $10.90 Energy drinks $15.75 $15.40 Sports drinks $14.30 $14.25 Variable cost per unit: Water bottles $3.65 $3.75 Energy drinks $4.50 $4.40 Sports drinks $4.20 $4.20 Promotion costs: Water bottles $1,200 $1,200 Energy drinks $4,750 $4,550 Sports drinks $4,500 $4,400 Western region: $1,823,115 = [85,000 units ($10.90 $3.75)] + [61,800 units ($15.40 $4.40)] + [54,300 units ($14.25 $4.20)] ($1,200 + $4,550 + $4,400) Water bottles: = $1,170,475 = [82,500 units ($10.50 $3.65)] + [85,000 units ($10.90 $3.75)] ($1,200 + $1,200) Strategy: To determine the contribution margin, calculate the sales revenue for the segment. Then, calculate the costs to produce the sales. The difference between the sales revenue and the costs is called the contribution margin. The contribution margin ratio is calculated by dividing the contribution margin by the total sales revenue.
14 Chapter 20 (5) 25. During the year, Poe s Candles expected to sell 40,000 units of goods for $15 each. The actual sales for the year totaled 41,400 units at $14.95 each. Calculate the quantity factor and price factor for sales. Quantity factor: $21,000 increase in sales = 1,400 units $15 Price factor: $2,070 decrease in sales = 41,400 units $0.05 26. Management of The Rarebit expected to produce 35,000 units for the last quarter and incur $6 per unit of variable costs. The company actually produced 37,000 units and incurred $225,700 of variable costs. Determine the variable cost quantity factor and the unit cost factor. Variable cost quantity factor: $12,000 increase in costs = 2,000 units $6 Unit cost factor: $3,700 increase in costs = $225,700 (37,000 units $6) or 37,000 units $0.10 27. Rather than selling the budgeted 12,000 units for the month, Thirst Killer sold 11,000 units to customers. At the beginning of the month, the company expected for the selling price to be $5.10. Instead, the selling price was $5.08. Determine the quantity and price factor for sales. Quantity factor: $5,100 decrease in sales = 1,000 units $5.10 Price factor: $220 decrease in sales = 11,000 $0.02 Strategy: Differences between planned and actual revenue (or costs) are caused by the difference in number of units sold (or produced), called the quantity factor, or the difference in the selling price (or costs to produce), called the price (or cost) factor. The quantity factor is calculated by multiplying the variance between planned and actual units by the planned selling price (or cost to produce). The price (or cost) factor is calculated by multiplying the actual units by the difference in selling price (or cost). As a check, the sum of the factors should equal the difference between planned and actual sales (or production costs). 28. Determine if each of the following would be considered a variable or fixed cost for a law firm. If the expense should be considered a variable cost, provide an example of the activity base. a. Fixed b. Variable; number of advertisements, number of commercials c. Variable; number of hours worked d. Fixed
Variable Costing for Management Analysis 15 29. Would each of the following expenses be considered a fixed or variable cost for an interior designer? If a variable cost, provide an example of the activity base. a. Commissions expense Variable; designing revenue, number of rooms designed b. Office depreciation expense Fixed c. Travel and lodging expenses Variable; number of miles traveled, number of days traveling d. Insurance expense Fixed 30. Determine if each of the following should be considered a variable or fixed cost for a dry cleaner. If the expense is a variable cost, provide an example of the activity base. a. Detergent expense Variable; pieces of clothing washed, machine hours b. Salary for tailor Fixed c. Electricity expense Variable; number of hours opened, machine hours d. Payroll taxes expense Variable; direct labor hours Strategy: If a service firm will incur more of an expense due to an increase in an activity or increase in services provided, the cost should be classified as a variable cost. If the firm has a fixed amount to pay each period for an expense, the expense should be classified as a fixed cost. Under the variable costing method, the fixed costs will all be expensed in the period incurred.