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CHAPTER 9

COST ALLOCATIONS: THEORY AND APPLICATIONS


TRUE/FALSE
1. Changing a product mix is an example of a short-term decision.
LO1 False Changing a product mix is an example of a long-term decision.
2. Capacity costs are controllable over the long-term.
LO1 True
3. While profit margin is the appropriate measure of value for short-term decisions,
contribution margin is the appropriate measure for long-term decisions.
LO1 False While contribution margin is the appropriate measure of value for
short-term decisions, profit margin is the appropriate measure for longterm decisions.
4. Some firms refer to the overhead rate as the burden because they charge, or
burden, each product with this amount.
LO1 True
5. When firms use allocated costs to make decisions, the quality of their decisions
depend on how well the allocation estimates the capacity cost associated with
the various options.
LO1 True
6. Firms must prepare income statements and balance sheets in accordance with
Generally Accepted Accounting Principles, which requires firms to use variable
costing.
LO2 False Firms must prepare income statements and balance sheets in
accordance with Generally Accepted Accounting Principles, which
requires firms to use absorption costing.
7. Because indirect manufacturing costs are not traceable to individual products,
their cost is allocated only to period expenditures.
LO2 False Because indirect manufacturing costs are not traceable to individual
products, companies must allocate them to products.
8. Under absorption costing, the value of a unit of a product includes all product
costs.
LO2 True
9. Accounting for fixed manufacturing overhead is the only difference between
variable and absorption costing.
LO2 True
10.At the end of the accounting period, the cost of goods sold account and the
finished goods inventory account will include fixed manufacturing costs.
LO2 True

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Balakrishnan/Managerial Accounting, 2e
11.An example of allocations to justify costs and reimbursements is when
government entities contract to compensate their suppliers on a fixed negotiated
contract amount.
12.LO3 False An example of allocations to justify costs and reimbursements is
when government entities contract to compensate their suppliers on a costplus basis.
13.
14.Suppliers often prefer cost-plus contracts when there is uncertainty about the
final cost or project success, as it allows them to share the risk of cost overruns
with the customer.
15.
LO3 True
16.
17.An example of organizations using allocated costs to justify prices is when a
hospital negotiates rates with insurance companies and other payers.
18.
LO3 True.
19.
20.Cost allocations provide subtle, ineffective means to achieve change.
21.
LO3 False Cost allocations provide subtle, yet effective means to
achieve change.
22.
23.By discouraging wasteful use, cost allocations can induce efficient utilization of
resources shared by multiple users.
24.LO3 True
25.
26.In essence, only sales and variable costs determine income reported under
variable costing.
27.
Appendix False
In essence, sales, the unit contribution
margin, and fixed costs determine income reported under
variable costing.
28.
29.Absorption costing separates costs that are required to ready goods for sale from
all other costs.
30.Appendix True
31.
32.A common criticism of absorption costing is that it provides incentives to
produce more than what is necessary to satisfy demand.
33.
Appendix True
34.
35.Under variable costing, a firm can report a higher income merely by increasing
production.
36.
Appendix False Under absorption costing, a firm can report a
higher income merely by increasing production.
37.
38.Under absorption costing, the finished goods inventory account will contain the
fixed manufacturing costs of units produced but not sold.
39.Appendix True
40.
41.

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Cost Allocations: Theory and Applications


42.

MULTIPLE CHOICE

43.Which of the following is not an example of a long-term decision?


A. Changing product mix.
B. Dropping products.
C. Expanding operations.
D. Purchasing inventory.
E. All of the above are examples of long-term decisions.
44.LO1 D
45.
46.The allocation rate is calculated by:
A. Dividing the costs in the cost pool by the denominator volume.
B. Dividing the costs in the cost pool by the overhead costs.
C. Dividing the volume by the costs in the cost pool.
D. Dividing the overhead costs by the unit contribution margin.
E. Dividing the overhead costs by the profit margin.
47.LO1 A
48.
49.Profit margin equals:
A. Sales less contribution margin.
B. Revenue less fixed costs.
C. Contribution margin less variable costs.
D. Contribution margin less allocated capacity costs.
50.LO1 D
51.
52.A driver that is appropriate for some resources may not be appropriate for other
resources. The solution to the problem is:
A. Use capacity resources in different proportions.
B. Do not allocate the resources.
C. Allocate the resources only if they are variable.
D. Use a separate cost pool for each class of similar resources.
E. None of the above are solutions to the problem.
53.LO1 D
54.
55.The allocation rate may also be referred to as:
A. The overhead rate.
B. Burden.
C. Self-Consumption.
D. Both A and B.
E. A, B and C.
56.LO1 D
57.

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Balakrishnan/Managerial Accounting, 2e
58.The budget analyst for Tire Town determined that the volume of tires sold for
each product line is the best cost driver for the fixed marketing and
administrative costs related to its two tire models. How would you determine the
total allocated cost to each of two models of tires for marketing and
administrative costs?
a. Divide the total overhead by the total number of tires produced.
b. Calculate the allocation rate per tire. Then multiply the rate by the fixed
marketing and administrative costs for each type of tire. Then divide by the
fixed marketing and administrative cost pool.
c. Calculate the allocation rate per tire by dividing the fixed marketing and
administrative cost pool by the direct labor dollar amount. Then multiply the
rate by the fixed marketing and administrative costs for each model of tire.
d. Calculate the allocation rate per tire by dividing the fixed marketing and
administrative cost pool by the number of tires. Then multiply the rate by the
fixed marketing and administrative costs for each model of tire.
59.LO1 Pre-test D
60.
61.Martina Mushroom Farm grows and distributes two different mushroomsshitake
and portabella. How much is the allocated overhead cost per pound of
mushrooms for each variety given the following information:
62.
Total overhead to be allocated: $31,360
63.
Shitake: 16,000 pounds produced with $5,440 of direct labor
cost
64.
Portabella: 8,000 pounds produced with $2,400 of direct labor
cost
65.
Which one of the following is a correct calculation of the amount to be
allocated to each mushroom variety?
A. Shitake mushrooms at $ 0.33 per pound
B. Shitake mushrooms at $5.92 per pound
C. Portobello mushrooms at $0.30 per pound
D. Portobello mushrooms at $1.20 per pound
66.LO1-Post test-D
67.
68.XT Manufacturing has two cost pools for its bicycle product line and has prepared
a variable costing income statement. Which one of the following will enable XT
to determine the allocated cost per bicycle if number of units is the cost driver
for one pool, and direct labor dollars is the cost driver for the other pool?
A. Determine the total capacity costs and divide by the total number of
bicycles.
B. Divide total capacity costs by the rate per unit. Then multiply each rate
respectively by actual units or actual direct labor dollars to get the allocated
cost for that portion each capacity cost pool.
C. Divide each cost pool by its chosen cost driver to determine a rate for each
cost pool. The rate for each pool is multiplied respectively by actual units or
actual direct labor dollars to get the allocated cost for that portion each
capacity cost pool.
D. Divide total overhead costs by the total of the two cost pools.
69.LO1-Post test-C

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Cost Allocations: Theory and Applications


70.The following information is available for the Rollin Baby Company which
produces two types of strollers, standard and deluxe.
71.
Standard
Deluxe
Total
72.
Sales volume (units)
4,000
3,500
7,500
73.
Revenue
$96,000
$147,000
$243,000
74.
Variable Costs
75.
Direct materials 12,000
17,500
29,500
76.
Direct labor 16,000
24,000
40,000
77.
Marketing & Sales 20,000
28,500
48,500
78.
Contribution Margin
$48,000
$77,000
$125,000
79.
Fixed Costs
80.
Manufacturing
$24,000
81.
Marketing & Sales
$18,000
82.
Administration
$16,000
83.
Profit Before Tax
$67,000
84.
85.If the company allocates their fixed costs based on direct labor dollars, the
profit before tax for the standard and deluxe product line, respectively, would be:
A. $8,000/$59,000
B. $19,000/$48,000
C. $16,000/$51,000
D. $24,800/$42,200
86.LO1-Self test-D
87.
88.Cost allocations can be used to divide what type of costs among products or
divisions:
A.
fixed selling and administrative costs
B.
all indirect fixed costs
C.
fixed manufacturing costs
D.
all manufacturing costs
89.LO1-Self test-B
90.

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Balakrishnan/Managerial Accounting, 2e
91.The following information is available for the Downtown Furniture Company
which produces two types of tables.
92.
Oak
Cherry
Total
93.
Sales volume (units)
500
300
800
94.
Revenue
$80,000
$78,000
$158,000
95.
Variable Costs
96.
Direct materials
$5,000
$7,000
$12,000
97.
Direct labor
$17,000
$22,000
$39,000
98.
Contribution Margin
$58,000
$49,000
$107,000
99.
Fixed Costs
100.
Manufacturing
$25,500
101.
Administrative
$31,000
102.
Profit Before Tax
$50,500
103.
104.
Management feels that the fixed manufacturing costs should be
allocated based on direct labor costs and fixed administrative costs should be
allocated based on units sold. The amount of fixed administrative costs which
should be allocated to the Cherry tables is:
A. $15,500
B. $18,600
C. $31,000
D. $11,625
105.
LO1-Self test-D
106.
107. The following information is available for the Downtown Furniture Company
which produces two types of tables.
108. Oak
Cherry
Total
109.
Sales volume (units)
500
300
800
110.
Revenue
$80,000
$78,000
$158,000
111.
Variable Costs
112.
Direct materials $5,000
$8,000
$13,000
113.
Direct labor $17,000
$21,000
$38,000
114.
Contribution Margin
$58,000
$49,000
$107,000
115.
Fixed Costs
116.
Manufacturing
$40,000
117.
Administrative
$33,000
118.
Profit Before Tax
$34,000
119.
Management feels that the fixed manufacturing costs should be
allocated based on direct labor costs and fixed administrative costs should be

9-6

Cost Allocations: Theory and Applications


allocated based on units sold. The rate at which fixed manufacturing costs
which should be allocated is: (rounded)
A. $1.05 per direct labor dollar
B. $.95 per direct labor dollar
C. $1.34 per direct labor dollar
D. $3.08 per direct labor dollar
120.
LO1-Self test-A
121.
122. Tire Town has two product lines of tires currently on the manufacturing floor.
The product line managers provided the following information concerning the
fixed overhead cost and production:
123. Total fixed costs to be allocated: $4,322,500
124. Standard Tire: 20,000 tires produced with $975,000 of direct labor cost
125. Deluxe Tire: 15,000 tires produced with $1,300,000 of direct labor cost
126.
Which one of the following is a correct amount to be allocated to one of
the two types of tires?
A.
Standard tire at $92.63 per tire
B.
Deluxe tire at $123.50 per tire
C.
Standard tire at $1.90 per tire
D.
Deluxe tire at $288.17 per tire
127.
LO1 Pre-test A
128.
129. Firms must prepare income statements and balance sheets in accordance
with Generally Accepted Accounting Principles which requires firms to use:
A. Variable costing.
B. Absorption costing.
C. Cost-based reporting.
D. Variance analysis.
E. None of the above.
130.
LO2 B
131.
132. Which of the following would not be considered to be a period cost on an
absorption costing income statement?
A. Manufacturing overhead costs
B. Fixed marketing and sales costs
C. Administration costs
D. Variable marketing and sales costs
133.
LO2-Post test-A
134.
135. Redplum Computers sales volume is below its production volume for the
month. How will profit margin differ on an absorption costing income statement
from profit margin on a variable costing income statement?
A. Profit margin will be higher on a variable costing income statement.
B. Profit will be higher on an absorption costing income statement.
C. Both amounts will be the same. The costs are just located in different
sections of the two statements.
D. It depends on the number of cost pools the company uses to allocated
capacity costs.
136.
LO2-Post test-B
137.

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Balakrishnan/Managerial Accounting, 2e
138. Grey Corporation produces mattresses. If grey produces more units than it
sells during a period, then reported income using absorption costing will be:
A. Equal to reported income using variable costing.
B. Greater than reported income using variable costing.
C. Less than reported income using variable costing.
D. Less than reported income using variable costing plus total fixed production
costs.
E. None of the above.
139.
LO2 B
140.
141. Brown Corporation produced 2,200 units during the most recent period.
Browns costs were as follows:
142. Direct material
143.
$1,00
0
144. Direct labor
145.
2,000
146. Variable manufacturing
147.
overhead
500
148. Variable marketing and sales
149.
300
150. Fixed manufacturing overhead
151.
900
152. Fixed marketing and sales
153.
400
154.
155.
If Brown uses absorption costing, what amount per unit would be
included in ending inventory?
A. $2.32
B. $1.73
C. $2.00
D. $1.36
E. $2.14
156.
LO2 C
157.
158. The following information is available for the Rollin Baby Company which
produces two types of strollers, standard and deluxe.
159. Standard
Deluxe
Total
160.
Sales volume (units)
4,000
3,500
7,500
161.
Revenue
$96,000
$147,000
$243,000
162.
Variable Costs
163.
Direct materials 12,000
17,500
29,500
164.
Direct labor 16,000
24,000
40,000
165.
Marketing & Sales 20,000
28,500
48,500

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Cost Allocations: Theory and Applications


166.
167.
168.
169.
170.
171.

Contribution Margin
$48,000
$77,000
$125,000
Fixed Costs
Manufacturing
$24,000
Marketing & Sales
$18,000
Administration
$16,000
Profit Before Tax
$67,000

172.
173.
If the company sells just one more standard unit their profit before tax
will increase by:
a. $24
b. $12
c. $17
d. $19
174. LO2- Self test-B
175.

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Balakrishnan/Managerial Accounting, 2e
176. The following information is available for the Rollin Baby Company which
produces two types of strollers, standard and deluxe.
177. Standard
Deluxe
Total
178.
Sales volume (units)
4,000
3,500
7,500
179.
Revenue
$96,000
$147,000
$243,000
180.
Variable Costs
181.
Direct materials 12,000
17,500
29,500
182.
Direct labor 16,000
24,000
40,000
183.
Marketing & Sales 20,000
28,500
48,500
184.
Contribution Margin
$48,000
$77,000
$125,000
185.
Fixed Costs
186.
Manufacturing
$24,000
187.
Marketing & Sales
$18,000
188.
Administration
$16,000
189.
Profit Before Tax
$67,000
190.
191.
If the company shifts its product mix to 3,000 standard units and 4,500
deluxe units, profit before tax will:
A. Increase by $10,000
B. Increase by $135,000
C. Decrease by $12,000
D. Decrease by $22,000
192.
LO1-Self test-A
193.
194. If a company produces more units than it sells in a period, net operating
income under variable costing will:
A.
Be the same as it would be under absorption costing
B.
Be less than it would be under absorption costing
C.
Be equal to the net operating income using absorption costing plus
selling and administrative costs
D.
Be equal to the net operating income using absorption costing less
fixed manufacturing costs
195.
LO2-Self test-B
196.
197. When using variable costing which of the following is not considered a
product cost?
A.
Direct materials
B.
Variable manufacturing overhead
C.
Fixed manufacturing overhead
D.
Direct labor

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Cost Allocations: Theory and Applications


198.
LO2-Self test-C
199.
200. The following unit information is available for the ClubOne Company for 2013:
201. 1st Qtr
2nd Qtr
3rd Qtr
4th Qtr
202. Production
10,000
12,000
9,000
14,000
203. Sales
8,000
12,000
10,000
15,000
204.
205.
For the entire year of 2013:
A. Total net operating income will be greater if the company uses variable
costing
B. Total net operating income will be greater if the company uses absorption
costing
C. Total net operating income will be the same under either method
D. None of the above choices are correct
206.
LO2-Self test-C
207.
208. Brown Corporation produced 2,200 units during the most recent period.
Browns costs were as follows:
209. Direct material
210. $
1,000
211. Direct labor
212. 2,
000
213. Variable manufacturing
214. 5
overhead
00
215. Variable marketing and sales 216. 3
00
217. Fixed manufacturing
218. 9
overhead
00
219. Fixed marketing and sales
220. 4
00
221.
222.
Sales totaled 1,800 units ($10,800). If Brown uses absorption costing,
the ending inventory would be valued at:
a. $0
b. $928
c. $544
d. $800
e. $856
223.
LO2 D
224.
225. At the end of an accounting period, using absorption costing, the cost of
goods sold account will include:
a. Direct material, direct labor, variable manufacturing overhead.
b. Direct material, direct labor, variable manufacturing overhead, and variable
marketing and sales.
c. Direct material, direct labor, variable manufacturing overhead, and fixed
manufacturing overhead.

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Balakrishnan/Managerial Accounting, 2e
d. Direct material, direct labor, variable manufacturing overhead, fixed
manufacturing overhead, and variable marketing and sales.
e. Direct material, direct labor, variable manufacturing overhead, fixed
manufacturing overhead, variable marketing and sales, and fixed marketing
and sales.
226.
LO2 C
227.
228. Which of the following formulas will reconcile the difference between variable
and absorption costing?
229.
A. Income reported under variable costing
230.
+ Fixed manufacturing costs in ending inventory
231.
Fixed manufacturing costs in beginning inventory
232.
= Income reported under absorption costing
233.
B. Income reported under absorption costing
234.
+ Fixed manufacturing costs in ending inventory
235.
Fixed manufacturing costs in beginning inventory
236.
= Income reported under variable costing
237.
C. Income reported under variable costing
238.
Total manufacturing costs in ending inventory
239.
+ Total manufacturing costs in beginning inventory
240.
= Income reported under absorption costing
241.
D. Income reported under absorption costing
242.
Total manufacturing costs in ending inventory
243.
+ Total manufacturing costs in beginning inventory
244.
= Income reported under variable
costing
245.
LO2-Post test-A
246.
247. Geronimo Gym Equipment produces playground equipment with a selling
price of $800 per set. The costs to produce each set include: direct materials,
$300; direct labor, $125, variable manufacturing overhead, $100. The fixed
manufacturing overhead per year is $12,000. There is no beginning inventory. If
Geronimo produces 200 sets and sells 180 sets, and income under variable
costing is $37,500, how much is income under absorption costing?
A. $106,500
B. $38,700
C. $49,500
D. $43,000
248.
LO2-Post test-B
249.
250. Which criterion determines which costs to measure?
A. GAAP
B. Controllability
C. Traceability
D. Incentives
251.
LO2- Post test-B
252.
253. On an absorption costing income statement, which of the following correctly
determines gross margin?
a. Revenue (direct materials + direct labor + fixed marketing and sales).
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Cost Allocations: Theory and Applications


b. Revenue (direct materials + direct labor + variable marketing and sales).
c. Revenue (direct materials + direct labor + manufacturing overhead).
d. Revenue (direct materials + direct labor).
254.
LO2 Pre-test C
255.
256. In the month of March, the Asai Company produced 100,000 units but only
sold 85,000 units. Costs incurred were:
257. Direct materials
$18,000
258. Direct labor
$36,000
259. Variable manufacturing overhead
$18,000
260. Variable selling & administrative
$16,000
261. Fixed manufacturing overhead
$19,000
262. Fixed selling & administrative
$10,000
263. Total
$117,000
264.
265.
If the company utilizes absorption costing, the value in the finished
goods inventory account at the end of March will be:
A.
$13,200
B.
$17,550
C.
$13,650
D.
$10,800
266.
LO2-Self test-C
267.
268. In the month of December the Valhalla Company produced 28,000 units and
sold 30,000 units. Under absorption costing:
A. Fixed manufacturing costs will be released from inventory and therefore
net operating income will be lower than it would under variable costing
B. Fixed selling & administrative costs will be released from inventory and
therefore net operating income will be lower than it would under variable
costing
C. Fixed manufacturing costs will be included in inventory instead of on the
income statement and therefore net operating income will be higher than it
would under variable costing
D. All fixed costs will be released from inventory and therefore net operating
income will be lower than it would under variable costing
269.
LO2-Self test-A
270.
271. In the month of November, the Philly Company produced and sold 40,000
units of a single product. Costs incurred during the month included:
272. Direct materials and labor
$600,000
273. Variable manufacturing overhead
$380,000
274. Fixed manufacturing overhead
$360,000
275. Variable selling & administrative
$280,000
276.
277.
Using variable costing the unit product cost would be:
A. $40.50
B. $33.50
C. $31.50
D. $24.50
278.
LO2-Self test-D

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Balakrishnan/Managerial Accounting, 2e
279.
280. In the month of November, the SuperSoap Company provided the following
information:
281. Units in beginning inventory
0
282. Units produced
20,000
283. Units sold
18,000
284. Variable costs per unit:
285.
Direct materials
$10
286.
Direct labor
14
287.
Variable manufacturing overhead
6
288.
Variable selling & administrative
5
289. Fixed costs:
290.
Fixed manufacturing overhead
$22,000
291.
Fixed selling & administrative
$9,000
292.
Using absorption costing the unit product cost would be:
A. $35.00
B. $30.00
C. $31.10
D. $36.10
293. LO2-Self test-C
294.
295. In 2012 the Jetson Company reported net operating income of $160,000
using absorption costing and $146,000 using variable costing. With this
information only it is known that:
A. Units sold exceeded units produced
B. Units produced and sold were equal
C. There was no beginning inventory
D. Units produced exceeded units sold
296.
LO2-Self test-D
297.
298. Marquez, Inc. noted that its sales volume was less than its production volume
for the month of March. Which one of the following is correct when comparing
absorption costing and variable costing?
a. With variable costing, fixed manufacturing overhead is fully expensed on the
income statement in the period the units are sold.
b. With absorption costing, a portion of the fixed manufacturing overhead
incurred is included in inventory cost.
c. Variable costing requires that a portion of the fixed manufacturing overhead
cost be reported as inventory cost on the balance sheet.
d. Absorption costing requires that fixed manufacturing overhead cost be
allocated to all units produced using the number of units sold as the cost
driver.
299.
LO2 Pre-test B
300.
301. The amount of cost allocated to a particular cost object depends on:
a. What costs we allocate.
b. How we group them into cost pools.
c. The drivers we choose.
d. A and B only.
e. A, B and C.

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Cost Allocations: Theory and Applications


302.
LO3 E
303.
304. Which of the following is not a common reason to use allocations:
a. To justify costs and reimbursements.
b. To increase net income.
c. To justify prices.
d. If there is uncertainty about a projects success.
e. All of the above are reasons to use allocations.
305.
LO3 B
306.
307. The management of Samson Manufacturing has determined that production
workers have been consistently using more and more labor hours while
producing the same number of units, despite new technology implementation.
Management suspects that lack of training on the new technology has caused
productivity to decline. Administrative costs are currently split equally among
the product lines. Which of the following is the most effective cost driver to
allocate administrative costs to encourage production supervisors to increase
productivity?
A. Keep the administrative cost allocation the same and reduce the number of
employees.
B. Allocate administrative costs based on direct materials used in
manufacturing.
C. Allocate administrative costs based on the total sales revenue.
D. Allocate administrative costs based on direct labor used in manufacturing.
308.
LO3-Post test-D
309.
310. Allocated costs equals:
A. The number of cost pools used multiplied by the driver units.
B. The number of cost pools used divided by the driver units.
C. The number of driver units used multiplied by the cost per driver unit.
D. The number of driver units used divided by the cost per driver unit.
E. None of the above.
311.
LO3 C
312.
313. One reason why capacity costs should be allocated among products is that:
A.
It allows management to estimate changes in capacity costs over the
long run
B.
It assists in making decisions specifically for the short-term
C.
It follows the rules for utilizing variable costing
D.
It separates product costs from period costs
314.
LO3-Self test-A
315.
316. Why do managers care about the costs allocated to their individual
departments?
a. Managers performance evaluations frequently depend on their units
performance more than overall firm performance.
b. The cost allocated is an integral part of the departments reported profit.
c. Carefully chosen allocation methods can induce desired behavior.
d. Carefully chosen allocation methods can dissuade undesired behavior.

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Balakrishnan/Managerial Accounting, 2e
e. All of the above are reasons managers care about the costs allocated to their
individual departments.
317.
LO3 E
318.
319. When allocating costs to value inventory, what is the underlying reason why
firms allocate rather than directly measure capacity costs?
a. Traceability.
b. Profitability.
c. Responsibility.
d. Reliability.
e. None of the above.
320.
LO3 A
321.
322. Administrative costs are currently split equally among 4 different product
lines at WDT Company. To encourage the managers of each of the product lines
to implement a new material waste policy aimed at reducing materials used in
manufacturing, which of the following would best achieve this goal?
a. Allocating administrative costs based on the cost per unit of materials used in
production.
b. Allocating administrative costs based on the number of labor hours used in
manufacturing.
c. Allocating administrative costs based on the amount of scrap produced from
manufacturing.
d. Allocating administrative costs based on the speed of production.
323.
LO3 Pre-test C
324.
325. Absorption costing is also referred to as:
a. Direct costing.
b. Full costing.
c. Variable costing.
d. Indirect costing.
e. None of the above.
326.
Appendix B
327.
328. To comply with GAAP, which of the following costs are allocated to units
produced?
a. Variable manufacturing costs and fixed manufacturing costs.
b. Variable manufacturing costs and variable period costs.
c. Fixed manufacturing costs and fixed period costs.
d. Variable manufacturing costs, fixed manufacturing, variable period costs.
e. Variable manufacturing costs, fixed manufacturing, variable period costs, and
fixed period costs.
329.
Appendix A
330.

9-16

Cost Allocations: Theory and Applications


331. The fundamental tenet of GAAP that requires firms to recognize costs in the
same period in which the associated revenue occurs is referred to as the:
a. Assignment of income principle.
b. Historical cost principle.
c. Matching principle.
d. Relevance theory.
e. Periodicity.
332.
Appendix C
333.

9-17

Balakrishnan/Managerial Accounting, 2e
334. A common criticism of absorption costing is that:
a. A firm must have personnel to implement the complex systems.
b. It does not provide as accurate allocation as variable costing.
c. A firm can report higher income merely by increasing production.
d. Under absorption, costs are difficult to trace to products.
e. None of the above is a criticism of absorption costing.
335.
Appendix C
336.
337. Over the lifetime of the firm, variable costing:
a. Will consistently lead to higher income than that produced by absorption
costing.
b. Will consistently lead to lower income than that produced by absorption
costing.
c. Will lead to higher incentives for managers.
d. Will lead to lower incentives for managers.
e. Will lead to the same total income as absorption costing, as the firm begins
and ends with zero inventories.
338.
Appendix E
339.
340. Ward Scooters managers have discovered that the companys production
departments have been misusing the maintenance department by requesting
the maintenance department perform trivial and minor tasks that the
departments should be doing themselves. Management has decided to allocate
the costs of the maintenance department to the production departments based
on the number of hours that maintenance spends in each production
department. If the costs incurred by the companys maintenance department are
significantly less than market price of maintenance, what is the expected result
if managements plan is implemented?
a. Managers of production departments will stop using the maintenance
department for trivial and minor tasks so that fewer costs are allocated to
their departments.
b. The departments will completely stop using the maintenance department.
c. The departments will decrease their use of the maintenance department.
d. The production departments will hire outside maintenance.
341.
Appendix Pre-test A
342.
343. Marx Manufacturing produces buckets with a selling price of $15 per bucket.
The costs to produce each bucket are: direct materials, $3; direct labor, $2,
variable manufacturing overhead, $1.50. The fixed manufacturing overhead per
year is $18,000. There is no beginning inventory. If Marx produces 5,000 buckets
and sells 4,500 buckets, and income under variable costing is $20,250, how
much is income under absorption costing?
a. $18,450
b. $22,050
c. $24,500
d. $26,300
344.
Appendix Pre-test - B
345.

9-18

Cost Allocations: Theory and Applications


346.

Problems

1. Bettys Boutique sells hand-crafted jewelry. Betty sells her jewelry for $40, a
300% markup. Her annual sales range from $30,000 to $40,000, with sales for
the current year expected to be $34,000. Fixed costs generally are $17,000.
347.
348.
Required:
a. Betty anticipates sales of $40,000 next year. Calculate her expected profit
for the current year and next year. Use the contribution margin format.
349.
b. If Betty expects sales to increase to $45,000 next year and fixed costs to
increase to $20,000, what will be her estimated profit for next year? Use the
contribution margin format.
350.
c. Should Betty spend the $20,000 in anticipation of the increased sales in (b)?
Why?
351.
352.
353.
354.
355.
2. Johns Boat Shop began business on January 1 st of the current year and
manufacturers and sells high-quality bass boats. John produced boats during the
year that consumed $45,000 in material and $30,000 in labor. Johns ending
inventory is comprised of boats with $5,000 of materials and $8,000 of labor.
Based on his actual fixed manufacturing overhead costs, John added overhead to
products at the rate of 50% of direct labor cost.
356.
357.
Required:
358.
a. What is the value of Johns ending inventory under absorption costing?
359.
b. What is the value of Johns ending inventory under absorption costing
assuming John adds overhead to products at the rate of 100% of material
costs?
360.
c. Which of the two allocation bases, labor costs or material costs, will cause
John to report higher income for the year?
361.
362.
363.
364.
365.

9-19

Balakrishnan/Managerial Accounting, 2e
3. Bonner Construction Company is currently working on two projects that have
considerable overlap in the use of equipment and materials. For example,
Bonner is renting a crane with a minimum lease time of one day and will be able
to use the crane on both projects during the one-day period. Bonner is billing
Project One on a cost-plus basis of cost + 20% and Project Two on a cost-cost
basis of cost + 30%. Bonners cost of the crane is $6,000 per day (12 hours) and
Bonner expects that moving the crane from Project One to Project Two will take
approximately one hour. Bonner provides the following additional data:
366.
367.
368. Proj 369. Proj
ect One
ect Two
370. Total cost of completing project
371. $45, 372. $180
000
,000
373. Estimated total cost of material 374. $15, 375. $40,
used on project
000
000
376. Estimated total cost of labor
377. $20, 378. $18,
used on project
000
000
379. Estimated hours of crane use
380. 2
381. 4
on project
hours
hours
382.
383.
Required:
a. Calculate the cost of the crane allocated to the two projects using budgeted
hours of crane use as the allocation basis.
384.
b. Calculate the cost of the crane allocated to the two projects using the total
cost of labor used on the project as the allocation basis.
385.
c. Which of the above allocation basis should Bonner use? Why?
386.
d. Assume you are the project manager for Project Two. Justify why allocating
the cost of the crane based on the estimated total cost of labor would be the
best allocation basis.
387.
388.
389.
4. Assume Superior Manufacturing, Inc. produces and sells fork lift motors.
Superior began operation January 1st of the current year. Superior produced
2,000 engines during its first year of operation and sold 1,800 engines. The
selling price per engine is $700. Variable manufacturing costs are 25 percent of
the sales price and variable selling and administrative costs are 10 percent of
the sales price. Fixed manufacturing costs total $800,000 and fixed selling and
administrative costs total $50,000.
390.
391.
Required:
392.
a. Prepare an income statement using absorption costing.
393.
b. Prepare an income statement using variable costing.

9-20

Cost Allocations: Theory and Applications


394.
395.

9-21

Balakrishnan/Managerial Accounting, 2e
396.

Solutions to Problems

1. Increase in volume of business and cost projections (LO2)


397.
a. Expected profit:
398.
Current Year
399.
400.
Next Year
401.
Sale
402.
$ 403. 404.
Sales
405.
$
s
34,0
40,0
00
00
406.
Varia
407.
408. 409.
Varia
410.
ble costs
8,50
ble costs
10,0
(850
0
(1,000
00
units)
units)
411.
Cont
412.
2 413. 414.
Cont
415.
3
ribution
5,50
ribution
0,00
margin
0
margin
0
416.
Fixed
417.
418. 419.
Fixed
420.
costs
17,0
costs
17,0
00
00
421.
Profit
422.
$ 423. 424.
Profit
425.
$
8,5
13,0
00
00
426.
b. Estimated profit:
427.
428.
Next Year
429. 430.
Sales
431.
$45,0
00
432. 433.
Variabl
434.
e costs
11,2
(1,125
50
units)
435. 436.
Contrib
437.
ution
33,75
margin
0
438. 439.
Fixed
440.
costs
20,0
00
441. 442.
Profit
443.
$13,7
50
444.
c. Answers will vary. Some students will answer yes because profit is
increased by $750. Other students will answer no because of the
uncertainty of reaching the projected sales of $45,000.
445.
446.
447.
448.

9-22

Cost Allocations: Theory and Applications


2. Absorption Costing , Income and Inventory Effects of Alternative Allocation bases
(LO2)
449.
a. $5,000 + 8,000 + $4,000 (50% x $8,000) = $17,000
450.
b. $5,000 + $8,000 + $5,000 (100% x $5,000) = $18,000
451.
c. Using material as the allocation base, John will transfer $1,000 more costs to
the balance sheet in ending inventory
452.
453.

9-23

Balakrishnan/Managerial Accounting, 2e
3. Cost allocations (LO3)
454.
a. Allocated using budgeted hours.
455.
Project One - $6,000 x 1/3 = $2,000
456.
Project Two - $6,000 x 2/3 = $4,000
457.
b. Allocated cost using the estimated total cost of labor:
458.
Project One - $6,000 x 52.63% = $3,158
459.
Project Two - $6,000 x 47.37% = $2,842
460.
c. Which basis should Bonner use and why?
461.
Answers will vary. Most students will probably answer that using the
estimated hours of crane use would seem to be the most relevant option.
462.
d. Project Two managers justification:
463. Answers will vary. One justification might be that a majority of the
labor cost is for crane operators (cranes other than the rented crane) and
allocation would be more reliable based on labor cost rather than hours.
464.
465.
4. Variable and Absorption costing income statements (Appendix)
466.
a. Absorption costing:
467.
468.
Sales
469.
470.
$
1,26
0,00
0
471.
Cost of goods
472.
473.
474.
Inventory
January 1

475.

477.
Cost of goods
manufactured

478.
1,150,0
00
481.
(115,
000
)
484.

480.
Ending
inventory
483.

Gross profit

486.
Variable selling
and administrative
costs
489.
Fixed selling and
administrative costs
492.

476.
$
0

Net Income

9-24

487.
126,00
0
490.
50,
000
493.

479.
482.
1,03
5,00
0
485.
2
25,0
00
488.
491.
176,
000
494.
$

Cost Allocations: Theory and Applications


49
,000
495.

9-25

Balakrishnan/Managerial Accounting, 2e
b. Variable costing:
496.
497.

500.

Sales

498.

Variable costs

501.

499.

$
1,26
0,00
0
502.

503.
Inventory
January 1

504.

506.
Variable
manufacturing costs

507.
315,0
00
510.
126,
00
0
513.

509.
Variable selling
and administrative
costs
512.
Contribution
margin
515.
Variable selling
and administrative
costs
518.
Fixed selling and
administrative costs
521.

505.
$
0

Net Income

524.

9-26

516.
800,0
00
519.
50
,00
0
522.

508.
511.
441,
000
514.

8
19,0
00
517.

520.
850,
000
523.

(
$
31,0
00)

Cost Allocations: Theory and Applications


525.

End of Chapter Content

526.

Short Answer

1. What is the appropriate measure of value for long-term decisions?


527.
2. What is the difference between a contribution margin and a profit margin?
528.
3. What are the two approaches for estimating the controllable cost of capacity
resources over the long term?
529.
4. Describe the direct estimation method for estimating controllable capacity costs.
List one advantage and one disadvantage of this approach.
530.
5. In addition to decision making, what are the other common uses of cost
allocations?
531.
6. Which of the two methods, variable costing or absorption costing, is allowed
under GAAP?
532.
7. What costs does the value of a unit of product include under absorption costing?
533.
8. Under variable costing, how does sales volume affect the amount of fixed
manufacturing overhead expensed in the income statement?
534.
9. Under absorption costing, how does sales volume affect the amount of fixed
manufacturing overhead expensed in the income statement?
535.
10.When will income reported under variable costing be the same as income
reported under absorption costing?
536.
11.Why might the Department of Defense pay some of its suppliers on a cost-plus
basis?
537.
12.Why might a firm be strategic in the choice of allocation procedures to determine
reimbursable costs?
538.
13.How could a firm induce desirable behavior or dissuade undesirable behavior by
changing its cost allocation procedures?
539.
14.What are the two main influences that guide the choice of a cost allocation
procedure?
540.
541.

9-27

Balakrishnan/Managerial Accounting, 2e
542.

Solutions to Short Answer

1. (LO1)
(LO1) Profit margin.
543.
2. (LO1)
Contribution margin equals revenues less variable costs, and profit
margin equals contribution margin less allocated capacity costs.
544.
3. (LO1)
Direct estimation, and cost allocations.
545.
4. (LO1)
The direct estimation approach involves systematically examining
each cost account to evaluate whether (and how much) a decision would change
a capacity cost. An advantage of this approach is that it can be very accurate.
However, it is tedious and time-consuming, and is subject to the biases and
incentives of the decision maker.
546.
5. (LO1) To calculate income in accordance with GAAP, and to influence behavior.
547.
6. (LO2)
Absorption costing
548.
7. (LO2)
All product costs direct materials, direct labor, as well as variable and
fixed manufacturing overhead
549.
8. (LO2)
Sales volume does not affect the fixed manufacturing overhead
expensed on the income statement. Under variable costing, the entire amount of
fixed overhead is expensed, regardless of sales volume.
550.
9. (LO2)
As sales volume increases, the amount of fixed manufacturing
overhead expensed on the income statement also increases (and vice-versa).
This occurs because, under absorption costing, fixed manufacturing overhead
travels with the units produced and sold.
551.
10.(LO2)
When inventory levels do not change that is, when sales =
production.
They might do this when there is uncertainty about the final cost e.g., it allows
the government and the supplier to share the risk of cost overruns.
552.
11.(LO3)
To protect its suppliers from the risk of cost over-runs, so that they
make the necessary investments and supply DoDs requirements.
553.
12.(LO3)
To increase profits, as the Ryan Supply Systems example illustrates
554.
13.(LO3)
Allocations can act like a tax for example, organizations might
allocate costs based on labor hours to encourage divisions to automate.
555.
14.(LO3)
Controllability and incentives
556.

9-28

Cost Allocations: Theory and Applications


557.

Short Essays

1. Many firms dedicate separate production facilities to each of their product


lines. What are some of the advantages and disadvantages of this approach
from the perspective of allocating costs for decision making?
558.
2. Suppose a firm currently makes three products using the same capacity
resources and that one of the products has a negative profit margin. Identify
two reasons why the firm may wish to continue making the unprofitable
product.
559.
3. Depreciation is nothing but an allocation of the purchase price over different
accounting periods. Do you agree with this statement? If so, identify the
elements of cost allocations (cost pool, cost objects, cost driver, denominator
volume) Implicit in the computation of depreciation. If not, identify differences
between cost allocations and depreciation.
560.
4. Assume a firms overall inventory has increased during the period. Is it
possible for income under variable costing to exceed income under
absorption costing? (Hint: think about multiproduct firms or changing prices
and inventory layers).
561.
5. The IRS exempts qualified charities from income taxes, provided the income
relates to their charitable activities. The provision exists because many
charities conduct activities deemed unrelated to their core charitable mission.
For example, a museum may earn income on its cafeteria sales or by renting
out its lobby for a corporate reception. Such unrelated business income is
taxable. Determining the portion of income that is taxable often involves
extensive cost allocations. How might a charity be strategic in its choice of
allocation methods? (Hint: An academic study found that nearly 30% of
sampled charities reported exactly $0 as their unrelated business income.)
562.
6. Suppose a firm produces two products, both of which are sold in competitive
markets. Are there any incentives to be strategic when allocating costs
between these two products?
563.
7. Firms that allocate costs based on head count motivate their managers to
reduce the number of employees. What kind of dysfunctional and profit
destroying (from the firms perspective) behavior might such allocations
engender?
564.
8. Suppose a firm allocates costs to its individual product lines using labor cost
as the allocation basis. Further assume that each product lines manager is
evaluated based on the lines reported profit. How might this allocation affect
a managers short-term decision to make or buy individual components?
565.
9. Even when a decision is short term, the use of allocated costs in managerial
performance evaluation implicitly makes the manager behave as if the
decision were a long-term decision. Do you agree with this statement?
566.

9-29

Balakrishnan/Managerial Accounting, 2e
10.Governments often use tax policy to induce desired behavior (e.g., allow
mortgage interest to be deducted) or to dissuade undesired behavior (e.g.,
sin taxes on cigarettes). Can you give two additional examples of how tax
policy influences behavior? Discuss the similarities and differences between
the use of tax policies and cost allocations to modify behavior.

9-30

Cost Allocations: Theory and Applications


567.

Solutions to Short Essay

1. (LO1)
In such production facilities, all costs that are traceable directly to each
product line need not be allocated among products. In other words, many
indirect costs become direct costs, and costing a product become simpler and
more accurate. The disadvantage is that when a production line is idle because
of temporary lull in demand, it cannot be used to make other products. That is,
dedicating production lines can often lead inefficient utilization of capacity.
568.
2. (LO1)
Supplying a product with a negative profit margin product may be
necessary to keep a large customer of the profitable products from going
elsewhere. Making a negative profit margin product may also be good for
business if it brings good reputation in the market place. For example, a
restaurant can establish reputation in a community by catering to large not-forprofit charity events at or below cost so as to develop a clientele.
569.
3. (LO2)
Yes. The cost pool is the original cost of the machine less salvage
value. The cost object is either the product(s) or the division(s) whose
profitability is being measured. The cost driver is the useful life of the asset
being depreciated. The denominator volume is the expected number of years of
useful life.
570.
4. (LO2)
Yes. The firms inventory will increase if production exceeds sales
during the period. Consider a firm using First-in First-out (FIFO) inventory flow
assumption, and assume that fixed costs have increased drastically from prior
period to current period. In this case, because all fixed costs are expensed under
variable costing, and the lower prior period fixed costs flow through to the
income statement under absorption costing, income can be higher under
absorption costing.
571.
5. (LO3)
The charity might wish to choose procedure that would allocate more
costs against non-charity related taxable revenues so as to save on taxes, and
use these tax savings for other presumably charitable causes.
572.
6. (LO3)
Not really. Strictly speaking, in competitive markets the prices are set
by the market forces. It is the firms overall profitability that matters. As long as
the two products are earning positive contribution margins and more capacity is
allocated to the product that makes the more profitable use of capacity,
allocation of capacity costs is not necessary.
573.
`
7. (LO3)
In many firms (especially service and IT firms), people are the most
valuable resource. Getting rid of good talent and people with valuable firmspecific experience just because of incentives arising from a cost allocation
procedure can hurt the company in the long run. Should the need arise in the
future for similar work force in the future it is a lot more costly to recruit and
train new people to the level where they become as efficient as those who
occupied their jobs previously.
574.
8. (LO3)
To avoid being allocated overhead costs based on labor consumption,
the product line managers natural incentive would be to outsource labor

9-31

Balakrishnan/Managerial Accounting, 2e
intensive activities, even if outsourcing may be costlier from the firms
perspective. For example, the manager might prefer outsourcing parts with high
labor content. Outsourcing reduces labor costs as well as the overhead that is
allocated based on labor costs, but it might increase material costs because of
the higher prices to be paid for the parts. However, the net result on the line
profit may be positive.
575.
9. (LO3)
Yes. From a performance evaluation perspective, the allocated costs
will be treated by the manager as if they are variable costs. By finding ways in
which to reduce the costs allocated to his/her unit, the manager can paint a
better picture of his/her performance. Thus, in making short-term decisions, the
managers natural incentive would be to not treat allocated costs as fixed costs
even if they are truly fixed
576.
10.(LO3)
Most governments permit some form of accelerated depreciation of
long-term assets to allow higher tax deductions in the initial years of the assets
lives to induce investment and growth in their economies. As we know,
depreciation is in essence allocation of an assets cost over its useful life. Some
governments levy taxes on imported foreign goods to protect local industries
from foreign competition. This is much like taxing labor via cost allocation to
promote automation. Even arbitrary allocations can induce desired behavior so
long as these allocations are not used for planning and decision making.

9-32

Cost Allocations: Theory and Applications


577.

Exercises

1. Located in Madras, India, Shah Company manufactures and sells leather


garments in India and in Europe. For the most recent year of operations, Shah
sold 20,000 garments each in Europe and India. Each garment sold in India
consumes 4 hours of labor, while each garment sold in Europe consumes 7 hours
of labor. Shah currently allocates fixed manufacturing overhead costs, which
amount to $660,000 per year, using the number of garments produced for the
allocation basis. Shahs income-tax rate in Europe is 40% and 30% in India.
Assume that each jurisdiction (Europe, India) taxes only income reported in that
jurisdiction.
578.
579.
Required:
580.
581.
Compute the net savings in taxes paid if Shah were to allocate
overhead costs using
582.
labor hours rather than garments as the allocation basis.
583.
2. Service providers such as plumbers and electricians often charge $60 per hour
even in rural areas where a factory job that pays perhaps $20$25 per hour
would be considered a good job. Furthermore, factory workers often have
training that equals that of most plumbers and electricians.
584.
585.
Required:
586.
587.
Explain the seeming discrepancy in the prices for labor services. Please
note that many
588.
plumbers and electricians operate small businesses.
589.
590.

9-33

Balakrishnan/Managerial Accounting, 2e
591.

Solutions to Exercises

1. (LO3)
592. Lets compute the taxes paid if Shah uses garments as the allocation
basis:
593.
594.
Cost per garment = $660,000 / (20,000 + 20,000) = $16.50 per
garment.
595.
596.
Costs allocated to Europe = 20,000 garments $16.50 /
garment = $330,000.
597.
Costs allocated to India = 20,000 garments $16.50 / garment
= $330,000.
598.
599. We cannot compute the tax directly as we do not have data relating to
income. However, we can calculate the tax savings as the overhead cost is an
allowable deduction to income.
600.
601. Thus, the allocation scheme will result in a tax shield of ($330,000
40%) + ($330,000 30%) = $231,000.
602.
603. Next, let us compute the tax shield if Shah were to allocate overhead
cost using labor hours as the allocation basis.
604.
605. Denominator volume
= (20,000 garments 7 hours) + (20,000
garments 4 hours)
= 220,000 hours.
606.
607. Cost rate per hour = $660,000 / 220,000 hours = $3 per hour.
608.
609. Costs allocated to Europe = 20,000 garments 7 hours / garment
$3 / hour = $420,000.
610.
611. Costs allocated to India = 20,000 garments 4 hours / garment $3 /
hour = $240,000.
612.
613. Thus, the allocation scheme will result in a tax shield of ($420,000
40%) + ($240,000 30%) = $240,000.
614.
615. Changing the allocation basis from garments to labor hours would
therefore save Shah Company, $240,000 - $231,000 = $9,000 in taxes
paid.
616.
2. (LO1)
This question is useful in pointing out that revenues do not equal profit.
For a factory worker, wages paid are the compensation for that persons effort
and skill. The employer will provide (almost always) the required tools, the jobs,
and so on. The worker is not responsible for procuring work. Employees also are
not liable for the general maintenance of the facility, or other overhead items.

9-34

Cost Allocations: Theory and Applications


617.
618.
In contrast, many plumbers and electricians work as independent
contractors. The rate they charge is the revenue for the business. Before they
can determine profit, this revenue must pay for all business expenses. For
instance, the plumber may not work for the entire day. Part of the day has to be
spent on developing the business. In addition, there are expenses such as paying
for accounting, leasing an office and so on. The person also is responsible for
wage-related taxes such as the employer portion of social security tax.
619.
620.
Small businesses recover such overhead charges by allocating the cost
to work done in proportion to labor hours expended. This choice of an allocation
basis makes sense because labor is their primary product. However, rather than
confuse the customer with an overhead charge and a profit, the entire amount is
rolled into a single chargeable rate per labor hour. Often, the net pay for a
plumber or electrician (i.e., the amount they take home) is not dramatically
different than that for a similarly skilled factory worker.

9-35