SOLUTIONS TO PROBLEMS

PROBLEM 8-21 (45 MINUTES)

1. a. Absorption-costing income statements:

Year 1 Year 2 Year 3

Sales revenue (at $25 per case) $2,000,000 $1,500,000 $2,250,000
Less: Cost of goods sold (at
absorption cost of $21 per case) * 1,680,000 1,260,000 1,890,000
Gross margin $ 320,000 $ 240,000 $ 360,000
Less: Selling and administrative expenses:
Variable (at $ .50 per case) 40,000 30,000 45,000
Fixed 37,500 37,500 37,500
Operating income $ 242,500 $ 172,500 $ 277,500

*The absorption cost per case is $21, calculated as follows:

Budgeted fixed manufacturing overhead variable manufacturing

+
Planned production cost per case

$400,000
+ $16
80,000

$5 + $16 = $21
Problem 8-21 (Continued)
b. Variable-costing income statements:

Year 1 Year 2 Year 3

Sales revenue (at $25 per case) ................................ $2,000,000 $1,500,000 $2,250,000
Less: Variable expenses:
Variable manufacturing costs (at
variable cost of $16 per case) 1,280,000 960,000 1,440,000
Variable selling and administrative
costs (at $ .50 per case) ............................... 40,000 30,000 45,000
Contribution margin ................................................... $ 680,000 $ 510,000 $ 765,000
Less: Fixed expenses:
Fixed manufacturing overhead ..................... 400,000 400,000 400,000
Fixed selling and administrative
expenses ....................................................... 37,500 37,500 37,500
Operating income ....................................................... $ 242,500 $ 72,500 $ 327,500

2. Reconciliation:

Difference In
Difference Predetermined Fixed Overhead
Reported Income
in Change in Fixed Expensed Under
Absorption Variable Reported Inventory Overhead Absorption and
Year Costing Costing Income (in units) Rate* Variable Costing
1 $242,500 $242,500 -0- -0- $5 0
2 172,500 72,500 $100,000 20,000 5 $100,000
3 277,500 327,500 (50,000) (10,000) 5 (50,000)

$400,000
*Predetermined fixed manufacturing overhead rate = 80,000
Problem 8-21 (Continued)
3. a. In year 4, the difference in reported operating income will be $50,000,
calculated as follows:

Change in Predetermined
inventory fixed overhead
(in units) rate

(10,000) $5 = $(50,000)

Income reported under absorption costing will be lower, because inventory

will decline during year 4.
b. Over the four-year period, the total of all reported operating income will be the
same under absorption and variable costing. This result will occur because
inventory does not change over the four-year period. It starts out at zero on
January 1 of year 1, and it ends up at zero on December 31 of year 4.
PROBLEM 8-22 (40 MINUTES)

Throughput-costing income statements:

Year 1 Year 2 Year 3

Sales revenue (at $25 per case) .............................. $2,000,000 $1,500,000 $2,250,000
Less: Cost of goods sold (at throughput cost,
equal to direct-material cost of $7.50 per
case)
600,000 450,000 675,000
Gross margin ........................................................... $1,400,000 $1,050,000 $1,575,000
Less: Operating costs:
Direct labora............................................. 200,000 200,000 200,000
b
Variable overhead .................................. 480,000 480,000 480,000
Variable selling and administrative
costs (at $ .50 per unitc)
........................................................... 40,000 30,000 45,000
Fixed manufacturing overhead.............. 400,000 400,000 400,000
Fixed selling and administrative costs 37,500 37,500 37,500
Net income $ 242,500 $ (97,500 ) $ 412,500

a
Assumes that management has committed to direct labor sufficient
to produce the planned production volume of 80,000 units; direct
labor is used at the rate of $2.50 per unit produced.
b
Assumes that management has committed to support resources
sufficient to produce the planned production volume of 80,000 units;
variable-overhead cost is used at the rate of $6 per unit produced.
c
Variable selling and administrative costs amount to $ .50 per unit
sold.
PROBLEM 8-27 (35 MINUTES)

1. Total cost:

Direct material (10,000 units x $36)... $ 360,000

Direct labor.. 135,000
Variable manufacturing overhead. 195,000
Fixed manufacturing overhead.. 660,000
Variable selling and administrative costs (9,600 units x $24)

230,400
Fixed selling and administrative costs 354,000
Total. $1,934,400

2. The cost of the year-end inventory of 400 units (10,000 units produced 9,600 units sold) is
computed as follows:

Absorption Variable Throughp

Costing Costing Costing

Direct material.. $ 360,000 $360,000 $360,000

Direct labor 135,000 135,000
Variable manufacturing overhead.. 195,000 195,000
Fixed manufacturing overhead 660,000 ________ ________
Total product cost $1,350,000 $690,000 $360,000
Cost per unit (total 10,000 units) $135 $69 $36
Year-end inventory (400 units x cost per unit)
...
$ 54,000 $ 27,600 $ 14,400

3. The total costs would be allocated between the current periods income statement and the
year-end inventory on the balance sheet. Thus:
Absorption costing: $1,934,400 - $54,000 = $1,880,400
Variable costing: $1,934,400 - $27,600 = $1,906,800
Throughput costing: $1,934,400 - $14,400 = $1,920,000
PROBLEM 8-27 (CONTINUED

Alternatively, these amounts can be derived as follows:

Absorption Variable Through

Costing Costing Costin
Cost of goods sold:
9,600 units x $135.................................... $1,296,000
9,600 units x $69...................................... $662,400
9,600 units x $36...................................... $345,60
Direct labor..................................................... 135,00
Variable manufacturing overhead................... 195,00
Fixed manufacturing overhead....................... 660,000 660,00
Variable selling and administrative costs........
230,400 230,400 230,40
Fixed selling and administrative costs............ 354,000 354,000 354,00
Total......................................................... $1,880,400 $1,906,800 $1,920,00

1. Throughput-costing income statement:

Sales revenue (9,600 units x $216).............................. $2,073,600

Less: Cost of goods sold.............................................. 345,600
Gross margin............................................................... $1,728,000
Less: Operating costs:
Direct labor........................................................... $ 135,000
Variable manufacturing overhead.......................... 195,000
Fixed manufacturing overhead.............................. 660,000
Variable selling and administrative costs............... 230,400
Fixed selling and administrative costs................... _ 354,000
Total operating costs....................................... $1,574,400
Net income.................................................................. $ 153,600*

*As a check: Net income = sales revenue - all costs expensed

= $2,073,600 - $1,920,000 (from req. 3)
= $153,600
5. The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.
PROBLEM 8-28 (45 MINUTES)

1. Reported income will be higher under absorption costing, because inventory is

expected to increase by 1,000 units during the year. (Twenty thousand units will
be produced in the last two months, but 19,000 units will be sold.)
2. a. Variable costing: Total contribution during first 10 months is equal to the fixed
costs plus profit for that period.

Fixed costs during first 10 months ...................................................... $3,000,000

Profit during first 10 months ................................................................. 300,000
Total contribution margin ...................................................................... $3,300,000

$3,300,000
Contribution margin per unit= 100,000 =$33 per unit
Projected total sales for the year are 119,000 units (100,000 in first 10 months
plus 19,000 units in last 2 months). We can compute projected income for the
year as follows. (There are no variances or selling and administrative costs.)

Projected total contribution margin ($33 119,000) ............................. $3,927,000

Less: Projected fixed costs ($300,000 12) ......................................... 3,600,000
Projected income ................................................................................... $ 327,000

The net income projected for the year under variable costing is $327,000.
Note: The problem states that the prior periods cost rates are the same as
those of the current period. There are 10,000 units on hand at October 31, and
production equals sales in the first 10 months. Thus, 10,000 units were on
hand at January 1.
b. Absorption costing: The gross margin for the first 10 months is $300,000. Notice
that income and gross margin are the same, since there are no selling or
administrative expenses. Therefore, during the first 10 months:

$300,000
Gross margin per unit= 100,000 units =$3 per unit
pROBLEM 8-28 (CONTINUED)
Projected sales for the year are 119,000 units, so we can compute the projected
gross margin for the year as follows:

Projected gross margin ($3 119,000) .................................................. $357,000

There were no selling and administrative expenses.

Therefore, the projected gross margin and projected income are the same.
So projected net income for the year under absorption costing is $357,000.
Check: Our conclusions can be checked by noting the following relationship:
Reported income under reported income under
absorption costing variable costing

= increase in inventory fixed-overhead rate

= 1,000 units $30 per unit = $30,000

Therefore, reported income will be $30,000 higher under absorption costing than
under variable costing.
3. The advantages and disadvantages of variable and absorption costing are
summarized as follows:

(a) Pricing decisions: Many managers prefer to use absorption-costing data in

cost-based pricing decisions. They argue that fixed manufacturing overhead is a
necessary cost incurred in the production process. To exclude this fixed cost
from the inventoried cost of a product, as is done under variable costing, is to
understate the cost of the product. For this reason, most companies that use
cost-based pricing base their prices on absorption-costing data.

Proponents of variable costing argue that a products variable cost provides a

better basis for pricing decisions. They point out that any price above a products
variable cost makes a positive contribution to covering fixed cost and profit.
(b) Definition of an asset: Another controversy about absorption and variable costing hinges
on the definition of an asset. An asset is a thing of value owned by the organization with
future service potential. By accounting convention, assets are valued at their cost. Since fixed
costs comprise part of the cost of production, advocates of absorption costing argue that
inventory (an asset) should be valued at its full (absorption) cost of production. Moreover,
they argue that these costs have future service potential since the inventory can be sold in the
future to generate sales revenue.

Proponents of variable costing argue that the fixed-cost component of a

products absorption-costing value has no future service potential. Their
reasoning is that the fixed manufacturing-overhead costs during the current
period will not prevent these costs from having to be incurred again next period.
Fixed-overhead costs will be incurred every period, regardless of production
levels. In contrast, the incurrence of variable costs in manufacturing a product
does allow the firm to avoid incurring these costs again.

(c) Cost-volume-profit analysis: Some managers find the inconsistency between

absorption costing and CVP analysis troubling enough to warrant using variable
costing for internal income reporting. Variable costing dovetails much more
closely than absorption costing with any operational analyses that require a
separation between fixed and variable costs.

(d) External reporting: For external reporting purposes, generally accepted

accounting principles require that income reporting be based on absorption
costing. Federal tax laws also require the use of absorption costing in reporting
income for tax purposes.