Chapter 19 - Variable Costing and Performance Reporting

PROBLEM SET B

Problem 19-1B (25 minutes)

Part 1

MITCHELL COMPANY
Variable Costing Income Statement
Sales (250,000 x $18)...... / $4,500,000
Variable expenses
Variable production costs (250,000 x $6*)...... / $1,500,000
Variable selling & admin. expenses (250,000 x $4)..... / 1,000,000
Total variable expenses...... / 2,500,000
Contribution margin...... / 2,000,000
Fixed expenses
Fixed manufacturing costs...... / 450,000
Fixed selling & administrative expenses...... / 1,200,000
Total fixed expenses...... / 1,650,000
Net income...... / $ 350,000
*Direct materials...... / $2.00 per unit
Direct labor...... / $2.40 per unit
Variable overhead...... / $1.60 per unit
Total variable production costs...... / $6.00 per unit

Part 2

Absorption costing income is $75,000 more than variable costing income. This is because there are 50,000 units in ending inventory which have $1.50 per unit in fixed overhead attached to them. Under variable costing all of the fixed overhead is expensed. Under absorption costing, only the portion of the fixed overhead attached to the units sold is expensed.

Problem 19-2B (45 minutes)

Part 1

FLORES COMPANY
Variable Costing Income Statements
2010 / 2011
Sales ($35 per unit sold)...... / $1,925,000 / $2,275,000
Variable expenses
Variable production costs ($18 per unit sold*).... / 990,000 / 1,170,000
Variable selling & admin. costs ($3 per unit sold).. / 165,000 / 195,000
Total variable costs...... / 1,155,000 / 1,365,000
Contribution margin...... / 770,000 / 910,000
Fixed expenses
Factory overhead...... / 480,000 / 480,000
Fixed selling & administrativecosts...... / 300,000 / 300,000
Total fixed expenses...... / 780,000 / 780,000
Net income (loss)...... / $ (10,000) / $ 130,000
*$4+ $6 + $8 = $18

Part 2

FLORES COMPANY
Reconciliation of Variable Costing Income to Absorption Costing Income
2010 / 2011
Variable costing income...... / $(10,000) / $130,000
Fixed overhead in ending inventory (5,000 x $8).... / 40,000
Fixed overhead in beginning inventory (5,000 x $8).. / ______ / (40,000)
Absorption costing income...... / $30,000 / $90,000

Problem 19-3B (20 minutes)

Memo to:Roberto Flores, President

Subject:Break-even volume and absorption costing

Break-even analysis is computed using a contribution margin approach. The contribution margin approach assumes that all fixed expenses – including fixed manufacturing expenses – are expensed in the period in which they are incurred. The calculation of break-even point, therefore, assumes that fixed factory overhead of $480,000 will be expensed in the current period.

However, absorption costing – which we must use for external reporting purposes – assumes that fixed factory overhead is attached to each unit of inventory. Therefore, the only amount of the fixed factory overhead that is expensed in the current period is the amount that is attached to the units that are sold. Any fixed factory overhead attached to units in ending inventory is not expensed until those units are sold.

By producing 60,000 units and only selling 55,000 units we find that only $440,000 (55,000 units x $8 per unit) of the fixed factory overhead is expensed, and not $480,000. If you look at the variable costing income statement (see Problem 19-2B) you will find that we do show a net loss under variable costing, because the 55,000 units sold are below the break-even units of 55,715. Our loss of $10,000 can be calculated as:

715 units below break-even x $14 contribution margin per unit = $10,010 (with a $10 rounding error)

It is possible to calculate break-even volume using absorption costing, assuming a 60,000 production volume level, but the calculations are more complicated.

[Instructor’s note: The break-even volume using absorption costing is 50,000 units.]

Problem 19-4B (15 minutes)

Expected contribution margin from JSA convention offer:

Revenue (100 rooms x 4 nights x $150 per night)...... / $60,000
Variable costs (100 rooms x 4 nights x $40 per night)...... / 16,000
Contribution margin...... / $44,000

As long as there are no additional fixed costs (additional staff that must be hired to see to the extra customers, for instance), and as long as no customers who would otherwise pay the full $300 per night are turned away, the hotel will realize a $44,000 increase in profits, rather than a $6,000 loss.

Problem 19-5B (30 minutes)

Part 1

Yes, it is possible for the company to report a net income by increasing its production to 300,000lbs. and storing the excess inventory. The following absorption costing income statement shows this.

PROTO CHEMICAL
Income Statement (Absorption Costing)
Sales (250,000lbs. x $8 per lb.)...... / $2,000,000
Cost of goods sold (250,000 lbs. x $6 per lb*)...... / 1,500,000
Gross margin...... / 500,000
Selling and administrative expenses...... / 450,000
Net income...... / $ 50,000
*Variable production costs (300,000 lbs. x $2 per lb.)...... / $ 600,000
Fixed production costs...... / 1,200,000
Total production costs...... / $1,800,000
Absorption cost per ton ($1,800,000/ 300,000 lbs.)...... / $6.00 per lb.

ProtoChemical can increase its income by $200,000 by producing 50,000 pounds more than it sells. Each of the 50,000 pounds in inventory will carry $4.00 in fixed overhead ($1,200,000/300,000 lbs.). 50,000 pounds times $4.00 per pound equals the $200,000 in fixed overhead that is not expensed in the current period. It will be expensed when the chemical is sold in a future period.

Part 2

Whether the company should produce the extra 50,000 pounds depends on a number of factors.

  • It would be unethical to produce the extra 50,000 pounds just to raise income (and perhaps have managers earn bonuses) if the company does not feel it can sell the chemical in the near future.
  • If the company feels that the extra chemical can be sold in the near future, it might be appropriate to produce it now and have the chemical on hand for the future. While the projection is for a mild winter, conditions can change without much warning. Those extra 50,000 pounds might be demanded if there is an unexpected ice storm.

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