Chapter 19: Q9DQ (page 867)
What are the major limitations of variable costing?
Limitations of variable costing includes cost inaccuracy and issues in long-term pricing.
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Chem-Melt produces and sells an ice-melting granular used on roadways and sidewalks in winter. The company annually produces and sells about 300,000 pounds of its granular. In its 10-year history, the company has never reported a net loss. Because of this year’s unusually mild winter, projected demand for its product is only 250,000 pounds. Based on its predicted production and sales of 250,000 pounds, the company projects the following income statement under absorption costing.
Sales (250,000 lbs. at \(8 per lb.) . . . . . . . . . . . . . . . . . . . . . . . \)2,000,000
Cost of goods sold (250,000 lbs. at \(6.80 per lb.) . . . . . . . . . 1,700,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300,000
Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . 450,000
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \) (150,000)
Its product cost information follows and consists mainly of fixed production cost because of its automated production process requiring expensive equipment.
Variable direct labor and materials costs per pound . . . . . . . . . . . \(2.00
Fixed production cost per pound (\)1,200,000∕250,000 lbs.) . . . . . . 4.80
Total product cost per pound . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6.80
The company’s selling and administrative expenses are all fixed. The president is concerned about the adverse reaction from its creditors and shareholders if the projected net loss is reported. The controller suggests that since the company has large storage capacity, it can report a net income by keeping its production at the usual 300,000-pound level even though it expects to sell only 250,000 pounds. The president was puzzled by the suggestion that the company can report a profit by producing more without increasing sales.
Required
1. Can the company report a net income by increasing production to 300,000 pounds and storing the excess production in inventory? Your explanation should include an income statement (using absorption costing) based on production of 300,000 pounds and sales of 250,000 pounds.
2. Should the company produce 300,000 pounds given that projected demand is 250,000 pounds? Explain, and also refer to any ethical implications of such a managerial decision.
Oak Mart, a producer of solid oak tables, reports the following data from its second year of business.
Sales price per unit | \(320 per unit | Manufacturing costs this year | |
Units produced this year | 115,000 units | Direct materials | \)40 per unit |
Units sold this year | 118,000 units | Direct labor | \(62 per unit |
Units in beginning-year inventory | 3,000 units | Overhead costs this year | |
Beginning inventory costs | Variable overhead | \)3,220,000 | |
Variable (3,000 units x \(135) | \)405,000 | Fixed overhead | \(7,400,000 |
Fixed (3,000 units x \)80) | 240,000 | Selling and administrative costs this year | |
Total | \(645,000 | Variable | \)1,416,000 |
Fixed | 4,600,000 |
1. Prepare the current-year income statement for the company using variable costing.
2. Prepare the current-year income statement for the company using absorption costing.
3. Explain any difference between the two income numbers under the two costing methods in parts 1 and 2.
Grand Garden is a luxury hotel with 150 suites. Its regular suite rate is \(250 per night per suite. The hotel’s cost per night is \)140 per suite and consists of the following.
Variable direct labor and material cost | \(30 |
Fixed cost | 110 |
Total cost per night per suite | \)140 |
The hotel manager received an offer to hold the local Bikers’ Club annual meeting at the hotel in March, which is the hotel’s low season with an occupancy rate of under 50%. The Bikers’ Club would reserve 50 suites for three nights if the hotel could offer a 50% discount, or a rate of \(125 per night. The hotel manager is inclined to reject the offer because the cost per suite per night is \)140. Prepare an analysis of this offer for the hotel manager. Explain (with supporting computations) whether the offer from the Bikers’ Club should be accepted or rejected.
Mortech had net income of \(250,000 based on variable costing. Beginning and ending inventories were 50,000 units and 48,000 units, respectively. Assume the fixed overhead per unit was \)0.75 for both the beginning and ending inventory. What is net income under absorption costing?
E’Lonte Company began operations this year. During this first year, the company produced 300,000 units and sold 250,000 units. Its income statement under absorption costing for this year follows.
Sales (250,000 units x \(18 per unit) | \)4,500,000 | |
Cost of goods sold | ||
Beginning inventory | \(0 | |
Cost of goods manufactured (300,000 units x \)7.50 per unit) | 2,250,000 | |
Cost of goods available for sale | 2,250,000 | |
Ending inventory (50,000 x \(7.50) | 375,000 | |
Cost of goods sold | 1,875,000 | |
Gross margin | 2,625,000 | |
Selling and administrative expenses | 2,200,000 | |
Net income | \)425,000 |
Additional Information
a. Selling and administrative expenses consist of \(1,200,000 in annual fixed expenses and \)4 per unit in variable selling and administrative expenses.
b. The company’s product cost of \(7.50 per unit is computed as follows.
Direct materials | \)2 per unit |
Direct labor | \(2.40 per unit |
Variable overhead | \)1.60 per unit |
Fixed overhead (\(450,000/300,000 units) | \)1.50 per unit |
Required
1. Prepare the company’s income statement under variable costing.
2. Explain any difference between the company’s income under variable costing (from part 1) and the income reported above.
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