Chapter 21: Q-21-1RQ (page 1166)
What is absorption costing?
Answer
Absorption costing is the traditional method of calculating product cost per unit.
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Question: The Hurley Hat Company manufactures baseball hats. Hurley’s primary customers are sporting goods stores that supply uniforms to youth baseball teams. Following is Hurley’s income statement for 2018:
In 2018, Hurley produced and sold 200,000 baseball hats. Of the Cost of Goods Sold, \(150,000 is fixed; 80% of the Selling and Administrative Expenses are fixed. There were no beginning inventories on January 1, 2018. The company is considering two options to increase sales.
Option 1: The company is operating at 100,000 hats below full production capacity and is considering increasing advertising to increase sales to the production capacity level in 2019. The marketing director predicts that an additional \)100,000 expenditure for advertising would increase sales to 300,000 hats per year.
Option 2: The sales manager has been negotiating with buyers for several national sporting goods retailers and recommends the company expand production capacity to 400,000 hats in order to secure long-term contracts beginning in 2019. The expansion is expected to increase fixed manufacturing costs by \(200,000 per year. Additionally, the retailers are requesting a higher-quality hat, and the changes to the hat materials and manufacturing process would increase variable manufacturing costs by \)1 per hat for the additional 200,000 hats. (The original 200,000 hats manufactured and sold would not be affected by this change.)
Requirements
1. Use the data from the 2018 income statement to prepare an income statement using variable costing. Assume no beginning or ending inventories. Calculate the contribution margin ratio. Round to two decimal places.
2. Prepare an absorption costing income statement assuming the company pursues Option 1 and increases advertising and production and sales increase to 300,000 hats.
3. Refer to the original data. Prepare an absorption costing income statement assuming the company pursues Option 2 and increases capacity and sales and production increases to 400,000 total hats.
4. Which option should the company pursue? Explain your reasoning.
Comparing variable and absorption costing Refer to Exercises E21-16 and E21-17.
Requirements:
Preparing variable and absorption costing income statements
Game Source manufactures video games that it sells for \(43 each. The company uses a fixed manufacturing overhead allocation rate of \)5 per game. Assume all costs and production levels are exactly as planned. The following data are from Game Store’s first two months in business during 2018:
October November Sales 1,500 units 2,900 units Production 2,500 units 2,500 units Variable manufacturing cost per game \( 17 \) 17Sales commission cost per game 7 7Total fixed manufacturing overhead12,500 12,500
Total fixed selling and administrative costs 11,500 11,500 Requirements
1. Compute the product cost per game produced under absorption costing and under variable costing.
2. Prepare monthly income statements for October and November, including columns for each month and a total column, using these costing methods:
a. absorption costing.
b. variable costing.
3. Is operating income higher under absorption costing or variable costing in October? In November? Explain the pattern of differences in operating income based on absorption costing versus variable costing.
4. Determine the balance in Finished Goods Inventory on October 31 and November 30 under absorption costing and variable costing. Compare the differences in inventory balances and the differences in operating income. Explain the differences in inventory balances based on absorption costing versus variable costing.
Why is it appropriate to use variable costing when planning production in the short term?
Question: Preparing absorption costing income statements, production less than sales
Refer to Exercise E21-19.
Requirements
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