CHAPTER 7

VARIABLE COSTING: A DECISION-MAKING

PERSPECTIVE

SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY

Ite SO BT Ite SO BT Ite SO BT Ite SO BT Ite SO BT
m m m m m
True-False Statements
1. 1 K 9. 2 C 17. 3 K 25. 4 K
2. 1 K 10. 2 K 18. 3 K 26. 4 K
3. 1 K 11. 2 K 19. 3 K 27. 5 K
4. 1 K 12. 2 K 20. 4 K 28. 5 K
5. 1 K 13. 3 K 21. 4 K 29. 5 K
6. 1 K 14. 3 K 22. 4 K 30. 5 C
7. 1 K 15. 3 K 23. 4 AP
8. 2 K 16. 3 K 24. A
4 AP
Multiple Choice Questions
31. 1 K 43. 1 K 55. 2 K 67. 3 C 79. 4 AP
32. 1 K 44. 2 AP 56. 2 K 68. 3 K 80. 4 AP
33. 1 K 45. 2 AP 57. 3 K 69. 4 K 81. 4 AP
34. 1 K 46. 2 AP 58. 3 K 70. 4 AP 82. 4 AP
35. 1 AP 47. 2 AP 59. 3 K 71. 4 AP 83. 5 K
36. 1 AP 48. 2 C 60. 3 K 72. 4 AP 84. 5 AP
37. 1 AP 49. 2 K 61. 3 C 73. 4 AP 85. 5 AP
38. 1 AP 50. 2 K 62. 3 C 74. 4 K 86. 5 AP
39. 1 AP 51. 2 K 63. 3 AP 75. 4 AP 87. 5 AP
40. 1 C 52. 2 K 64. 3 AP 76. 4 AP 88. 5 C
41. 1 C 53. 2 K 65. 3 AP 77. 4 AP 89. 5 C
42. 1 K 54. 2 C 66. 3 AP 78. 4 C 90. 5 K
Brief Exercises
91. 1 AP 93. 2 AP 95. 4 AP 97. 5 AP
92. 1 AP 94. 2 AP 96. 4 AP
Exercises
98. 1 K 101. 2 AP 104. 2 AP 107. 3 AP 110. 4 AP
99. 1 AP 102. 2 AP 105. 3 AP 108. 4 AP 111. 5 AP
100. 2 AP 103. 2 AP 106. 3 AP 109. 4 AP 112. 5 AP
Completion Statements
113. 1 K 116. 1 K 119. 2 K 122. 4 K
114. 1 K 117. 2 K 120. 2 K 123. 4 K
115. 1 K 118. 2 K 121. 3 K 124. 5 K
Essays
125. 1 K 126. 2 K 127. 3 K 128. 5 K
7-2 Test Bank for Managerial Accounting, Third Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Ite Typ Ite Typ Ite Typ Ite Typ Ite Typ Ite Typ Ite Typ
m e m e m e m e m e m e m e
Study Objective 1
1. TF 6. TF 34. MC 39. MC 91. BE 114. C
2. TF 7. TF 35. MC 40. MC 92. BE 115. C
3. TF 31. MC 36. MC 41. MC 98. Ex 116. C
4. TF 32. MC 37. MC 42. MC 99. Ex 125. Es
5. TF 33. MC 38. MC 43. MC 113. C
Study Objective 2
8. TF 44. MC 49. MC 54. MC 100. Ex 117. C
9. TF 45. MC 50. MC 55. MC 101. Ex 118. C
10. TF 46. MC 51. MC 56. MC 102. Ex 119. C
11. TF 47. MC 52. MC 93. BE 103. Ex 120. C
12. TF 48. MC 53. MC 94. BE 104. Ex 126. Es
Study Objective 3
13. TF 18. TF 60. MC 65. MC 106. Ex
14. TF 19. TF 61. MC 66. MC 107. Ex
15. TF 57. MC 62. MC 67. MC 121. C
16. TF 58. MC 63. MC 68. MC 127. Es
17. TF 59. MC 64. MC 105. Ex
Study Objective 4
20. TF 25. TF 72. MC 77. MC 82. MC 110. Ex
21. TF 26. TF 73. MC 78. MC 95. BE 122. C
22. TF 69. MC 74. MC 79. MC 96. BE 123. C
23. TF 70. MC 75. MC 80. MC 108. Ex
24. TF 71. MC 76. MC 81. MC 109. Ex
Study Objective 5
27. TF 84. MC 89. MC 124. C
28. TF 85. MC 90. MC 128. Es
29. TF 86. MC 97. BE
30. TF 87. MC 111. Ex
83. MC 88. MC 112. Ex
Note: TF = True-False Ex = Exercise
MC = Multiple Choice C = Completion
BE = Brief Exercise Es = Essay
 Variable Costing: A Decision-Making Perspective
7-3

CHAPTER STUDY OBJECTIVES

1. Explain the difference between absorption costing and variable costing.

2. Discuss the effect that changes in production level and sales level have on
net income measured under absorption costing versus variable costing.

3. Discuss the relative merits of absorption costing versus variable costing for
management decision making.

4. Explain the term sales mix and its effects on breakeven sales.

5. Understand how operating leverage affects profitability.

7-4 Test Bank for Managerial Accounting, Third Edition

TRUE-FALSE STATEMENTS
T1. Full costing is equivalent to absorption costing.

T2. In full or absorption costing, all manufacturing costs are charged to the product.

F3. Variable costing is the approach used for external reporting under generally
accepted accounting principles.

T4. Fixed manufacturing costs are not charged to the product under variable costing.

T5. The difference between absorption costing and variable costing is the treatment
of fixed manufacturing overhead.

F6. Fixed manufacturing overhead is a period cost under absorption costing.

T7. Selling and administrative costs are period costs under both absorption and
variable costing.

F8. Manufacturing cost per unit will be higher under variable costing than under
absorption costing.

*F9. Some fixed manufacturing costs of the current period are deferred to future
periods through ending inventory under variable costing.

T10. When units produced exceed units sold, income under absorption costing is
higher than income under variable costing.

F11. When units sold exceed units produced, income under absorption costing is
higher than income under variable costing.

T12. GAAP requires that absorption costing be used for the costing of inventory for
external reporting purposes.

F13. Net income under GAAP highlights differences between variable and fixed costs.

T14. When absorption costing is used for external reporting, variable costing can still
be used for internal reporting purposes.

*T15. When absorption costing is used, management may be tempted to overproduce

in a given period in order to increase net income.

*T16. Net income under variable costing is unaffected by changes in production levels.

F17. The use of absorption costing facilitates cost-volume-profit analysis.

T18. Net income under variable costing is closely tied to changes in sales levels.

*F19. Companies that use just-in-time processing techniques will have significant
differences between absorption and variable costing net income.
 Variable Costing: A Decision-Making Perspective
7-5

F20. Sales mix is a measure of the percentage increase in sales from period to period.

F21. Sales mix is not important to managers when different products have
substantially different contribution margins.

T22. The weighted–average contribution margin of all the products is computed when
determining the breakeven sales for a multi-product firm.

T23. If Conan Corporation sells two products with a sales mix of 75%-25%, and the
respective contribution margins are $100 and $300, then weighted-average unit
contribution margin is $150.

T24. If fixed costs are $100,000 and weighted-average unit contribution margin is $50,
then the breakeven point in units is 2,000 units.

T25. Net income can be increased or decreased by changing the sales mix.

F26. The breakeven point in dollars is variable costs divided by the weighted-average
contribution margin ratio.

T27. Cost structure refers to the relative proportion of fixed versus variable costs that
a company incurs.

*F28. Operating leverage refers to the extent to which a company’s net income reacts
to a given change in fixed costs.

T29. The degree of operating leverage provides a measure of a company’s earnings

volatility.

T30. If O’Brien Company has a margin of safety ratio of .60, it could sustain a 60
percent decline in sales before it would be operating at a loss.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. T 7. T 13. F 19. F 25. T
2. T 8. F 14. T 20. F 26. F
3. F 9. F 15. T 21. F 27. T
4. T 10. T 16. T 22. T 28. F
5. T 11. F 17. F 23. T 29. T
6. F 12. T 18. T 24. T 30. T
7-6 Test Bank for Managerial Accounting, Third Edition

MULTIPLE CHOICE QUESTIONS

31. Which cost is not charged to the product under variable costing?
a. direct materials.
b. direct labor.
c. variable manufacturing overhead.
d. fixed manufacturing overhead.

32. Which cost is not charged to the product under absorption costing?
a. direct materials.
b. direct labor.
c. variable manufacturing overhead.
d. fixed administrative expenses.

33. Which cost is charged to the product under variable costing?

a. variable manufacturing overhead.
b. fixed manufacturing overhead.
c. variable administrative expenses.
d. fixed administrative expenses.

34. Variable costing

a. is used for external reporting purposes.
b. is required under GAAP.
c. treats fixed manufacturing overhead as a period cost.
d. is also known as full costing.

Use the following information for items 35 – 39

Orbach Company sells its product for $40 per unit. During 2005, it produced
60,000 units and sold 50,000 units (there was no beginning inventory). Costs per
unit are: direct materials $10, direct labor $6, and variable overhead $2. Fixed
costs are: $480,000 manufacturing overhead, and $60,000 selling and
administrative expenses.

35. The per unit manufacturing cost under absorption costing is:
a. $16.
b. $18.
c. $26.
d. $27.

36. The per unit manufacturing cost under variable costing is:
a. $16.
b. $18.
c. $26.
d. $27.
 Variable Costing: A Decision-Making Perspective
7-7

37. Cost of goods sold under absorption costing is:

a. $ 900,000.
b. $1,080,000.
c. $1,300,000.
d. $1,560,000.

38. Ending inventory under variable costing is:

a. $ 180,000.
b. $ 260,000.
c. $ 400,000.
d. $ 900,000.

39. Under absorption costing, what amount of fixed overhead is deferred to a future
period?
a. $ 20,000.
b. $ 80,000.
c. $ 100,000.
d. $ 480,000.

40. Net income under absorption costing is gross profit less:

a. cost of goods sold.
b. fixed manufacturing overhead and fixed selling and administrative expenses.
c. fixed manufacturing overhead and variable manufacturing overhead.
d. variable selling and administrative expenses and fixed selling and
administrative expenses.

41. Net income under variable costing is contribution margin less:

a. cost of goods sold.
b. fixed manufacturing overhead and fixed selling and administrative expenses.
c. fixed manufacturing overhead and variable manufacturing overhead.
d. variable selling and administrative expenses and fixed selling and
administrative expenses.

42. The primary difference between variable costing and absorption costing is the
treatment of:
a. direct materials.
b. direct labor.
c. variable manufacturing overhead.
d. fixed manufacturing overhead.

43. Net income under absorption costing is higher than net income under variable
costing when:
a. units produced exceed units sold.
b. units produced equal units sold.
c. units produced are less than units sold.
d. regardless of the relationship between units produced and units sold.
7-8 Test Bank for Managerial Accounting, Third Edition

Use the following information for items 44 – 48.

Green Company sells its product for $11,000 per unit. Variable costs per unit are:
manufacturing, $6,000; and selling and administrative, $125. Fixed costs are:
$30,000 manufacturing overhead, and $40,000 selling and administrative. There
was no beginning inventory at 1/1/05. Production was 20 units per year in 2005 –
2007. Sales was 20 units in 2005, 16 units in 2006, and 24 units in 2007.

44. Income under absorption costing for 2006 is

a. $ 8,000.
b. $14,000
c. $16,000
d. $22,000.

45. Income under absorption costing for 2007 is

a. $33,000.
b. $39,000
c. $41,000
d. $47,000.

46. Income under variable costing for 2006 is

a. $ 8,000.
b. $14,000
c. $16,000
d. $22,000.

47. Income under variable costing for 2007 is

a. $33,000.
b. $39,000
c. $41,000
d. $47,000.

48. For the three years 2005-7,

a. absorption costing income exceeds variable costing income by $6,000.
b. absorption costing income equals variable costing income.
c. variable costing income exceeds absorption costing income by $6,000.
d. absorption costing income may be greater than, equal to, or less than
variable costing income depending on the situation.

49. If sales equals production in the long run,

a. absorption costing income will exceed variable costing income.
b. absorption costing income will equal variable costing income.
c. variable costing income will exceed absorption costing income.
d. absorption costing income may be greater than, equal to, or less than
variable costing income depending on the situation.
 Variable Costing: A Decision-Making Perspective
7-9

50. When production exceeds sales,

a. some fixed manufacturing overhead costs are deferred until a future period
under absorption costing.
b. some fixed manufacturing overhead costs are deferred until a future period
under variable costing
c. variable and fixed manufacturing overhead costs are deferred until a future
period under absorption costing.
b. variable and fixed manufacturing overhead costs are deferred until a future
period under variable costing.

51. When production exceeds sales,

a. Ending inventory under variable costing will exceed ending inventory under
absorption costing
b. Ending inventory under absorption costing will exceed ending inventory under
variable costing.
c. Ending inventory under absorption costing will be equal to ending inventory
under variable costing.
d. Ending inventory under absorption costing may either exceed, be equal to, or
be less than ending inventory under variable costing.

52. In income statements prepared under absorption costing and variable costing,
where would you find the terms contribution margin and gross profit?
Contribution margin Gross profit
a. In absorption costing income statement In variable costing income
statement
b. In absorption costing income statement In both income statements
c. In variable costing income statement In absorption costing income
statement
d. In both income statements In variable costing income
statement

53. Contribution margin is sales less

a. fixed manufacturing overhead and fixed selling and administrative expenses.
b. variable cost of goods sold and variable selling and administrative expenses.
c. variable selling and administrative expenses and fixed selling and
administrative
expenses.
d. variable cost of goods sold.

54. The computation of absorption costing gross profit always involves subtracting:
a. all current-year fixed manufacturing overhead.
b. some, but not all, current-year fixed manufacturing overhead.
c. all fixed manufacturing overhead applied to units sold in the current year.
d. no fixed manufacturing overhead.
7-10 Test Bank for Managerial Accounting, Third Edition

55. When units produced exceeds units sold,

a. net income under absorption costing is higher than net income under variable
costing.
b. net income under absorption costing is lower than net income under variable
costing.
c. net income under absorption costing equals net income under variable
costing.
d. the relationship between net income under absorption costing and net income
under variable costing cannot be predicted.

56. When units sold exceeds units produced,

a. net income under absorption costing is higher than net income under variable
costing.
b. net income under absorption costing is lower than net income under variable
costing.
c. net income under absorption costing equals net income under variable
costing.
d. the relationship between net income under absorption costing and net income
under variable costing cannot be predicted.

57. Absorption costing

a. is required under GAAP.
b. is required for external reporting purposes.
c. allows income to be manipulated through production decisions.
d. is (does) all of the above (a, b, and c).

58. Absorption costing

a. is required under GAAP.
b. is not allowed for external reporting purposes.
c. does not allow income to be manipulated through production decisions.
d. highlights differences between variable and fixed costs.

59. Variable costing

a. is required under GAAP.
b. is required for external reporting purposes.
c. allows income to be manipulated through production decisions.
d. highlights differences between variable and fixed costs.

60. Absorption costing

a. is not allowed under GAAP.
b. is not allowed for external reporting purposes.
c. may lead to poor business decisions
d. highlights differences between variable and fixed costs.

61. Management may be tempted to overproduce

a. when using variable costing, in order to increase net income.
b. when using variable costing, in order to decrease net income.
c. when using absorption costing, in order to increase net income.
d. when using absorption costing, in order to decrease net income.
 Variable Costing: A Decision-Making Perspective
7-11

62. If a division manager’s compensation is based upon the division’s net income,
the manager may decide to meet the net income targets by increasing production
a. when using variable costing, in order to increase net income.
b. when using variable costing, in order to decrease net income.
c. when using absorption costing, in order to increase net income.
d. when using absorption costing, in order to decrease net income.

Use the following information for items 63 – 66:

The Colin Division of Mochrie Company sells its product for $30 per unit.
Variable costs per unit are: manufacturing, $12; and selling andadministrative,
$2. Fixed costs are: $200,000 manufacturing overhead, and $50,000 selling and
administrative. There was no beginning inventory at 1/1/05. Expected sales for
next year is 40,000 units. Ryan Stiles, the manager of the Colin Division, is under
pressure to improve the performance of the Division. As he plans for next year,
he has to decide whether to produce 40,000 units or 50,000 units.

63. What would the manufacturing cost per unit be under absorption costing for each
alternative?
40,000 units 50,000 units
a. $12.00 $12.00
b. $14.00 $14.00
c. $16.00 $17.00
d. $17.00 $16.00

64. What would the manufacturing cost per unit be under variable costing for each
alternative?
40,000 units 50,000 units
a. $12.00 $12.00
b. $14.00 $14.00
c. $16.00 $17.00
d. $17.00 $16.00

65. What would the net income be under absorption costing for each alternative?
40,000 units 50,000 units
a. $390,000 $390,000
b. $390,000 $430,000
c. $390,000 $440,000
d. $430,000 $390,000
.
66. What would the net income be under variable costing for each alternative?
40,000 units 50,000 units
a. $390,000 $390,000
b. $390,000 $430,000
c. $390,000 $440,000
d. $430,000 $390,000
7-12 Test Bank for Managerial Accounting, Third Edition

67. Expected sales for next year for the Brady Division is 120,000 units. Drew Carey,
the manager of the Brady Division, is under pressure to improve the performance
of the Division. As he plans for next year, he has to decide whether to produce
120,000 units or 140,000 units. The Brady Division will have higher net income, if
Drew Carey decides to
a. produce 140,000 units if income is measured under absorption costing.
b. produce 140,000 units if income is measured under variable costing.
c. produce 120,000 units if income is measured under absorption costing.
d. produce 120,000 units if income is measured under variable costing.

68. Which of the following is not a potential advantage of variable costing relative to
aborption costing?
a. Net income computed under variable costing is unaffected by changes in
production levels.
b. It is easier to understand the impact of fixed and variable costs on the
computation of net income when variable costing is used.
c. The use of variable costing is consistent with cost-volume-profit analysis.
d. Net income computed under variable costing is not closely tied to changes in
sales levels.

69. Which is not true concerning sales mix?

a. Sales mix is the relative percentage in which each product is sold when a
company sells more than one product.
b. Sales mix is important to managers because different products often have
substantially different contribution margins.
c. Sales mix does not affect breakeven analysis.
d. The computation of weighted-average unit contribution margin is useful in
sales mix analysis.

Use the following information for items 70 – 73:

Brad Sherwood Corporation sells two types of computers; one is designed more
for audio applications and the other for video applications. Sherwood incurs
$224,000 in fixed costs.
Per unit data on the two products is presented blow:
Unit data Audio computer Video computer
Selling price $2,000 $3,200
Variable costs 1,200 1,600
Contribution margin $ 800 $1,600
Sales mix 60% 40%

70. The weighted-average contribution margin is:

a. $1,120
b. $1,200
c. $1,400
d. $2,600
 Variable Costing: A Decision-Making Perspective
7-13

71. The breakeven point in units is:

a. 140
b. 187
c. 200
d. 280

72. How many audio computers will be sold at the breakeven point?
a. 80
b. 116
c. 120
d. 200

73. What will be the total contribution margin at the breakeven point?
a. $96,000.
b. $160,000
c. $224,000.
d. $496,000.

74. In a sales mix situation, at any level of units sold, net income will be higher if
a. more higher contribution margin units are sold than lower contribution margin
units.
b. more lower contribution margin units are sold than higher contribution margin
units
c. more fixed expenses are incurred.
d. weighted-average unit contribution margin decreases.

75. Estes Company sells two types of computer chips. The sales mix is 30% (Chip A)
and 70% (Chip B). Chip A has variable costs per unit of $20 and a selling price of
$40. Chip B has variable costs per unit of $25 and a selling price of $55. The
weighted-average unit contribution margin for Estes is
a. $23.00.
b. $25.00.
c. $27.00.
d. $50.50.

76. Proops Company has a weighted-average unit contribution margin of $30 for its
two products, Drew and Carey. Expected sales for Proops are 40,000 Drews
and60,000 Careys. Fixed expenses are $1,800,000. How many Drews would
Proops sell at the breakeven point?
a. 24,000.
b. 36,000.
c. 40,000.
d. 60,000.
7-14 Test Bank for Managerial Accounting, Third Edition

77. Refer to the information in 76 above. At the expected sales level, Proops’ net
income will be:
a. $(300,000)
b. $ - 0 -.
c. $1,200,000.
d. $3,000,000.

78. T’pol Corporation is considering a plan that will increase total units sold. The plan
will cause a shift from high- to low-margin sales. The plan will
a. definitely increase net income.
b. definitely decrease net income.
c. not change net income.
d. either increase, decrease or not affect net income; more information is
needed.

Use the following information for items 79 – 82:

Ed Green Corporation has two divisions; Outdoor Sports and Indoor Sports. The
sales mix is 60% for Outdoor Sports and 40% for Indoor Sports. Green incurs
$2,420,000 in fixed costs. The contribution margin ratio for the Outdoor Sports
Division is 40%, while for the Indoor Sports Division it is 50%.

79. The weighted-average contribution margin ratio is:

a. 44%.
b. 45%.
c. 46%.
d. 50%.

80. The breakeven point in dollars is:

a. $985,600.
b. $4,869,565.
c. $4,977,777.
d. $5,500,000.

81. What will sales be for the Outdoor Sports Division at the breakeven point?
a. $2,200,000.
b. $2,750,000.
c. $2,921,739.
d. $3,300,000.

82. What will be the total contribution margin at the breakeven point?
a. $ 960,000.
b. $1,600,000
c. $2,420,000.
d. $4,960,000.
 Variable Costing: A Decision-Making Perspective
7-15

83. Cost structure refers to the relative proportion of

a. selling expenses versus administrative expenses.
b. selling and administrative expenses versus cost of goods sold.
c. gross margin versus sales.
d. fixed costs versus variable costs.

Use the following information for items 84 – 87:

Old American Company has sales of $500,000, variable costs of $425,000, and
fixed costs of $25,000. New World Company has sales of $500,000, variable
costs of $200,000, and fixed costs of $250,000.

84. Old American’s contribution margin ratio is:

a. 15%
b. 60%
c. 85%
d. 95%

85. New World’s degree of operating leverage is:

a. .85.
b. 1.50.
c. 6.00.
d. 6.67.

86. Old American’s breakeven point in dollars is:

a. $166,667.
b. $400,000.
c. $450,000.
d. $466,667.

87. New World’s margin of safety ratio is:

a. .17
b. .33
c. .67
d. .83

88. Which of the following statements is not true?

a. Operating leverage refers to the extent to which a company’s net income
reacts to a given change in sales.
b. Companies that have higher fixed costs relative to variable costs have higher
operating leverage.
c. When a company’s sales revenue is increasing, high operating leverage is a
good thing because it means that profits will increase rapidly.
d. When a company’s sales revenue is decreasing, high operating leverage is a
good thing because it means that profits will decrease at a slower pace than
revenues decrease.
7-16 Test Bank for Managerial Accounting, Third Edition

89. Manuel Company’s degree of operating leverage is 2.0. Techno Corporation’s

degree of operating leverage is 6.0. Techno’s earnings would go up (or down) by
________ as much as Manual’s with an equal increase (or decrease) in sales.
a. 1/3
b. 2 times
c. 3 times
d. 6 times

90. The margin of safety ratio

a. is computed as actual sales divided by breakeven sales.
b. indicates what percent decline in sales could be sustained before the
company would operate at a loss.
c. measures the ratio of fixed costs to variable costs.
d. is used to determine the breakeven point.

Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
31. d 45. c 59. d 73. c 87. a
32. d 46. a 60. c 74. a 88. d
33. a 47. d 61. c 75. c 89. c
34. c 48. b 62. c 76. a 90. b
35. c 49. b 63. d 77. c
36. b 50. a 64. a 78. d
37. c 51. b 65. b 79. a
38. a 52. c 66. a 80. d
39. b 53. b 67. a 81. d
40. d 54. c 68. d 82. c
41. b 55. a 69. c 83. d
42. d 56. b 70. a 84. a
43. a 57. d 71. c 85. c
44. b 58. a 72. c 86. a
 Variable Costing: A Decision-Making Perspective
7-17

BRIEF EXERCISES
BE 91
Huskie Company produces footballs. It incurred the following costs this year:

Direct materials $20,000

Direct labor 31,000
Fixed manufacturing overhead 22,000
Variable manufacturing overhead 38,000
Fixed selling and administrative expenses 23,000
Variable selling and administrative expenses 14,000

What are the total product costs for the company under variable costing?

Solution 91 (3–5 min.)

Direct materials $20,000
Direct labor 31,000
Variable manufacturing overhead 38,000
Total product costs under variable costing $89,000

BE 92
Huskie Company produces footballs. It incurred the following costs this year:

Direct materials $20,000

Direct labor 31,000
Fixed manufacturing overhead 22,000
Variable manufacturing overhead 38,000
Fixed selling and administrative expenses 23,000
Variable selling and administrative expenses 14,000

What are the total product costs for the company under absorption costing?

Solution 92 (3–5 min.)

Direct materials $20,000
Direct labor 31,000
Fixed manufacturing overhead 22,000
Variable manufacturing overhead 38,000
Total product costs under variable costing $111,000

BE 93
During 2005 Nowak Corporation produced 60,000 units and sold 50,000 for $10 per unit.
Variable manufacturing costs were $4 per unit. Annual fixed manufacturing overhead
was $120,000 ($2 per unit). Variable selling andadministrative costs were $1 per unit
sold, and fixed selling and administrative costs were $30,000. Prepare a variable costing
income statement.
7-18 Test Bank for Managerial Accounting, Third Edition

Solution 93 (5–7 min.)

Sales (50,000 X $10) $500,000
Variable cost of goods sold (50,000 X $4) $200,000
Variable selling and administrative expense (50,000 X $1) 50,000 250,000
Contribution margin 250,000
Fixed manufacturing overhead 120,000
Fixed selling and administrative expense 30,000 150,000
Net income $100,000

BE 94
During 2005 Nowak Corporation produced 60,000 units and sold 50,000 for $10 per unit.
Variable manufacturing costs were $4 per unit. Annual fixed manufacturing overhead
was $120,000 ($2 per unit). Variable selling and administrative costs were $1 per unit
sold, and fixed selling and administrative costs were $30,000. Prepare an absorption
costing income statement.

Solution 94 (5–7 min.)

Sales (50,000 X $10) $500,000
Cost of goods sold (50,000 X $6) 300,000
Gross margin 200,000
Variable selling and administrative expense (50,000 X $1) 50,000
Fixed selling and administrative expense 30,000 80,000
Net income $120,000

BE 95
Haldi Corporation sells three different sets of sportswear. Sleek sells for $30 and has
variable costs of $18; Smooth sells for $50 and has variable costs of $28; Potent sells
for $90 and has variable costs of $45. The sales mix of the three sets is: Sleek, 50%;
Smooth, 30%, and Potent, 20%. What is the weighted-average unit contribution margin?

Solution 95 (6–8 min.)

Sleek: 50% X ($30 - $18) = $6.00
Smooth 30% X ($50 - $28) = 6.60
Potent 20% X ($90 - $45) = 9.00
Weighted-average unit contribution margin $21.60

BE 96
Garrett Corporation sells two product lines. The sales mix of the product lines is:
Standard, 70%; and Deluxe, 30%. The contribution margin ratio of each line is:
Standard, 35%; and Deluxe, 45%. Garrett’s fixed costs are $2,280,000. What is the
dollar amount of Deluxe sales at the breakeven point?
 Variable Costing: A Decision-Making Perspective
7-19

Solution 96 (6–8 min.)

Standard: 70% X 35% = 24.5%
Deluxe 30% X 45% = 13.5%
Weighted-average contribution margin ratio 38.0%

$2,280,000 / 38% = $6,000,000 breakeven point in dollars.

Dollar amount of Deluxe sales at the breakeven point: $6,000,000 X 30% = $1,800,000.

BE 97
Sheldon Corporation is considering buying new equipment for its factory. The new
equipment will reduce variable labor costs, but increase depreciation expense.
Contribution margin is expected to increase from $200,000 to $300,000. Net income is
expected to remain the same $100,000. Compute the degree of operating leverage
before and after the purchase of the new equipment and interpret your results.

Solution 97 (4–6 min.)

Contribution margin / Net income = Degree of operating leverage
Before: $200,000 / $100,000 = 2
After: $300,000 / $100,000 = 3

After the new equipment is purchased, Sheldon’s earnings would go up (or down) by 1.5
times
(3/2) as much as it would have before the purchase, with an equal increase (or
decrease) in sales.
7-20 Test Bank for Managerial Accounting, Third Edition

EXERCISES
Ex. 98
Determine whether each of the following would bea product cost or a period cost under
an absorption or a variable system for Carson Company

Absorption Variable
Product Period Product Period

a. Direct Materials ___________ _________ ______ _______

b. Direct Labor ___________ __________ ______ _______

c. Factory Utilities (variable) ___________ __________ ______ ________

d. Factory Rent ___________ __________ ______ ________

e. Indirect Labor ___________ __________ ______ ________

f. Factory Supervisory Salaries ___________ __________ _______ _______

g. Factory Maintenance (variable) ___________ __________ ______ _______

h. Factory Depreciation ___________ __________ ______ _______

i. Sales salaries ___________ __________ ______ _______

j. Sales commissions ___________ __________ _______ _______

Solution 98 (10–15 min.)

Absorption Variable
Product Period Product Period
a. Direct Materials _____X_____ __________ _____X____ _________
b. Direct Labor _____X_____ __________ _____X____ _________
c. Factory Utilities (variable) _____X_____ __________ _____X____ _________
d. Factory Rent _____X_____ __________ __________ _____X___
e. Indirect Labor _____X_____ __________ _____X____ _________
f. Factory Supervisory Salaries _____X_____ __________ __________ _____X___
g. Factory Maintenance (variable) _____X_____ __________ _____X____ _________
h. Factory Depreciation _____X_____ __________ __________ _____X___
i. Sales salaries ___________ _____X____ __________ _____X___
j. Sales commissions ___________ _____X____ __________ _____X___
 Variable Costing: A Decision-Making Perspective
7-21

Ex. 99
Fresh Air Products manufactures and sells a variety of camping products. Recently the
company opened a new plant to manufacture a deluxe portable cooking unit. Cost and
sales data for the first month of operations are shown below:

Manufacturing Costs
Fixed overhead $ 108,000
Variable overhead $ 3 per unit
Direct labor $ 12 per unit
Direct material $ 30 per unit

Beginning inventory 0 units

Units produced 12,000
Units sold 10,000

Selling and administrative costs

Fixed $ 200,000
Variable $ 4 per unit
sold

The portable cooking unit sells for $110. Management is interested in the opening
month’s results and has asked for an income statement.
Instructions
Assume the company uses absorption costing. Calculate the production cost per unit,
and prepare an income statement for the month of June 2005.

Solution 99 (8–12 min.)

Per Unit
Direct materials $30
Direct labor 12
Variable overhead 3
Fixed overhead ($108,000 ÷ 12,000) 9
Total cost $54

Fresh Air Products

Income Statement (Absorption Costing)
For the Month Ending June 30, 2005

Sales (10,000 x $110) $1,100,000

Less: Cost of goods sold (10,000 x $54) 540,000
Gross profit 560,000
Less: Selling & administrative costs
Variable (10,000 x $4) $ 40,000
Fixed 200,000 240,000
Net income $ 320,000
 7-22 Test Bank for Managerial Accounting, Third Edition

Ex. 100
Fresh Air Products manufactures and sells a variety of camping products. Recently the
company opened a new plant to manufacture a deluxe portable cooking unit. Cost and
sales data for the first month of operations are shown below:

Manufacturing Costs
Fixed overhead $ 108,000
Variable overhead $ 3 per unit
Direct labor $ 12 per unit
Direct material $ 30 per unit

Beginning inventory 0 units

Units produced 12,000
Units sold 10,000

Selling and administrative costs

Fixed $ 200,000
Variable $ 4 per unit sold

The portable cooking unit sells for $110. Management is interested in the opening
month’s results and has asked for an income statement.
Instructions
Assume the company uses variable costing.
a. Calculate the production cost per unit, and prepare an income statement for the
month of June 2005.
b. Explain the amount by which absorption costing income would differ from variable
costing income. (Compute difference without computing absorption costing income)

Solution 100 (9–13 min.)

a.
Per Unit
Direct materials $30
Direct labor 12
Variable overhead 3
Total cost $45

Fresh Air Products

Income Statement (Variable Costing)
For the Month Ending June 30, 2005

Sales (10,000 x $110) $1,100,000

Less: Variable costs
Variable cost of goods sold (10,000 x $45) $450,000
Variable selling & administrative costs
(10,000 x $4) 40,000 490,000
 Variable Costing: A Decision-Making Perspective
7-23

Contribution margin 610,000

Less: Fixed costs
Fixed overhead 108,000
Fixed selling & administrative costs 200,000 308,000
Net income $ 302,000

b. When production exceeds sales, absorption costing net income will exceed variable
costing net income by an amount equal to the fixed overhead rate times the number of
units in ending inventory. The ending inventory for June was 2,000 units and the fixed
overhead rate was $9 per unit ($108,000 ÷ 12,000). Therefore, absorption costing income
would exceed variable costing income by $18,000 (9,000 X $2).

Ex. 101
Momentum Bikes manufactures a basic road bicycle. Production and sales data for the
most recent year are as follows (no beginning inventory):

Variable production costs $90 per bike

Fixed production costs $450,000
Variable selling & administrative costs $22 per bike
Fixed selling & administrative costs $500,000
Selling price $200 per bike
Production 20,000 bikes
Sales 17,000 bikes

Instructions
(a) Prepare a brief income statement using absorption costing.
(b) Compute the amount to be reported for inventory in the year end absorption costing
balance sheet.

Solution 101 (8 - 12 min.)

(a) Sales (17,000 x $200) $3,400,000
Less: Cost of goods sold (17,000 x $112.50*) 1,912,500
Gross profit 1,487,500
Less: selling & administrative costs
[(17,000 x $22) + $500,000] 874,000
Net income $ 613,500

*Variable production costs $ 90.00 per bike

Fixed production costs ($450,000 ÷ 20,000) 22.50 per bike
Total cost of goods sold per unit $112.50 per bike

(b) (20,000 – 17,000) X $112.50 = $337,500

7-24 Test Bank for Managerial Accounting, Third Edition

Ex. 102
Momentum Bikes manufactures a basic road bicycle. Production and sales data for the
most recent year are as follows (no beginning inventory):

Variable production costs $90 per bike

Fixed production costs $450,000
Variable selling & administrative costs $22 per bike
Fixed selling & administrative costs $500,000
Selling price $200 per bike
Production 20,000 bikes
Sales 17,000 bikes

Instructions
(a) Prepare a brief income statement using variable costing.
(b) Compute the amount to be reported for inventory in the year end variable costing
balance sheet.

Solution 102 (8 - 12 min.)

(a) Sales (17,000 x $200) $3,400,000
Less: Variable costs
Variable cost of goods sold (17,000 x $90) $1,530,000
Variable selling & admin. costs (17,000 x $22) 374,000 1,904,000
Contribution margin 1,496,000
Less: Fixed costs
Fixed production costs 450,000
Fixed selling & administrative costs 500,000 950,000
Net income $ 546,000

(b) (20,000 – 17,000) X $90. = $270,000

Ex. 103
Conan Company produces sporting equipment. In 2005, the first year of operations,
Conan produced 25,000 units and sold 18,000 units. In 2006, the production and sales
results were exactly reversed. In each year, selling price was $100, variable
manufacturing costs were $40 per unit, variable selling expenses were $8 per unit, fixed
manufacturing costs were $540,000, and fixed administrative expenses were $200,000.

Instructions

(a) Compute net income under variable costing for each year.
(b) Compute net income under absorption costing for each year.
(c) Reconcile the differences each year in income from operations under the two costing
approaches.
 Variable Costing: A Decision-Making Perspective
7-25

Solution 103 (20–25 min.)

(a) 2005: [18,000 X ($100 – $40 – $8)] – ($540,000 + $200,000) = $196,000

2006: [25,000 X ($100 – $40 – $8)] – ($540,000 + $200,000) = $560,000

(b) 2005: [18,000 X ($100 – $40 – $21.60)] – [$200,000 + (18,000 X $8) = $347,200
2006: {(25,000 X $100) – [7,000 X ($40 + $21.60)] – [18,000 X ($40 + $30)]} –
[$200,000 +
(25,000 X $8)] = $408,800

(c) The variable costing and the absorption costing income can be reconciled as follows:

2005 variable costing income $196,000

Fixed manufacturing costs deferred at 12/31/05
under absorption costing (7,000 X $21.60) 151,200
2005 absorption costing income $347,200

2006 variable costing income $560,000

2005 fixed manufacturing costs expensed in 2006
under absorption costing (7,000 X $21.60) (151,200)
2005 absorption costing income $ 408,800

Ex. 104
Conan Company produces sporting equipment. In 2005, the first year of operations,
Conan produced 25,000 units and sold 18,000 units. In 2006, the production and sales
results were exactly reversed. In each year, selling price was $100, variable
manufacturing costs were $40 per unit, variable selling expenses were $8 per unit, fixed
manufacturing costs were $540,000, and fixed administrative expenses were $200,000.

Instructions

(a) Prepare an income statement for 2005 using variable costing

(b) Prepare an income statement for 2005 using absorption costing.
(c) Reconcile the differences each year in income from operations under the two costing
approaches.

Solution 104 (15–20 min.)

(a)
Conan Company
Income Statement (Variable Costing)
2005

Sales (18,000 x $100) $1,800,000

Less: Variable costs
Variable cost of goods sold (18,000 x $40) $720,000
Variable selling & administrative costs
(18,000 x $8) 144,000 864,000
Contribution margin 936,000
 7-26 Test Bank for Managerial Accounting, Third Edition

Less: Fixed costs

Fixed manufacturing costs 540,000
Fixed selling & administrative costs 200,000 740,000
Net income $ 196,000

Conan Company
Income Statement (Absorption Costing)
2005

Sales (18,000 x $100) $1,800,000

Less: Cost of goods sold (18,000 x $61.60) 1,108,800
Gross profit 691,200
Less: Selling & administrative costs
Variable (18,000 x $8) $ 144,000
Fixed 200,000 344,000
Net income $ 347,200

(c) The variable costing and the absorption costing income can be reconciled as follows:

2005 variable costing income $196,000

Fixed manufacturing costs deferred at 12/31/05
under absorption costing (7,000 X $21.60) 151,200
2005 absorption costing income $347,200

Ex. 105
McCartney Pumps is a division of UK Controls Corporation. The division manufactures
and sells a pump used in a wide variety of applications. During the coming year it
expects to sell 30,000 units for $10 per unit. George Harrison manages the division. He
is considering producing either 30,000 or 50,000 units during the period. Other
information is presented in the schedule.

Division information - 2005

Beginning inventory 0
Expected sales in units 30,000
Selling price per unit $ 15.00
Variable manufacturing cost per unit $ 7.00
Fixed manufacturing overhead cost (total) $150,000
Fixed manufacturing overhead costs per unit
Based on 30,000 units $ 5.00 per unit ($150,000 ÷ 30,000)
Based on 50,000 units $ 3.00 per unit ($150,000 ÷ 50,000)
Manufacturing cost per unit
Based on 30,000 units $ 12.00 per unit ($7 variable + $5
fixed)
Based on 50,000 units $ 10.00 per unit ($7 variable + $3
fixed)
Selling and administrative expense (all fixed) $25,000
 Variable Costing: A Decision-Making Perspective
7-27

Instructions

(a) Prepare an absorption costing income statement with one column showing the
results if 30,000 units are produced, and one column showing the results if 50,000 units
are produced.
(b) Why is income different for the two production levels, when sales is 30,000 units
either way?

Solution 105 (15 - 20 min.)

(a)
McCartney Pumps Division
Income Statement
For the Year Ended 2005
Absorption Costing
30,000 50,000
Produced Produced
Sales (30,000 units X $15) $ 450,000 $ 450,000
Cost of goods sold 360,000 (30,000 X $12) 300,000 (30,000 X $10)
Gross profit 90,000 150,000
Fixed selling and
administrative expenses 25,000 25,000
Net income $ 65,000 $ 125,000

(b) Net income is $60,000 higher when 50,000 units are produced, because under
absorption costing $60,000 of fixed manufacturing costs (20,000 X $3) are deferred to
the next year.
Ex. 106
McCartney Pumps is a division of UK Controls Corporation. The division manufactures
and sells a pump used in a wide variety of applications. During the coming year it
expects to sell 30,000 units for $10 per unit. George Harrison manages the division. He
is considering producing either 30,000 or 50,000 units during the period. Other
information is presented in the schedule.
Division information - 2005
Beginning inventory 0
Expected sales in units 30,000
Selling price per unit $ 15.00
Variable manufacturing cost per unit $ 7.00
Fixed manufacturing overhead cost (total) $150,000
Fixed manufacturing overhead costs per unit
Based on 30,000 units $ 5.00 per unit ($150,000 ÷ 30,000)
Based on 50,000 units $ 3.00 per unit ($150,000 ÷ 50,000)
Manufacturing cost per unit
Based on 30,000 units $ 12.00 per unit ($7 variable + $5 fixed)
Based on 50,000 units $ 10.00 per unit ($7 variable + $3 fixed)
Selling and administrative expense (all fixed) $25,000
7-28 Test Bank for Managerial Accounting, Third Edition

Instructions

Prepare an variable costing income statement with one column showing the results if
30,000 units are produced, and one column showing the results if 50,000 units are
produced.

Solution 106 (15–20 min.)

McCartney Pumps Division
Income Statement
For the Year Ended 2005
Variable Costing
30,000 50,000
Produced Produced
Sales (30,000 units X $15) $ 450,000 $ 450,000
Variable cost of goods sold (30,000 X $7) 210,000 210,000
Contribution margin 240,000 240,000
Fixed manufacturing overhead 150,000 150,000
Fixed selling and
administrative expenses 25,000 25,000
Net income $ 65,000 $ 65,000

Ex. 107
Spirit Company produced 45,000 units and sold 41,000 during the current year. Under
absorption costing net income was $62,000. Fixed overhead was $225,000. Determine
the net income under variable costing.

Solution 107 (4–6 min.)

When production is greater than sales (as in this case where 45,000 units are produced
but only 41,000 units sold), absorption costing net income is greater than variable
costing net income by an amount equal to the number of units in ending inventory times
the fixed overhead rate per unit.

Fixed overhead rate per unit = $225,000 ÷ 45,000 units = $5 per unit

Variable costing net income = Absorption costing net income – fixed overhead in ending
inventory
$42,000 = $62,000 – ($5 x 4,000)
 Variable Costing: A Decision-Making Perspective
7-29

Ex. 108

Trail King manufactures mountain bikes. Its sales mix and contribution margin
information per unit is shown is follows:
Sales mix Contribution margin
Destroyer 15% $ 120
Voyager 60% $ 60
Rebel 25% $ 40

It has fixed costs of $5,440,000.

Instructions

Compute the number of each type of bike that the company would need to sell in order
to break-even under this product mix.

Solution 108 (8–12 min.)

Sales mix Margin Contribution Margin
Destroyer 15% $120 $ 18
Voyager 60% $ 60 $ 36
Rebel 25% $ 40 $ 10
64

Total break-even sales = $5,440,000 ÷ $64 = 85,000 bikes

Sales mix
Destroyer 15% X 85,000 = 12,750 bikes
Voyager 60% X 85,000 = 51,000 bikes
Rebel 25% X 85,000 = 21,250 bikes

Ex. 109
Account-Able provides primarily two-lines of service: accounting and tax. Accounting-
related services represent 60% of its revenue, and provide a contribution margin ratio of
30%. Tax services provide 40% of its revenue, and provide a 45% contribution margin
ratio. The company’s fixed costs are $8,100,000.

Instructions

(a) Calculate the revenue from each type of service that the company must achieve to
break-
even.
(b) The company has a desired net income of $1,800,000. What amount of revenue
would
Account-Able earn from tax services if they achieve this goal with the current sales
mix?
7-30 Test Bank for Managerial Accounting, Third Edition

.
Solution 109 (10–15 min.)
(a) Contribution Weighted Average
Sales mix Margin Ratio Contribution Margin Ratio
Accounting 60% 30% 18%
Tax 40% 45% 18%
36%

Total break-even sales = $8,100,000 ÷ .36 = $22,500,000

Sales mix
Accounting 60% X $22,500,000 = $13,500,000
Tax 40% X $22,500,000 = $ 9,000,000

(b) Sales to achieve target net income = ($8,100,000 + $1,800,000) ÷ .36 =

$27,500,000

Sales mix
Tax 40% X $27,500,000 = $11,000,000

Ex. 110
Mad City Flash sells computers and video game systems. The business is divided into
two divisions along product lines. Variable costing income statements for the current
year are presented below:

Computers VG Systems Total

Sales $800,000 $200,000 $1,000,000
Variable costs 480,000 140,000 620,000
Contribution margin $320,000 $ 60,000 380,000
Fixed costs 228,000
Net income $ 152,000

Instructions
a. Determine the sales mix, and contribution margin ratio for each division.
b. Calculate the company’s weighted average contribution margin ratio.
c. Calculate the company’s break-even point in dollars.
d. Determine the sales level, in dollars, for each division at the break-even point.

Solution 110 (15–20 min.)

1. Sales mix:
Computers: $800,000 ÷ ($800,000 + $200,000) = 80%
VG Systems: $200,000 ÷ ($800,000 + $200,000) = 20%
Contribution margin ratio:
Computers: $320,000 ÷ $800,000 = 40%
VG Systems: $ 60,000 ÷ $200,000 = 30%

2. Weighted average contribution margin ratio = (80% x .40%) + (20% x 30%) = 38%
 Variable Costing: A Decision-Making Perspective
7-31

3. Break-even point in dollars = $228,000 ÷ .38 = $600,000

4. Sales dollars at break-even point

Computers: $600,000 x .80 = $480,000
VG Systems: $600,000 x .20 = $120,000

Ex. 111
The following variable costing income statements are available for Antique Company
and Contemporary Company.

Antique Company Contemporary Company

Sales revenue $ 700,000 $700,000
Variable costs 350,000 140,000
Contribution margin 350,000 560,000
Fixed costs 200,000 410,000
Net income $150,000 $150,000

Instructions
(a) Compute the degree of operating leverage for each company.
(b) Assume that sales revenue decreases by 20%. Prepare a variable costing income
statement for each company.

Solution 111 (15–20 min.)

(a)

Contribution ÷ Net = Degree of

Operating
Margin Income Leverage

Antique $350,000 ÷ $150,000 = 2.333

Contemporary $560,000 ÷ $150,000 = 3.733

(b)
Antique Company Contemporary Company
Sales revenue $ 560,000* $560,000*
Variable costs 280,000** 112,000***
Contribution margin 280,000 448,000
Fixed costs 200,000 410,000
Net income $ 80,000 $ 38,000

*$700,000 x .8
** ($350,000 ÷ $700,000) x $560,000
*** ($140,000 ÷ $700,000) x $560,000
7-32 Test Bank for Managerial Accounting, Third Edition

Ex. 112
An investment banker is analyzing two companies that specialize in the production and
sale of gourmet cappuccino and chai mixes. Fireside uses a labor-intensive approach
and Stirring Moments uses a mechanized system. Variable costing income statements
for the two companies are shown below:

Fireside Stirring Moments

Sales $1,000,000 $1,000,000
Variable costs 600,000 250,000
Contribution margin 400,000 750,000
Fixed costs 200,000 550,000
Net income $ 200,000 $200,000

The investment banker is interested in acquiring one of these companies. However, she
is concerned about the impact that each company’s cost structure might have on its
profitability.

Instructions
(a) Calculate each company’s degree of operating leverage.
(b) Determine the affect on each company’s net income if sales decrease by 10% and if
sales increase by 20%. Do not prepare income statements.

Solution 112 (8–10 min.)

(a) Degree of
Operating
Contribution Margin ÷ Net Income = Leverage
Fireside $400,000 ÷ $200,000 = 2.00
St. Moments $750,000 ÷ $200,000 = 3.75

(b) Degree of % Change

Operating in
% Change in Sales x Leverage = Net Income

Fireside (10%) x 2.00 = (20.0%)

St. Moments (10%) x 3.75 = (37.5%)

Fireside 20% x 2.00 = 40.0%

St. Moments 20% x 3.75 = 75.0%
 Variable Costing: A Decision-Making Perspective
7-33

COMPLETION STATEMENTS
113. Under ______________________ all manufacturing costs are charged to, or
absorbed by, the product..

114. Only direct materials, direct labor, and variable manufacturing costs are
considered product costs when using _________________ .

115. Fixed manufacturing costs are treated as period costs under

__________________.

116. The use of absorption costing is required by __________________ for

__________________ financial reports.

117. When production exceeds sales, a portion of the _______________ is deferred

to a future period as part of the cost of ending inventory under absorption
costing, but not under variable costing.

118. The one primary difference between variable costing and absorption costing is
that under variable costing, fixed manufacturing overhead is recorded as a(an)
_______________ in the current period.

119. When units produced exceed units sold, income under absorption costing is
_________________ than income under variable costing.

120. The amount remaining after deducting total variable costs from revenue is called
the _________________________.

121. Management may be tempted to overproduce in a given period in order to

increase net income if _______________ is used for internal decision-making.

122. _________________ is the relative percentage in which each product is sold

when a company sells more than one product.

123. When more than one product is sold, breakeven point can be determined by
dividing fixed expenses by __________________________.

124. The _________________________ provides a measure of a company’s

earning’s volatility and can be used to compare operating leverage across two
companies.

Answers to Completion Statements

113. absorption costing 120. contribution margin
114. variable costing 121. absorption costing
115. variable costing 122. Sales mix
116. GAAP, external 123. weighted-average unit contribution
margin
117. fixed manufacturing overhead 124. degree of operating leverage
118. expense
119. higher
7-34 Test Bank for Managerial Accounting, Third Edition

SHORT-ANSWER ESSAY QUESTIONS

S-A E 125
Define variable costing and absorption costing. What are some of the benefits to a
manager from using variable costing instead of absorption costing for internal decision-
making?

Solution 125
Variable costing is a system for determining product costs that is used primarily for
making managerial decisions. This system determines product costs by considering
only direct materials, direct labor, and variable manufacturing overhead. In contrast,
absorption costing is used by some managers and also for external reporting. Under
absorption costing, product costs include direct material, direct labor, and both fixed and
variable manufacturing overhead costs.

Some of the benefits to a manager from using variable costing instead of absorption
costing for internal decision-making include: variable costing already has to be used
when constructing a contribution margin income statement, variable costing puts greater
focus on cost behaviors, fixed expenses do not get tied up in inventory under variable
costing, variable costing is better suited for cost-volume-profit analysis ,variable costing
produces income statements that are closer to net cash flows than absorption costing,
and the method ties in with standard costing and flexible budgeting more effectively.

S-A E 126
How do differences in production and sales levels affect income under absorption and
variable costing?

Solution 126
If production equals sales in any given period, the net incomes under both absorption
and variable mcosting will be equal. Under this scenario, fixed manufacturing overhead
will not differ, because the direct cost expense under variable costing will be equal to the
product cost component of fixed overhead under absorption costing.

If production exceeds sales, absorption costing netincome will be greater than variable
costing net income. Absorption costing net income is higher because some fixed
manufacturing overhead costs will be deferred in the inventory account until the products
are sold, whereas under variable costing, all fixed manufacturing overhead costs will be
expensed.

If sales exceeds production, absorption costing net income will be less than variable
costing net income. Absorption costing net income is less because some fixed
manufacturing overhead costs from the previous period will now be expensed when the
older product is sold., whereas under variable costing, only fixed manufacturing
overhead costs of the current period will be expensed.
 Variable Costing: A Decision-Making Perspective
7-35

S-A E 127
Explain why either absorption or variable costing is best for a company to use as their
costing system for internal decision making. Why do many firms maintain accounting
records under both systems?

Solution 127
Variable costing is generally preferred over absorption costing for internal decision
making. Netincome computed using GAAP (absorption costing) does not highlight
differences between variable and fixed costs, as does variable costing, and can lead to
poor business decisions. Mangers may be tempted to over produce in a given period in
order to increase net income when absorption costing is used. Net income under
variable costing is unaffected by changes is production levels. In addition, the use of
variable costing is consistent with cost-volume-profit analysis and other decision-making
tools.

Many firms maintain accounting records under both systems because while they want to
use variable costing for internal decision making, GAAP does require the use of
absorption costing for external financial reports. Also, absorption costing must be used
on tax returns.

S-A E 128
Jacob Andrews, president of Video Adventure, has heard about operating leverage and
asks you to explain this term. What is operating leverage? How does a company
increase its operating leverage?

Solution 128
Operating leverage refers to the change in net income that a company experiences
when there is a change in net sales revenue. Companies that have higher fixed costs
relative to variable costs have higher operating leverage. In that case, the company’s
profits will increase rapidly when sales revenue increases, but decrease rapidly when
sales revenue decreases. A company can increase its operating leverage by increasing
its reliance on fixed costs, with a corresponding decrease in variable costs.