Study unit 7

Q1
A company has the following budget formula for annual electricity expense in its shop:
Expense = $7,200 + (Units produced × $0.60)

If management expects to produce 20,000 units during February, for the purpose of performance evaluation, what amount o
A. $19,200
B. $12,000
C. $7,200
D. $12,600

Q2
Consider the following situation for a company for the prior year.
1. The company produced 1,000 units and sold 900 units, both as budgeted.
2. There were no beginning or ending work-in-process inventories and no beginning finished goods inventory.
3. Budgeted and actual fixed costs were equal, all variable manufacturing costs are affected by volume of production only, a
4. Budgeted per unit revenues and costs were as follows:
Per Unit

Sales price $100

Direct materials 30
Direct labor 20
Variable manufacturing costs 10
Fixed manufacturing costs 5
Variable selling costs 12
Fixed selling costs ($3,600 total) 4
Fixed administrative costs ($1,800 total) 2
Assuming that the company uses variable costing, the operating income for the prior year was
A. $14,200
B. $14,800
C. $13,600
D. $15,300

Q3
A manufacturing company estimates semi-variable costs by using the high-low method with machine hours as the cost driv
Period Semi-VariableMachine Hours
1 € 100,000 22,000
2 120,000 30,000
3 96,000 23,600
If 29,000 machine hours were budgeted for the next period, estimated semi-variable costs would total
A. € 117,000
B. € 117,500
C. € 116,250
D. € 121,220

Q4
An assembly plant accumulates its variable and fixed manufacturing overhead costs in a single cost pool, which is then app
The assembly plant management wants to estimate the magnitude of the total manufacturing overhead costs for different vo
If there is an increase in the application activity base that is within the relevant range of activity for the assembly plant, wh
 A. The variable cost per unit is constant, and the total fixed costs de
B. The variable cost per unit is constant, and the total fixed costs inc
C. The variable cost per unit and the total fixed costs remain consta
D. The variable cost per unit increases, and the total fixed costs rem

Q5
Fact Pattern: Estimated unit costs for Cole Lab using full absorption costing and operating at a production level of 12,000 u
Estimated
Cost Item Unit Cost

Direct material $32

Direct labor 20
Variable manufacturing overhead 15
Fixed manufacturing overhead 6
Variable selling 3
Fixed selling 4

Cole Lab’s estimated conversion costs per unit are

A. $44
B. $48
C. $35
D. $41

Q6
Fact Pattern: Consider the following situation for Weisman Corporation for the prior year:
1. The company produced 1,000 units and sold 900 units, both as budgeted.
2. There were no beginning or ending work-in-process inventories and no beginning finished goods inventory.
3. Budgeted and actual fixed costs were equal, all variable manufacturing costs are affected by volume of production only, a
4. Budgeted per unit revenues and costs were as follows.
Per Unit

Sales price $100

Direct materials 30
Direct labor 20
Variable manufacturing overhead 10
Fixed manufacturing overhead 5
Variable selling costs 12
Fixed selling costs ($3,600 total) 4
Fixed administrative costs ($1,800 total) 2

If Weisman uses variable costing, its operating income earned in the last fiscal year was
A. $14,200
B. $14,800
C. $13,600
D. $15,300

Q7
Using absorption costing, a company’s income for October was $250,000. The company began the month with 10,000 units
During October, the company produced 330,000 units and sold 325,000 units.
The fixed manufacturing overhead for October totaled $990,000. If the company used variable costing, its income for Octob
A. $265,000
B. $250,000 sol
C. $234,308 Under variable costing, fixed manufacturing overh
D. $235,000 Each of the units produced under absorption costin
Therefore, because they increased their inventory b

Q8
A corporation pays bonuses to its managers based on operating income, as calculated under variable costing.
It is now 2 months before year end, and earnings have been depressed for some time.
Which one of the following actions should the production manager definitely implement to maximize the bonus for this yea
A. Postpone $1.8 million of discretionary equipment maintenance u
B. Implement, with the aid of the controller, an activity-based costin
C. Step up production so that more manufacturing costs are deferred
D. Cut $2.3 million of advertising and marketing costs.

Q9
A company produces 200,000 units of a good that has the following costs:
Direct material costs $ 2,000,000
Direct manufacturing labor costs $ 1,000,000
Indirect manufacturing labor costs $ 600,000
The company’s per unit prime costs and conversion costs, respectively, are
A. $10 and $8.
B. $8 and $18.
C. $8 and $15.
D. $15 and $8.

Q10
A corporation produces and sells smart phones. The following information relates to operations for the last year:
Variable cost per unit $5.20
Total fixed manufacturing overhead cost $260,000
Total fixed selling and administrative cost $180,000
Units produced and sold 400,000
Using absorption costing, what was the cost per unit last year?
A. $5.85
B. $6.30
C. $5.00
D. $4.55

Q11
Fact Pattern: Dremmon Corporation uses a standard cost accounting system. Data for the last fiscal year are as follows:
Units

Beginning inventory of finished goods 100

Production during the year 700
Sales 750
Ending inventory of finished goods 50
Per Unit

Product selling price $200

Standard variable manufacturing cost 90
Standard fixed manufacturing cost 20*
Budgeted selling and administrative costs (al $45,000
*Denominator level of activity is 750 units for the year.
There were no price, efficiency, or spending variances for the year, and actual selling and administrative expenses equaled t
Any volume variance is written off to cost of goods sold in the year incurred. There are no work-in-process inventories.
If Dremmon uses absorption costing, its operating income earned in the last fiscal year was
A. $28,000
B. $30,000
C. $21,500
D. $27,000

Q12
A company budgets its total production costs at $220,000 for 75,000 units of output and $275,000 for 100,000 units of outp
Since additional facilities are needed to produce 100,000 units, fixed costs are budgeted at 20% more than for 75,000 units
What is the budgeted variable cost per unit of output?
A. $1.10
B. $1.20
C. $2.75
D. $2.20
sol
First, state the information known about the two production levels mathematically:
Variable costs + Fixed costs =

(75,000 × UVC) + (1.0 × FC) =

(100,000 × UVC) + (1.2 × FC) =
Next, state one of them in terms of fixed costs:
(75,000 × UVC) + (1.0 × FC) =
FC =
Substitute this relationship into the second equation and solve for the budgeted unit variable cost:
(100,000 × UVC) + 1.2 ($220,000 – 75,000 = $275,000
(100,000 × UVC) + $264,000 – (90,000 × = $275,000
(10,000 × UVC) = $11,000
UVC = $1.10

Q13
Consider the following situation for Weisman Corporation for the prior year:
1. The company produced 1,000 units and sold 900 units, both as budgeted.
2. There were no beginning or ending work-in-process inventories and no beginning finished goods inventory.
3. Budgeted and actual fixed costs were equal, all variable manufacturing costs are affected by volume of production only, a
4. Budgeted per unit revenues and costs were as follows.
Per Unit

Sales price $100

Direct materials 30
Direct labor 20
Variable manufacturing overhead 10
Fixed manufacturing overhead 5
Variable selling costs 12
Fixed selling costs ($3,600 total) 4
Fixed administrative costs ($1,800 total) 2
If Weisman uses absorption costing, its operating income earned in the last fiscal year was
A. $15,840
B. $13,600
C. $15,300
D. $14,200

sol
Weisman’s absorption-basis operating income can be calculated as follows:
Sales 900 units at $
Beginning inventory
Variable production costs 1,000 units at $
Fixed production costs 1,000 units at $

Goods available for sale

Less: Ending inventory 100 units at $

Abs. cost of goods sold

Gross margin
Variable S&A expenses 900 units at $
Fixed S&A expenses 900 units at $

Operating income

Q14
Last year a company had sales of 75,000 units and production of 100,000 units. Other information for the year is shown bel
Direct manufacturing labor $187,500
Variable manufacturing overhead 100,000
Direct materials 150,000
Variable selling expenses 100,000
Fixed administrative expenses 100,000
Fixed manufacturing overhead 200,000
Assuming no beginning inventory, what is the total value of ending finished goods inventory under absorption costing?
A. $279,175
B. $209,375
C. $159,375
D. $184,375
sol
With no beginning inventory, cost of goods manufactured is simply the sum of direct labor, direct materials, variable overh
and fixed overhead, or $637,500 ($187,500 + $100,000 + $150,000 + $200,000). The cost of the ending inventory is equal

Q15
At the end of a company’s first year of operations, 2,000 units of inventory are on hand.
Variable costs are $100 per unit, and fixed manufacturing costs are $30 per unit.
The use of absorption costing, rather than variable costing, would result in a higher net income of what amount?
A. $200,000
B. $140,000
C. $60,000
D. $260,000

sol
Absorption costing is required under GAAP. It includes all manufacturing costs in product cost: direct materials, direct labo
Variable costing differs only in that it expenses fixed manufacturing costs.
Hence, given no beginning inventory, pretax net income for absorption costing purposes exceeds pretax net income for vari
This amount is expensed using variable costing and treated as a product cost using absorption costing.

Q16
Dremmon Corporation uses a standard cost accounting system. Data for the last fiscal year are as follows:
Units

Beginning inventory of finished goods 100

Production during the year 700
Sales 750
Ending inventory of finished goods 50
Per Unit

Product selling price $200

Standard variable manufacturing cost 90
Standard fixed manufacturing cost 20*
Budgeted selling and administrative costs (al $45,000
*Denominator level of activity is 750 units for the year.
There were no price, efficiency, or spending variances for the year, and actual selling and administrative expenses equaled t
If Dremmon uses variable costing, its operating income earned in the last fiscal year was
A. $31,000
B. $22,500
C. $21,500
D. $28,000

sol
Dremmon’s variable-basis operating income can be calculated as follows:
Sales
Beginning inventory 100 units @ $
Variable production costs 700 units @ $
Volume variance writeoff 50 units @ $

Goods available for sale

Less: Ending inventory 50 units @ $
Variable cost of goods sold
Variable S&A expenses None

Contribution margin
Fixed production costs 700 units @ $
Fixed S&A expenses Fixed

Operating income

Please note that the volume variance is used to find contribution margin in this case because the question states, “Any volum

Q17
At the start of its fiscal year, a company anticipated producing 300,000 units throughout the year.
The annual budgeted manufacturing overhead was $150,000 for variable costs and $600,000 for fixed costs.
In April, when there was a beginning inventory for finished goods of 5,000 units, the company showed an income of $40,00
That same month, ending inventory for finished goods was 7,000 units. What amount would the company recognize as inco
A. $36,000
B. $35,000
C. $44,000
D. $45,000

sol
Production for the month of April 25,000
Add - O/S 5,000 Change in unit 25000-23000 = 2000
Goods Available for sale 30,000 Fixed OH per unit = 600000/300000= 2
Less - C/S 7,000 Change in Income = 2000 x 2=4000
Sales 23,000 Since Prod>sales, Income under Absorption costin
Therefore, income under VC = 40000-4000=36000

Q18
Osawa, Inc., planned and actually manufactured 200,000 units of its single product during its first year of operations. Osaw
Variable manufacturing costs were $30 per unit of product. Planned and actual fixed manufacturing costs were $600,000, an
Osawa sold 120,000 units of product at a selling price of $40 per unit.
Osawa’s operating income using absorption (full) costing is
A. $840,000
B. $600,000
C. $440,000
D. $200,000

sol
Absorption costing net income is computed as follows:
Sales (120,000 units × $40) $4,800,000
Variable production costs (200,000 units × $30)
$6,000,000
Fixed production costs 600,000

Total production costs $6,600,000

Ending inventory (80,000 units × $33) -2,640,000

Cost of goods sold -3,960,000

Gross profit $ 840,000
Selling and administrative expenses -400,000

Operating income $ 440,000

Q19

Last year, a company had sales of 75,000 units and production of 100,000 units. Other information for the year is shown be
Direct manufacturing labor $187,500
Variable manufacturing overhead 100,000
Direct materials 150,000
Variable selling expenses 100,000
Fixed administrative expenses 100,000
Fixed manufacturing overhead 200,000
Assuming no beginning inventory, what is the cost of goods sold under variable costing?
A. $478,125
B. $553,125
C. $403,125
D. $328,125
Sol
Under variable costing, product cost includes only the variable portion of manufacturing costs.
Thus, the direct manufacturing labor, the variable manufacturing overhead, and the direct materials costs are all included in
The total variable manufacturing cost is equal to $437,500 ($187,500 + 100,000 + 150,000), and the total variable manufact
Because 100,000 units were produced but only 75,000 were sold, the cost of goods sold is $328,125 ($4.375 × 75,000 units

Q20
In which one of the following situations will ending inventory on the balance sheet computed under absorption costing be e
A. When the number of units produced equals the number of units sold.
B. When the denominator variance is zero.
C. When there is no variable overhead cost.
D. When there is no fixed factory overhead cost.
 Study unit 7

nse in its shop:

purpose of performance evaluation, what amount of expenses should the company expect to incur in February?

o beginning finished goods inventory.

g costs are affected by volume of production only, and all variable selling costs are affected by sales volume only.

for the prior year was

gh-low method with machine hours as the cost driver. Recent data are shown below.

mi-variable costs would total

rhead costs in a single cost pool, which is then applied to work in process using a single application base.
total manufacturing overhead costs for different volume levels of the application activity base using a flexible budget formula
elevant range of activity for the assembly plant, which one of the following relationships regarding variable and fixed costs is true?
cost per unit is constant, and the total fixed costs decrease.
cost per unit is constant, and the total fixed costs increase.
cost per unit and the total fixed costs remain constant.
cost per unit increases, and the total fixed costs remain constant.

ting and operating at a production level of 12,000 units per month:

for the prior year:

o beginning finished goods inventory.

g costs are affected by volume of production only, and all variable selling costs are affected by sales volume only.

Sol Weisman’s variable-basis operating income can be calculated as

Sales 900 units
Beginning inventory
Variable production costs 1,000 units

Goods available for sale

Less: Ending inventory 100 units

Var. cost of goods sold

Variable S&A expenses 900 units
fiscal year was
Contribution margin
Fixed production costs 1,000 units
Fixed S&A expenses 900 units

Operating income

0. The company began the month with 10,000 units in finished goods inventory that contained $30,000 of fixed manufacturing overhead
ompany used variable costing, its income for October would be

Under variable costing, fixed manufacturing overhead is treated as a period expense and is expensed in the period incurred.
Each of the units produced under absorption costing carries $3/unit of fixed manufacturing overhead expense that is incurred when the
Therefore, because they increased their inventory by 5,000 units (330,000 produced – 325,000 sold), an additional $15,000 ($5,000 × $

as calculated under variable costing.

r some time.
itely implement to maximize the bonus for this year?
million of discretionary equipment maintenance until next year.
ith the aid of the controller, an activity-based costing and activity-based management system.
ction so that more manufacturing costs are deferred into inventory.
on of advertising and marketing costs.

on relates to operations for the last year:

tem. Data for the last fiscal year are as follows:

actual selling and administrative expenses equaled the budget amount.
rred. There are no work-in-process inventories.
ast fiscal year was

sol
Dremmon’s absorption-basis operating income can be calculated as follows:
Sales
Beginning inventory 100 units @ $ 110
Variable production costs 700 units @ $ 90
Fixed production costs 700 units @ $ 20
Volume variance writeoff 50 units @ $ 20

Goods available for sale

Less: Ending inventory 50 units @ $ 110

Absorption cost of goods sold

Gross margin
Variable S&A expenses None
Fixed S&A expenses Fixed

Operating income

ts of output and $275,000 for 100,000 units of output.

sts are budgeted at 20% more than for 75,000 units.

Total cost

$220,000
$275,000

$220,000
$220,000 – (75,000 × UVC)
dgeted unit variable cost:
o beginning finished goods inventory.
g costs are affected by volume of production only, and all variable selling costs are affected by sales volume only.

ast fiscal year was

100 = $90,000
$ 0
60 = 60,000
5= 5,000

$65,000
65 = -6,500

-58,500

$31,500
12 = -10,800
6= -5,400

$15,300

0 units. Other information for the year is shown below.

hed goods inventory under absorption costing?

 um of direct labor, direct materials, variable overhead,
200,000). The cost of the ending inventory is equal to $159,375 [$637,500 × (25,000 units ÷ 100,000 units)].

ory are on hand.

in a higher net income of what amount?

g costs in product cost: direct materials, direct labor, and fixed as well as variable manufacturing overhead.

osting purposes exceeds pretax net income for variable costing purposes by $60,000 (2,000 units in EI × $30 fixed manufacturing cost p
cost using absorption costing.

the last fiscal year are as follows:

actual selling and administrative expenses equaled the budget amount. Any volume variance is written off to cost of goods sold in the ye
t fiscal year was

$150,000
90 = $ 9,000
90 = 63,000
20 = 1,000

$73,000
90 = -4,500
 -68,500
0

$ 81,500
20 = -14,000
-45,000

$ 22,500

in this case because the question states, “Any volume variance is written off to cost of goods sold in the year incurred.”

units throughout the year.

costs and $600,000 for fixed costs.
00 units, the company showed an income of $40,000 using absorption costing.
What amount would the company recognize as income for April using variable costing?

Change in unit 25000-23000 = 2000

Fixed OH per unit = 600000/300000= 2
Change in Income = 2000 x 2=4000
Since Prod>sales, Income under Absorption costing > Variable costing
Therefore, income under VC = 40000-4000=36000

le product during its first year of operations. Osawa sold 120,000 units of product at a selling price of $40 per unit.
actual fixed manufacturing costs were $600,000, and selling and administrative costs totaled $400,000
0 units. Other information for the year is shown below.

variable costing?

f manufacturing costs.
ad, and the direct materials costs are all included in the cost of goods sold calculation.
100,000 + 150,000), and the total variable manufacturing cost per unit is equal to $4.375 ($437,500 ÷ 100,000 units manufactured).
t of goods sold is $328,125 ($4.375 × 75,000 units sold).

ance sheet computed under absorption costing be exactly equal to ending inventory computed under variable costing?
roduced equals the number of units sold.
nce is zero.
verhead cost.
ry overhead cost.
 sol
Operating income based on variable costing is $14,800 calculated as follows:
Sales (900 × $100) $90,000
COGS [900 × ($30 + $20 + $10)] 54,000
Fixed manufacturing (1,000 × $5) 5,000
Variable selling (900 × $12) 10,800
Fixed selling 3,600
Fixed administrative 1,800

Operating income $14,800

exible budget formula

able and fixed costs is true?
ng income can be calculated as follows:
at $ 100 = $90,000
$ 0
at $ 60 = 60,000

$60,000
at $ 60 = -6,000

-54,000
at $ 12 = -10,800

$25,200
at $ 5= -5,000
at $ 6= -5,400

$14,800

of fixed manufacturing overhead costs.

 the period incurred.
xpense that is incurred when the unit is sold.
n additional $15,000 ($5,000 × $3) must be expensed in the current period that would not have been otherwise expensed until sale under
 $150,000
= $11,000
= 63,000
= 14,000
= 1,000

$89,000
= -5,500

-83,500

$ 66,500
0
-45,000

$ 21,500
× $30 fixed manufacturing cost per unit).

ff to cost of goods sold in the year incurred. There are no work-in-process inventories.
year incurred.”

40 per unit.
0,000 units manufactured).

iable costing?
expensed until sale under absorption costing, reducing income to $235,000.
Q21

A company uses a standard cost accounting system. Data for the last fiscal year are as follows.
Units

Beginning inventory of finished goods 100

Production during the year 700
Sales 750
Ending inventory of finished goods 50
Per Unit

Product selling price $200

Standard variable manufacturing cost 90
Standard fixed manufacturing cost 20*
Budgeted selling and administrative costs (all fixed) $45,000

*Denominator level of activity is 750 units for the year.

There were no price, efficiency, or spending variances for the year, and actual selling and administrative expenses equaled t
The amount of operating income earned for the last fiscal year using variable costing was
A. $31,000
B. $28,000
C. $21,500
D. $22,500

sol
Variable-basis operating income can be calculated as follows:
Sales
Beginning inventory 100 units @ $90
Variable production costs 700 units @ $90
Volume variance write-off 50 units @ $20

Goods available for sale

Less: ending inventory 50 units @ $90

Variable cost of goods sold

Variable S&A expenses None

Contribution margin
Fixed production costs 700 units @ $20
Fixed S&A expenses Fixed

Operating income

Please note that the volume variance is used to find contribution margin in this case because the first question states, “Any v

Q22
A firm manufactures light bulbs. The following salaries were included in the firm’s manufacturing costs for the year:
Machine operators $145,000
Factory supervisors 60,000
Machinery mechanics 25,000
What is the amount of direct labor for the year?
A. $170,000
B. $230,000
C. $205,000
D. $145,000

Q23
During the first month of its operations, a company manufactured a product with variable production costs of $50 per unit.
Fixed manufacturing overhead totaled $1,800,000 and is allocated based upon units produced.
During the month, the company completed 15,000 units, sold 12,000 units, and incurred no variances. If the company’s op

A. (110,000)
B. 40,000
C. (50,000)
D. 760,000
Q24
The marketing manager has learned the following about a new product that is being introduced: Sales of this product are pla
Sales commission expense is budgeted at 8% of sales plus the marketing manager’s incentive budgeted at an additional 1/2%
The preparation of a product brochure will require 20 hours of marketing salaried staff time at an average rate of $100 per h
The variable marketing cost for this new product will be
A. $10,500
B. $8,500
C. $10,000
D. $8,000
Q25
When identifying fixed and variable costs, which one of the following is a typical assumption concerning cost behavior?
A. Cost behavior is assumed to be realistic for all lev
B. General and administrative costs are assumed to b
C. The relevant time period is assumed to be 5 years
D. Total costs are assumed to be linear when plotted
Q26
Which one of the following is least likely to be a reason to adopt a standard cost system?
A. Setting standards at an ideal level can motivate em
B. A standard cost system identifies what the level o
C. Utilizing standard costs tends to simplify recordk
D. Costs of using standard costing are low relative to
Q27
Which one of the following is least likely to be an objective of a cost accounting system?
A. Product costing.
B. Department efficiency.
C. Inventory valuation.
D. Sales commission determination.
Q28
When a firm prepares financial reports by using absorption costing,
A. Profits will always increase with increases in sales.
B. Profits will always decrease with decreases in sales.
C. Profits may decrease with increased sales even if there is no chan
D. Decreased output and constant sales result in increased profits.
Q29
A company has significant fixed overhead costs in the manufacturing of its sole product, auto mufflers. For internal reportin
A. If more units were produced than were sold durin
B. If more units were sold than were produced durin
C. In all cases when ending finished goods inventory
D. None of these situations.
sol
The monetary value of ending inventory is never higher under direct costing than under absorption costing because fewer co

Q30
A manufacturing company employs variable costing for internal reporting and analysis purposes.
However, it converts its records to absorption costing for external reporting.
The Accounting Department always reconciles the two operating income figures to assure that no errors have occurred in th
The fixed manufacturing overhead cost per unit was based on the planned level of production of 480,000 units. Financial da

Budget Actual

Sales (in units) 495,000 510,000

Production (in units) 480,000 500,000
Variable Absorption
Costing Costing

Variable costs $10.00 $10.00

Fixed manufacturing overhead 0 6

Total unit manufacturing costs $10.00 $16.00

The difference between the operating income calculated under the variable costing method and the operating income calcul
A. $57,600
B. $60,000
C. $90,000 The amount of $90,000 is the difference between
D. $120,000

Q31
Last year a company had sales of 75,000 units and production of 100,000 units. Other information for the year is shown bel
Direct manufacturing labor $187,500
Variable manufacturing overhead 100,000
Direct materials 150,000
Variable selling expenses 100,000
Fixed administrative expenses 100,000
Fixed manufacturing overhead 200,000
Assuming no beginning inventory, what is the total value of ending finished goods inventory under absorption costing?
A. $159,375
B. $184,375
C. $209,375
D. $279,175

Q32
Using absorption costing, a company’s income for October was $250,000.
The company began the month with 10,000 units in finished goods inventory that contained $30,000 of fixed manufacturin
During October, the company produced 330,000 units and sold 325,000 units. The fixed manufacturing overhead for Octob
A. $265,000
B. $250,000
C. $235,000
D. $234,308
 administrative expenses equaled the budget amount. Any volume variance is written off to cost of goods sold in the year incurred. Ther

$150,000
= $ 9,000
= 63,000
= 1,000

$73,000
= -4,500

-68,500
0

$ 81,500
= -14,000
-45,000

$ 22,500

use the first question states, “Any volume variance is written off to cost of goods sold in the year incurred.”

facturing costs for the year:

 production costs of $50 per unit.

no variances. If the company’s operating income under absorption costing was $400,000, its operating income (loss) under variable cost

duced: Sales of this product are planned at $100,000 for the first year.
tive budgeted at an additional 1/2%.
me at an average rate of $100 per hour, and 10 hours at $150 per hour for an outside illustrator’s effort.

tion concerning cost behavior?

s assumed to be realistic for all levels of activity from zero to maximum capacity.
ministrative costs are assumed to be variable costs.
me period is assumed to be 5 years.
assumed to be linear when plotted on a graph.

ds at an ideal level can motivate employees.

system identifies what the level of costs should be and who should be responsible for the costs.
rd costs tends to simplify recordkeeping.
tandard costing are low relative to costs of using actual costing.

on determination.

th increases in sales.
ith decreases in sales.
eased sales even if there is no change in selling prices and costs.
sales result in increased profits.
auto mufflers. For internal reporting purposes, in which one of the following situations would ending finished goods inventory be highe
ere produced than were sold during a given year.
ere sold than were produced during a given year.
n ending finished goods inventory exists.

bsorption costing because fewer costs are capitalized under direct costing.

that no errors have occurred in the conversion.

tion of 480,000 units. Financial data for the year are presented below:

d and the operating income calculated under the absorption costing method would be

$90,000 is the difference between planned sales (495,000 units) and actual sales (510,000 units), times the fixed manufacturing overhea

ormation for the year is shown below.

ory under absorption costing?

ned $30,000 of fixed manufacturing overhead costs.

manufacturing overhead for October totaled $990,000. If the company used variable costing, its income for October would be
sold in the year incurred. There are no work-in-progress inventories.
come (loss) under variable costing was
shed goods inventory be higher under direct (variable) costing rather than under absorption costing?

e fixed manufacturing overhead per unit ($6).

or October would be
 Job Order costing
Q1
Fact Pattern: Farber Company employs a normal cost system. The following information is from the financial records of the co
• Total manufacturing costs were $2,500,000.
• Cost of goods manufactured was $2,425,000.
• Applied factory overhead was 30% of total manufacturing costs.
• Factory overhead was applied to production at a rate of 80% of direct labor cost.
• Work-in-process inventory at January 1 was 75% of work-in-process inventory at December 31.
The carrying value of Farber Company’s work-in-process inventory at December 31 is
A. 75,000
B. $300,000
C. $100,000
D. $225,000
Sol –
Cost of goods manufactured ($2,425,000) equals total manufacturing costs ($2,500,000) plus beginning work-in-process (75%
$2,500,000 + .75 EWIP – EWIP = $2,425,000
$2,500,000 – .25 EWIP = $2,425,000
EWIP = $75,000 ÷ .25
EWIP = $300,000
NOTE –
For Manufacturer –
O/s of Raw materials + Purchases – C/s of raw materials = Raw materials Used in production
Raw materials used in production + Direct labor + Manufacturing OH cost = Total Manufacturing Cost
Total Manufacturing Cost + Beg WIP inventory – C/s WIP inventory = Cost of goods Manufactured
Cost of goods Manufactured + Beg Finished Goods Inventory – Ending FG Inventory = COST OF GOODS SOLD
Q2
A corporation manufactures a specialty line of dresses using a job-order costing system. During January, the following costs we
Direct materials
$27,400
Direct labor
9,600
Administrative costs
2,800
Selling costs
11,200
Factory overhead was applied at the rate of $50 per direct labor hour, and job J-1 required 400 direct labor hours. If job J-1 resu
A. $9.25
B. $17.75
C. $14.25
D. $14.95
Q3
A company using job-order costing had the following transactions during a calendar year for Job 101:
Date Transaction Amount

1-Jan Direct materials purchased £500

1-Feb Direct materials used 450
1-Mar Direct labor incurred 350
 1-Jun Overhead applied 50
The company’s beginning finished goods inventory on January 1 for Job 101 was £1,500. The company completed and shipped
A. £2,850
B. £2,400
C. £1,350
D. £2,350
Q4
A manufacturer produces unique tapestries and bedding for hotel chains and uses a job order costing system. During the curren
Overhead is applied on the basis of direct labor hours at a rate of 60%. Overapplied or underapplied overhead is closed to cost o
The actual overhead incurred this month was $10,000. Balances in the manufacturer’s inventory accounts are presented below.
Beginning End of
of month month

Direct materials $2,000 $3,500

Work-in-process 5,000 9,000
Finished goods 2,500 1,700
What is the cost of goods manufactured this month?
A. $80,500
B. $76,500
C. $83,700
D. $79,700
Q5.
Fact Pattern: Farber Company employs a normal cost system. The following information is from the financial records of the co
• Total manufacturing costs were $2,500,000.
• Cost of goods manufactured was $2,425,000.
• Applied factory overhead was 30% of total manufacturing costs.
• Factory overhead was applied to production at a rate of 80% of direct labor cost.
• Work-in-process inventory at January 1 was 75% of work-in-process inventory at December 31.
Farber Company’s total direct labor cost for the year is
A. $937,500
B. $600,000
C. $750,000
D. $909,375
Q6.
A company produces disk brakes for mountain bikes. During the current reporting period, the company has normal spoilage of
A. 300 units.
B. 400 units.
C. 5,200 units.
D. 1,000 units.
Sol
Ending inventory is calculated as follows:
Ending inventory = Beginning inventory + Units started and completed – Units transferred out – Normal spoilage – Abnormal s
The given values can be used to solve for abnormal spoilage:
3,100 = 3,400 + 5,600 – 4,900 – 700 – Abnormal spoilage
3,100 = 3,400 – Abnormal spoilage
Abnormal spoilage = 300
Q7.
A company produces stereo speakers for automobile manufacturers. The automobile manufacturers reject approximately 3% of
A. Waste.
B. Spoilage.
C. Scrap.
D. Rework costs.
Sol
Rejected units that are discarded are classified as spoilage. Spoilage is separated into abnormal or normal spoilage. Normal spo
Q8
A company manufactures a specialty line of T-shirts using a job-order costing system. During March, the following costs were
A. $5.70
B. $5.50
C. $6.50
D. $6.30
Sol
Cost of goods sold is based on the manufacturing costs incurred in production but does not include selling or general and admin
Manufacturing costs equal $38,500 [$13,700 DM + $4,800 DL + (800 hours × $25) OH]. Thus, per-unit cost is $5.50 ($38,500

Q9

A company uses a job order cost system and applies overhead using a plant-wide rate of $5.75 per direct labor hour. The compa
Machining Department Assembly Department

Allocation base Machine hours Direct labor hours

Departmental overhead costs $850,000 $300,000
Machine hours used 250,000 30,000
Direct labor hours used 75,000 125,000
The company tested its new system by comparing the plant-wide and departmental overhead assigned to two different jobs. The
A. Search for cost drivers that would present more consistent results when the two methods ar
B. Continue to use the plant-wide rate because of the insignificant (less than 10%) difference b
C. Change to two departmental overhead rates because of the significant (more than 10%) diff
D. Change to two departmental overhead rates regardless of the differences between methods

Sol
For the second job, allocated overhead using the two departmental rates is $21,080 {[($850,000 ÷ 250,000 hours) × 5,000] Mac
Under the plant-wide rate, the applied overhead is $17,250 ($5.75 × 3,000). The difference of 22.2% [($21,080 – $17,250) ÷ $1

Q10

The amount of raw materials left over from a production process or production cycle for which there is no further use is
A. Waste.

Waste is the amount of raw materials left over from a production process or production cycle for which there is no further use.

Q11
he financial records of the company for the year.

entory at December 31 is

nning work-in-process (75% of EWIP) minus ending work-in-process. The ending work-in-process is $300,000.

GOODS SOLD

nuary, the following costs were incurred in completing job J-1:

ect labor hours. If job J-1 resulted in 4,000 good dresses, the cost of goods sold per unit is
mpany completed and shipped Job 101 on August 1. If the customer paid the company £5,000 for Job 101 on September 1, how much should

ng system. During the current month, the manufacturer purchased $50,000 of direct materials and incurred $22,000 in direct labor
d overhead is closed to cost of goods sold at the end of the period.
ccounts are presented below.

he financial records of the company for the year.

pany has normal spoilage of 700 units. At the beginning of the current reporting period, the company had 3,400 units in inventory and start

Normal spoilage – Abnormal spoilage

s reject approximately 3% of the stereo speakers received as being of unacceptable quality. The company inspects the rejected speakers to d
normal spoilage. Normal spoilage is an inherent result of the normal production process. Abnormal spoilage is spoilage that is not expected

rch, the following costs were incurred in completing job ICU2: direct materials, $13,700; direct labor, $4,800; administrative, $1,400; and s

e selling or general and administrative expenses.

r-unit cost is $5.50 ($38,500 ÷ 7,000 units).

direct labor hour. The company is considering changing to two departmental overhead rates with annual information shown below.

ned to two different jobs. The first job’s allocated overhead using the plant-wide rate totaled $23,000 and was $23,750 using the two depart
ults when the two methods are compared.
nt (less than 10%) difference between methods for the first job.
nificant (more than 10%) difference between methods for the second job.
differences between methods for better cause-and-effect relationships.

250,000 hours) × 5,000] Machining + [($300,000 ÷ 125,000 hours) × 1,700] Assembly}.

% [($21,080 – $17,250) ÷ $17,250] is significant, so the two departmental overhead rates should be used.

ere is no further use is

which there is no further use. Waste is usually not salable at any price and must be discarded.
ptember 1, how much should the company report as cost of goods sold for Job 101 for the year?

000 in direct labor

0 units in inventory and started and completed 5,600 units. 4,900 units were transferred out, and ending inventory had 3,100 units. In this re

cts the rejected speakers to determine which ones should be reworked and which ones should be discarded. The discarded speakers are clas
spoilage that is not expected to occur under normal, efficient operating conditions.

dministrative, $1,400; and selling, $5,600. Overhead was applied at the rate of $25 per machine hour, and job ICU2 required 800 machine h

mation shown below.

$23,750 using the two departmental rates. The second job took 5,000 machine hours in the Machining Department and a total of 3,000 labor
ad 3,100 units. In this reporting period, the abnormal spoilage for the company disk brakes production was –

carded speakers are classified as

2 required 800 machine hours. If job ICU2 resulted in 7,000 good shirts, the cost of goods sold per unit would be –

and a total of 3,000 labor hours, 1,700 of which were used in the Assembly Department. The company should
 Activity Based Costing
Q1.
A plant has two departments, Machining and Assembly. This year’s budget for the plant contained the following informatio
Machining

Manufacturing overhead $4,000,000

Direct labor hours 100,000
Machine hours 40,000
Assume the plant uses machine hours as the overhead base in machining and direct labor in Assembly. If Job 2420 uses 20
A. $2,200
B. $1,100
C. $1,200
D. $2,100
SOL -
The machining department uses machine hours as its allocation base. Thus, the machining allocation rate is equal to $100 p
The assembly department uses direct labor hours as its allocation base. Thus, the assembly allocation rate is equal to $10 pe
Job 2420 uses 20 direct labor hours in assembly and 10 machine hours in machining (the 5 machine hours used in assembly
This job will be assigned $200 overhead from assembly ($10 rate × 20 direct labor hours) and $1,000 overhead from machi

Q2.
Which one of the following is not a benefit of activity-based management?
A.
B.
C.
D.

Q3.

A company manufactures two types of engineering diagnostic equipment used in construction.

The two products are based on different technologies, x-ray and ultrasound, but are manufactured in the same factory.
The manufacturer has computed the manufacturing cost of the x-ray and ultrasound products by adding together direct mate
The factory has three overhead departments that support the single production line that makes both products. Budgeted over

Department

Engineering Material
design handling

$6,000 $5,000

Budgeted manufacturing activities and costs for the period are as follows:
X-Ray

Units produced and sold 50

Direct materials used $5,000
Direct labor hours used 100
Direct labor cost $4,000
Number of parts used 400
Number of engineering changes 2
Number of product setups 8
The budgeted cost to manufacture one ultrasound machine using the activity-based costing method is
A. $264
B. $293
C. $305
D. $225
Sol -
Charges for direct materials and direct labor are traceable to each type of machine ($8,000 and $12,000 respectively for the
Direct materials ($8,000 ÷ 100 units) $ 80
Direct labor ($12,000 ÷ 100 units) 120
Engineering changes {$6,000 × [1 engineering change ÷ (1 + 2)] ÷ 100 units} 20
Material handling {$5,000 × [600 parts used ÷ (600 + 400)] ÷ 100 units} 30
Setup {$3,000 × [7 product setups ÷ (7 + 8)] ÷ 100 units} 14

Total $264

Q4

A corporation has used a traditional cost accounting system to apply quality control costs uniformly to all products at a rate of 15% of di
Monthly direct labor cost for its main product is $30,000. In an attempt to distribute quality control costs more equitably, the corporation
activity-based costing (ABC). The monthly data shown below have been gathered for the main product. The three activities are (1) incom
inspection, (2) in-process inspection, and (3) product certification. Costs are to be allocated to each activity on the basis of cost drivers.

Activity Cost Driver

Number of types of
-1
materials

-2 Number of units
-3 Number of orders
The monthly quality control cost assigned to the main product using ABC is

A. $4,500
B. $404 higher than using the traditio
C. $150 per order.
D. $404 lower than using the tradition
Q5

Fact Pattern:

Zeta Company is preparing its annual profit plan. As part of its analysis of the profitability of
individual products, the controller estimates the amount of overhead that should be allocated to
the individual product lines from the information given in the next column:
Zeta Company is preparing its annual profit plan. As part of its analysis of the profitability of
individual products, the controller estimates the amount of overhead that should be allocated to
the individual product lines from the information given in the next column:

Under activity-based costing (ABC), Zeta’s materials handling costs allocated to one unit of wall mirrors would be
A.
B.
C.
D.
Sol
An activity-based costing (ABC) system allocates overhead costs on the basis of some causal relationship between the incur
Because the moves for wall mirrors constitute 25% (5 ÷ 20) of total moves, the mirrors should absorb 25% of the total mate
Thus, $12,500 ($50,000 × 25%) is allocated to mirrors. The remaining $37,500 is allocated to specialty windows. Dividing

Q6
Fact Pattern:
Believing that its traditional cost system may be providing misleading information, Farragut
Manufacturing is considering an activity-based costing (ABC) approach. It now employs a
traditional cost system and has been applying its manufacturing overhead on the basis of machine
hours.
Farragut plans on using 50,000 direct labor hours and 30,000 machine hours in the coming year.
The following data show the manufacturing overhead that is budgeted.

Activity Cost Driver

Material handling No. of parts handled

Setup costs No. of setups
Machining costs Machine hours
Quality control No. of batches

Total manufacturing overhead cost:

Cost, sales, and production data for one of Farragut’s products for the coming year are as follows:
Prime costs:

Direct material cost per unit $4.40

Direct labor cost per unit
.05 DLH @ $15.00/DLH 0.75

Total prime cost $5.15

Sales and production data:

Expected sales 20,000 units

Batch size 5,000 units
Setups 2 per batch
Total parts per finished unit 5 parts
Machine hours required 80 MH per batch

If Farragut uses the traditional cost system, the cost per unit for this product for the coming year would be
A.
 B.
C.
D.

Q7
A company is implementing an activity-based budgeting system. Set-up overhead is allocated based on set-up hours and manufacturing
Budget information is listed in the table below.
Cost driver information Product A
Numbers of units per batch 50
Set-up time per batch 1.75 hours
Direct manufacturing labor time per batch 1.00 hours

The company plans to produce 1,000 units of Product A and 750 units of Product B. The activity
rates are $100 per set-up hour and $150 per direct manufacturing labor hour. What is the total
budgeted overhead?
A. $13,625
B. $22,188
C. $15,125
D. $10,063

Q8
A firm that specializes in chocolate baked goods has long assessed the profitability of a product line by comparing revenues to the cost o
However, the firm’s new accountant wants to use an activity-based costing system that takes into consideration the cost of the delivery p
Listed below are activity and cost information relating to two of the firm’s major products.
Muffins

Revenue $53,000
Cost of goods sold $26,000
Delivery activity:
Number of deliveries 150
Avg. length of delivery 10 min.
Cost per hour for delivery $20.00
Using activity-based costing, which one of the following statements is true?
A. The cheesecakes are $75 more pro
B. The muffins have a higher profitab
C. The muffins are $2,000 more profi
D. The muffins are $1,925 more profi

Sol The first step is to calculate the gro

Revenues

Cost of goods sold

Gross margin

The next step is to calculate total d

Number of deliveries
Times: Minutes per
delivery
 Times: Minutes per
delivery

Total delivery minutes

Divided by: Minutes

per hour
Total delivery hours
Times: Delivery cost
per hour

Total delivery cost

The operating profits on these two

Muffins

Cheesecake

Excess

Q9
A company manufactures diamond earrings and pendants. The company uses activity-based budgeting and has established
diamond inspection as one of its cost pools with number of diamonds used as its cost driver. Inspection supplies for each
diamond inspected are $0.35. For the upcoming year, the company originally believed it would produce and sell 10,000
pendants containing one diamond and 5,000 sets of earrings containing two diamonds, resulting in the following
inspection cost per diamond.
Salary of inspector $60,000
Equipment costs 3,000
Inspection supplies 7,000

Total $70,000

Cost per diamond $ 3.50

If the company now believes it will only be able to produce and sell 8,000 pendants (in addition to the earrings), the
inspection cost per set of earrings would be

Q10.
Fact Pattern: Atmel, Inc. manufactures and sells two products. Data with regard to these products are given below.
Product A

Units produced and sold 30,000

Machine hours required per unit 2
Receiving orders per product line 50
Production orders per product line 12
Production runs 8
Inspections 20
Total budgeted machine hours are 100,000. The budgeted overhead costs are shown below.
Receiving costs $450,000
Engineering costs 300,000
Machine setup costs 25,000
Inspection costs 200,000
 Total budgeted overhead costs $975,000

Atmel’s cost driver for engineering costs is the number of production orders per product line. Using activity-based costing,
A.
B.
C.
D.
Sol

The first step in performing an activity-based costing assignment is to divide the dollar amount of the indirect cost activity i
question by the number of units of the appropriate allocation base. Total engineering costs for both products amounted to
$300,000. Between them, Products A and B had 30 (12 + 18) production orders. Thus, the allocation rate is $10,000 per ord
($300,000 ÷ 30 orders). The amount allocated to Product B is $180,000 (18 orders × $10,000). Dividing this amount by the
number of units of Product B (12,000) results in a per-unit engineering cost of $15.00.

Q11
Fact Pattern:
Believing that its traditional cost system may be providing misleading information, Farragut
Manufacturing is considering an activity-based costing (ABC) approach. It now employs a
traditional cost system and has been applying its manufacturing overhead on the basis of machine
hours.
Farragut plans on using 50,000 direct labor hours and 30,000 machine hours in the coming year.
The following data show the manufacturing overhead that is budgeted.

Activity Cost Driver

Material handling No. of parts handled

Setup costs No. of setups
Machining costs Machine hours
Quality control No. of batches

Total manufacturing overhead cost:

Cost, sales, and production data for one of Farragut’s products for the coming year are as follows:
Prime costs:

Direct material cost per unit $4.40

Direct labor cost per unit
.05 DLH @ $15.00/DLH 0.75

Total prime cost $5.15

Sales and production data:

Expected sales 20,000 units

Batch size 5,000 units
Setups 2 per batch
Total parts per finished unit 5 parts
Machine hours required 80 MH per batch

If Farragut employs an activity-based costing system, the cost per unit for the product described for the coming year would
A.
B.
C.
D.

Sol

Materials handling cost per part is $.12 ($720,000 ÷ 6,000,000), cost per setup is $420
($315,000 ÷ 750), machining cost per hour is $18 ($540,000 ÷ 30,000), and quality cost
per batch is $450 ($225,000 ÷ 500). Hence, total manufacturing overhead applied is
$22,920 [(5 parts per unit × 20,000 units × $.12) + (4 batches × 2 setups per batch ×
$420) + (4 batches × 80 machine hours per batch × $18) + (4 batches × $450)]. The
total unit cost is $6.296 [$5.15 prime cost + ($22,920 ÷ 20,000 units) overhead].
 Costing
he following information.
Assembly

$2,000,000
200,000
40,000
bly. If Job 2420 uses 20 direct labor hours in each department, 10 machine hours in Machining and 5 machine hours in Assembly, how m

n rate is equal to $100 per machine hour ($4,000,000 ÷ 40,000).

n rate is equal to $10 per direct labor hour ($2,000,000 ÷ 200,000).
hours used in assembly are distractors).
00 overhead from machining ($100 rate × 10 machine hours) for a total overhead of $1,200 ($1,000 + $200).

Improved competitive advantage by using continuous improvement methods.

Better costing information.
Improving the value the customer receives.
Better allocation of resources to key value-added activities.

n the same factory.

ding together direct materials, direct labor, and overhead cost applied based on the number of direct labor hours.
products. Budgeted overhead spending for the departments is as follows:

Setup Total

$3,000 $14,000

Ultrasound

100
$8,000
300
$12,000
600
 1
7

000 respectively for the ultrasound). The departmental costs must be allocated based on each machine’s proportional driver level. Engin

ducts at a rate of 15% of direct labor cost.

e equitably, the corporation is considering
hree activities are (1) incoming materials
the basis of cost drivers.

Quantity for
Cost Rate Main Product

$12 per type 12 types

$0.14 per unit 17,500 units

$77 per order 30 orders

er than using the traditional system.

r than using the traditional system.

Wall Specialty
Mirrors Windows

Units produced 25 25

Material moves
5 15
per product line

Direct labor
200 200
hours per unit
 Budgeted materi
als handling cost $50,000
s

irrors would be
$1,500
$2,500
$1,000
$500

onship between the incurrence of cost and activities

rb 25% of the total materials handling costs.
alty windows. Dividing the $12,500 by 25 units produces a cost of $500 per unit of mirrors.

Budgeted Budgeted
Activity Cost

6,000,000 $ 720,000
750 315,000
30,000 540,000
500 225,000

$1,800,000

Sol
Given that manufacturing overhead is applied on the basis of machine hours, the overhead rate is $60 per h
or $.96 per unit [(80 machine hours per batch × $60) ÷ 5,000 units per batch].
Accordingly, the unit full cost is $6.11 ($5.15 unit prime cost + $.96).

$5.39
 $5.44
$6.95
$6.11

hours and manufacturing overhead is allocated based on direct manufacturing labor hours.

Product B
25 Sol
1.25 hours Because every batch of Product A contains 50 units and every batch of Product B contains 25 units,
0.75 hours the company will produce 20 (1,000 ÷ 50) batches of Product A and 30 (750 ÷ 25) batches of Product B. Th
Product A: (20 batches × 1.75 hours × $100) + (20 batches × 1.00 hours × $150) = $6,500

Product B: (30 batches × 1.25 hours × $100) + (30 batches × 0.75 hours × $150) = $7,125

Therefore, total budgeted overhead is $13,625.

aring revenues to the cost of goods sold.

n the cost of the delivery person.

Cheesecake

$46,000
$21,000

85
15 min.
$20.00

ecakes are $75 more profitable.

ns have a higher profitability as a percentage of sales and therefore are more advantageous.
ns are $2,000 more profitable.
ns are $1,925 more profitable.

tep is to calculate the gross margin on the two products:

Muffins Cheesecake

$53,000 $46,000
-26,000 -21,000

$27,000 $25,000

tep is to calculate total delivery cost for each product:

Muffins Cheesecake

150 85
× 10 × 15
 1,500 1,275
÷ 60 ÷ 60

25 21.25
× $20 × $20

$500 $425

ing profits on these two products, and the difference between them, can now be determined:
($27,000 – $500) $26,500
-24,575
($25,000 – $425)

$ 1,925

Sol
The original per-unit cost of inspection supplies was $0.35 {$7,000 total inspection costs ÷ [10
pendants + (2 diamonds per set of earrings × 5,000 earring sets)]}. The new per-diamond cost
$3.85 [($60,000 + $3,000) ÷ (8,000 + 5,000 × 2) + $0.35]. Since a set of earrings requires two
inspection cost per set of earrings is $7.70 ($3.85 × 2).

A. $7.78
B. $7.00
C. $7.70
D. $6.30

re given below.
Product B

12,000
3
150
18
12
30
 activity-based costing, the engineering cost per unit for Product B is
$29.25
$15.00
$10.00
$4.00

he indirect cost activity in

products amounted to
n rate is $10,000 per order
ding this amount by the

Budgeted Budgeted
Activity Cost

6,000,000 $ 720,000
750 315,000
30,000 540,000
500 225,000

$1,800,000
the coming year would be
$6.08
$6.00
$6.30
$6.21
hours in Assembly, how much overhead would be assigned to the job?
rtional driver level. Engineering design costs can be allocated to the ultrasound machine at a rate of 33.3% [1 ÷ (1 + 2)], material handl
overhead rate is $60 per hour ($1,800,000 ÷ 30,000)
 contains 25 units,
) batches of Product B. Thus, the budgeted overhead is calculated as follows:
 otal inspection costs ÷ [10,000 diamonds for
he new per-diamond cost of inspection is
et of earrings requires two diamonds, the
3% [1 ÷ (1 + 2)], material handling at a rate of 60% [600 ÷ (600 + 400)], and setup at a rate of 46.7% [7 ÷ (7 + 8)]. The cost for a single
7 ÷ (7 + 8)]. The cost for a single ultrasound machine can thus be calculated as follows:
 Life cycle costing
Q1
Fact Pattern: Dixon Porter Co., which uses life cycle costing, is considering the manufacture of a product with a 5-year life cycle that will re
Annual fixed and unit variable costs for the product and projected average annual unit sales at three selling prices are given below:

Sales Price

Fixed Variable $750 $900 $1,125

Production costs $1,500,000 $100

Marketing and
distribution 1,500,000 100
costs
Customer
180,000 40
service costs
Unit average
8,000 6,000 4,800
annual sales
At the highest price, R&D costs will increase by $500,000 and design and testing costs by $1,000,000.
Additionally, at the highest price, fixed customer service costs will rise by $30,000 per year, and variable customer service cost
At the lowest price, fixed marketing and distribution costs will decrease by $30,000 per year.
Which unit sales price should Dixon Porter select to obtain the maximum profit over the product’s 5-year life cycle?
A. No profit can be earned.
B. $750
C. $1,125
D. $900
SOL -
Life cycle costs include upstream (R&D and design and testing) and downstream (marketing and
distribution and customer service) costs over the product’s 5-year life cycle. At a unit price of $750,
upstream costs equal $3,000,000 ($1,000,000 + $2,000,000). Fixed costs of production and the fixed
downstream costs equal $15,750,000 [($1,500,000 + $1,500,000 + $180,000 – $30,000) × 5 years], and
variable costs of production and variable downstream costs equal $9,600,000 [8,000 units × ($100 +
$100 + $40) × 5 years]. Accordingly, the life cycle costs at a price of $750 equal $28,350,000
($3,000,000 + $15,750,000 + $9,600,000). Sales revenue at this price is $30,000,000 (8,000 units ×
$750 × 5 years). Hence, profit at a price of $750 is $1,650,000 ($30,000,000 – $28,350,000).

Q2
A company has been asked to evaluate the profitability of a product that it manufactured and sold from Year 7 through Year 10.
The product had a one-year warranty from date of sale. The following information appears in the financial records:

Research, Manufacturing
Warranty Warranty
development, and and distribution
costs cost
design cost costs

Yr 7 - Yr
Yr 5 & Yr 6 Yr 7 - Yr 10 Yr 11
10 SOL -
Life-cycle costing takes into accou
$5,000,000 $7,000,000 $200,000 $100,000 manufacturing. The life-cycle c
The life-cycle cost for this product is $7,000,
A. $12,000,000
B. $12,300,000
C. $12,200,000
D. $10,000,000

Q3
An entity produced two new products last year. Sales and cost data for the two products are summarized below.
BM2 SM4

Sales price per unit $100 $120

SOL -
Under traditional abs
Quantity sold 1,500 970 same ($150,000
Costs: manufacturing costs as
R&D $20,000 $28,000 a product as product co
Marketing 7,000 10,000 is $93,500 ($46,000 +
$25,000 + $9,500). B
Direct materials 46,000 42,000
costing, the manufa
Direct labor 35,500 25,000 $12,000 + $4,000), an
Manufacturing
12,000 9,500
$25,000 + $9,500 + $5
overhead
Warranties 4,000 5,500

Manager A measures product performance using traditional absorption costing. Manager B uses life-
cycle costing for performance measurement. Which one of the following correctly describes how the
managers will evaluate the new products?
A. Both managers conclude that BM2 and SM4 are profitable products.
B. Manager B finds SM4 is not profitable.
C. Manager A finds SM4 to be more profitable than BM2.
D. Manager B finds both BM2 and SM4 to be unprofitable products.

Q4
A company will introduce a new product in Year 1 that is expected to have a 3-year life. The company expects to sell 100,000 units each yea
Year 0 Year 1 Year 2 Year 3

Research/design $260,000 $ 0 $ 0 $ 0
Production 0 900,000 900,000 900,000
Marketing 10,000 300,000 100,000 50,000
Customer service 0 40,000 60,000 80,000
If the company uses life-cycle costing to price its new product and desires a 10% mark-up over cost, the selling price for Year 3 would be
A. $11.66
B. $9.90
C. $13.20 SOL -
D. $12.21

Total life-cycle cost is equal to $3,600,000 [($260,000 + $10,000) + ($900,000 +

+ ($900,000 + $100,000 + $60,000) + ($900,000 + $50,000 + $80,000)]. Thi
recovered over 3 years, with 100,000 units per year. Therefore, $1,200,000 of co
in Year 3, with a per-unit cost of $12. At a 10% mark-up, the total price per un
$12).
 recovered over 3 years, with 100,000 units per year. Therefore, $1,200,000 of co
in Year 3, with a per-unit cost of $12. At a 10% mark-up, the total price per un
$12).

Q5

A company’s product has an expected

4-year life cycle from research,
development, and design through its
withdrawal from the market.
Budgeted costs are
SOL -
Upstream costs
$2,000,000
(R&D, design)

Manufacturing costs 3,000,000 Whole-life costs include after-purchase cost

customers as well as life-cycle costs (R&D
Downstream costs research). Hence, the budgeted unit whole-lif
(marketing, $1,000,000) ÷ 200,000 units], and the
distribution,
1,200,000
customer service)

After-purchase costs 1,000,000

The company plans to produce

200,000 units and price the product at
125% of the whole-life unit cost.
Thus, the budgeted unit selling price
is
A. $31
B. $15
C. $36
D. $45
-year life cycle that will require spending $1,000,000 for R&D and $2,000,000 for design and testing.
are given below:

le customer service costs will rise by $25 per unit.

ar life cycle?

ough Year 10.

costing takes into account costs incurred at all stages of the value-chain, not just
cturing. The life-cycle cost for this product is thus $12,300,000 ($5,000,000 +
$7,000,000 + $200,000 + $100,000).
 Under traditional absorption costing and life-cycle costing, revenue for the products would be the
same ($150,000 for BM2 and $116,400 for SM4). Traditional absorption costing treats all
manufacturing costs as product costs, but life-cycle costing takes all costs incurred over the lifespan of
a product as product costs. Thus, under traditional absorption costing, the manufacturing cost for BM2
is $93,500 ($46,000 + $35,500 + $12,000), and the manufacturing cost for SM4 is $76,500 ($42,000 +
$25,000 + $9,500). Both products are profitable in traditional absorption costing. Under life-cycle
costing, the manufacturing cost for BM2 is $124,500 ($20,000 + $7,000 + $46,000 + $35,500 +
$12,000 + $4,000), and the manufacturing cost for SM4 is $120,000 ($28,000 + $10,000 + $42,000 +
$25,000 + $9,500 + $5,500). After comparing revenue with manufacturing costs, BM2 is found to be
profitable, but SM4 is found to be unprofitable under life-cycle costing.

ell 100,000 units each year. Estimated costs are shown below.

ce for Year 3 would be

$10,000) + ($900,000 + $300,000 + $40,000)

50,000 + $80,000)]. This amount must be
refore, $1,200,000 of costs must be recovered
up, the total price per unit is $13.20 (110% ×
 refore, $1,200,000 of costs must be recovered
up, the total price per unit is $13.20 (110% ×

lude after-purchase costs (operating, support, repair, and disposal) incurred by

as life-cycle costs (R&D, design, manufacturing, marketing, distribution, and
budgeted unit whole-life cost is $36 [($2,000,000 + $3,000,000 + $1,200,000 +
200,000 units], and the budgeted unit selling price is $45 ($36 × 125%).