CHAPTER 19

STANDARD COSTS, VARIABLE COSTING SYSTEMS,

QUALITY COSTS, AND JOINT COSTS
Changes from Tenth Edition
All changes to Chapter 19 were minor.
Approach
One of the advantages of standard costs is that a standard cost system requires less recordkeeping than
does an actual cost system. Students have difficulty in accepting this fact. To learn about standard costs
requires an additional intellectual effort on their part, and they equate this effort with the physical effort of
operating a standard cost system. The text explains why the saving in recordkeeping occurs, but the
explanation may well require reinforcement by the instructor.
We have omitted a discussion of waste and spoilage on the grounds that it is inappropriate for a first
course. This is an important, but difficult, topic in practice. Some instructors may wish to add a treatment
of it on their own initiative.
The Black Meter Company description provides a useful vehicle for understanding a standard cost
system; and it may be desirable to discuss it in considerable detail. The description in the text does not
cover every number, but it should be adequate so that the students can deduce for themselves where each
number on the exhibits comes from, and in particular, how one exhibit relates to others.
We are sometimes criticized for not being advocates of variable costing systems, as some authors seem to
be. Aside from the fact that we dont view our role as being advocates of particular techniques, we feel
that variable costing finds far more favor in textbooks than in practice. The technique appeared in the
literature over 60 years ago, yet relatively few companies use it today. We interpret this fact not as a
matter of company ignorance or inertia, but rather that companies do not find the system useful enough to
justify the costs of implementing it, which are nontrivial costs. Any company having a flexible budget for
overhead costs can combine the variable portion of the overhead rate with direct labor and material costs
to get an adequate approximation of short-term costs for certain short-term decisions, without
implementing a formal variable costing system. The increased use of investment centers also leads
companies to want to value inventories at full costs (in some companies, full replacement costs) for
management reporting purposes. We have tried to maintain a balanced presentation on this topic, so that
our students upon graduation dont assume that their new employer is ignorant or in the Dark Ages when
they find no variable costing system in that particular organization.
The cost of quality is an evolving topic. Students should be aware of the concepts and related
terminology, but there are no specific techniques to describe as yet. Similarly, students should have
awareness of the issues in joint and by-product costing even if the alternative costing procedures are not
pursued.
Cases
Bennett Body Company examines the nature and advantages of a standard cost system in a simple
environment. It also reinforces the job-order vs. process costing distinction.
Black Meter Company asks questions about the illustration in the text for instructors who wish to discuss
this illustration thoroughly.
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Brisson Company provides further practice in setting up accounts for a standard cost system and
preparing financial statements.
Landau Company contrasts variable costing and full absorption costing.
Lynchs Chicken Ranch is a joint cost case. It emphasizes conceptual understanding more than numerical
analysis (this case is new in the Twelfth edition.)

Problems
Problem 19-1: Veronica Company
a. Overhead rate =

$180,000
Estimated overhead
=
Estimated direct labor hours 20,000 hours

= $9 per direct labor hour

b.

Jobs
G
H
Direct material.......................................................................................................................................................................
$10,000
$10,000
Direct labor............................................................................................................................................................................
28,000
32,000
Overhead................................................................................................................................................................................
21,600*
25,200+
Total production costs............................................................................................................................................................
$59,600
$67,200
*2,400 hours @ $9 = $21,600
+2,800 hours @ $9 = $25,200

c.

Job G
Job H
Production cost.......................................................................................................................................................................
$ 59,600
$ 67,200
Selling price (180%)..............................................................................................................................................................
$107,280
$120,960

Problem 19-2: Vermont Sugar Enterprises

a.

Selling price of sugar1,000 @ $2.00..................................................................................................................................

$2,000.00
Traceable costs (after split-off)...............................................................................................................................................
280.00
Gross margin..........................................................................................................................................................................
$1,720.00

Total syrup cost:

Process costs ($12,280 + $100,000)...................................................................................................................................
$112,280
Less sugar gross margin.....................................................................................................................................................
1,720
Cost allocated to syrup.......................................................................................................................................................
$110,560
b.

Joint product costs:

Syrup
Sugar
Sales value............................................................................................................................................................................
$300,000
$2,000
Less costs after split-off........................................................................................................................................................
12,000
280
Adjusted sales value..............................................................................................................................................................
$288,000
$1,720
Cost allocation:
Syrup:
288,000/289,720 x 100,000
$99,406 + $12,000
Sugar:
1,720/289,720 x 100,000
594 + 280

=
=
=
=

$ 99,406
$111,406
$594
$874

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Chapter 19

Problem 19-3: Monrad Corporation

Allocation
Allocated
DL Hours
Rate/Hour*
Expenses
Cost of goods sold.....................................................................................................................................................
30,000
$14
$420,000
Inventory...................................................................................................................................................................
3,000
14
42,000
33,000
462,000
*$462,000 33,000 DL hours = $14/Direct labor hour

a.

dr. Finished Goods Inventory....................................................................................................................................

42,000
Cost of Goods Sold..............................................................................................................................................
420,000
cr. Nonvariable Production Costs.........................................................................................................................
462,000

b.

As the above entry shows, full costing capitalizes $42,000 of the nonvariable costs in inventory,
rather than treating the entire $462,000 as an expense; hence, in this particular year, full costing
will result in $42,000 higher pretax income than will variable costing.

c.

Finished goods inventory (full costs) = $75,000 + 42,000 = $117,000

Problem 19-4: Nemad Company

Approach
This problem raises an issue not discussed in the text: building normal materials waste and worker idle
time into standard costs. The case is not difficult enough to justify spending an entire class session on it. I
use it in the same session as the Amurath Company case.
I discuss materials first. The relevant materials figures are these:
1. Each assembly requires eight levers.
2. To get eight good levers, 8 / 90% = 8 8/9 levers must be produced.
3. The current price is $.45 per lever or $4.00 per assembly.
4. Inflation is expected to raise this by 4 percent during the year, or to a year-end total of $4.16. If
inflation is at an even rate, the average materials price per assembly during the year will be $4.08.
This last amount would be the appropriate standard cost if the standard is to be left unchanged for the
year. This means, of course, that the company should expect favorable materials price variances for the
first half of the year, unfavorable ones for the second half, and zero for the year. (This would not
necessarily be true if the case did not state that production is level throughout the year).
Turning to direct labor, the relevant facts are these:
1. The standard workweek is 40 hours.
2. Daily breaks reduce this by 2.5 hours per week, to 37.5 hours. (Apparently a lunch break is not part of
the standard 8-hour day.)
3. Only 85 percent of the nominal productive hours are in fact productive, because of necessary waiting
or interruptions: 37.5 * 85% = 31.875 hours.
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4. The time-studied operation time is 12 minutes. Management believes this represents only 90 percent
of practical efficiency; i.e., if not being watched, the workers could perform the operation 10/9 times
in 12 minutes, or one time in 10.8 minutes.
5. 31.875 hrs/wk * 60 min/hr / 10.8 min/unit = 177.08 units/week. (If a student applied the 15 percent
waiting time to 40 hours rather than 37.5, this will be 188.9 units/week.)
6. Weekly pay averages 40 * 18 = $720; so standard labor per operation = $720 / 177.08 = $4.07 (or
$3.81 for the alternative interpretation of waiting time).

Cases
Case 19-1: Bennett Body Company
Note: This case is unchanged from the Eleventh Edition.
Approach
This case contrasts a standard cost system with an actual job cost system, and thereby brings out several
points about cost accounting, including: the purposes for which cost accounting data are used; the
paperwork involved in cost accounting; the use of costs for pricing; the problem of controlling costs
under the two types of systems; and the problem of the normal overhead rate.
Students may have difficulty in seeing that: (1) in the Conley standard cost system, costs are not traceable
to individual bodies or models, and therefore no comparison of actual and standard costs by models is
possible; (2) the Conley system easily could be changed to permit comparison of actual and standard
labor and material costs by models, but it is doubtful that such information would be useful for control;
(3) the variances have no meaning unless the standard costs for each model are reasonable; (4) the
overhead variance in Exhibit 1 is meaningless; and (5) the paperwork involved in the Conley system is
less than that in the Bennett system.
Comments on Questions (Numbered as in Mr. Bennetts memorandum)
1. It may be well to discuss the Bennett system first. The subject may be broken down into records of
material, labor, and overhead cost, and the job-cost sheet. Enough hints are given in the case so that
students should be able to visualize the contents of the documents needed to record the incurrence of
each type of cost and how information is recorded on the job-cost sheet. They should also see that the
work involved is not great (perhaps they can even estimate roughly the number of pieces of paper
required). Presumably somewhat less work would be required in the Conley system since only actual
aggregate labor, material, and overhead costs by department would be compiled, plus information on
the number of units produced, plus also the paperwork necessary for the annual calculation of
standard cost figures for the 12 models. There is no need to collect separate costs for each job at
Conley, but this is potentially useful for pricing at Bennett.
2. Conleys direct cost variances could be caused by changes in material prices or labor rates, by
material waste or savings, or by labor costs being more or less efficient than was assumed when the
standard cost sheets were developed. Since actual overhead in Exhibit I is not actual, but is actual
direct labor times the predetermined rate, actual overhead behavior does not show up on Exhibit 1,
and we can make no useful statements about the overhead variance in Exhibit 1.
There is no evidence that Conley in fact decomposes the labor and materials variances into price and
usage components, nor that the net overhead variance (which would be identified when the overhead

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clearing account is closed) is decomposed to identify the spending and volume variances. (The
overhead variance in Exhibit 1 is what is sometimes called an overhead efficiency variance; as is
clear from the exhibit, it has nothing to do with overhead cost control, but is a phenomenon caused by
the labor variance.)
A rather subtle point is that we cannot tell from the case whether Conley debits Work in Process at
actual or standard amounts. Exhibit 1 can be prepared in either instance, since all that is required is a
standard cost sheet for each model in each department, and a numerical count of each model in each
department (plus actual costs by department). The variances (as nearly as we can tell) are calculated
in Exhibit 1, not taken from formal variance accounts.
3. At first the company probably did some figuring as to its total factory overhead for the year,
considering possible changes in price as in the case of supplies or supervision. Conceivably, the
different overhead assessments for different models might have been worked out on some basis such
as length of processing periods, department by department, or in total. Also the company might have
worked on the basis of the average price and average units produced over a period of some years in
an attempt to avoid a cyclical perversity in its per unit overhead costs: low in periods of expansion,
high in periods of contraction. In this case, however, the total overhead cost in each department was
divided by the estimated labor cost in the department to establish an overhead rate per direct labor
dollar. From Exhibit I, we can infer that the overhead rate is $1.00 per labor dollar for Department 4.
The key to assigning standard overhead to a particular model, then, is the department-by-department
labor standard for that model. Note that the November Department 4 overhead standard of $92,502
is not a meaningful budget unless standard monthly production volume is about 593,000 DL$.
4. Such a practice would have eliminated the fluctuations in overhead rates that result from changes in
volume and in actual overhead expenses from month to month. The proposed rate could be used for
pricing jobs, whereas the rate now used was probably too erratic for this purpose. Illustrative figures
for volume fluctuations, which can reasonably show wide monthly swings for seasonal reasons, can
be used to show how this system would lead to high, and probably noncompetitive, prices at a time
when the company most needed the business.
5. Conleys unit standards, if meaningfully developed, do provide the basis for preparing budgets by
department for direct labor and material costs, as illustrated by Exhibit 1. However, a monthly
flexible budget is needed to support control of production overhead costs, whereas Conleys
standard overhead is really an absorption figure, not a budget. In Bennetts custom job-order
environment, the lack of repetitive jobs makes cost control difficult. Certainly the actual job-cost
record for a job can be compared with a detailed cost estimate, if one was developed in bidding on the
job. But in this environment, there is a greater chance than in a more mass-production setting that
variances were the result of poor estimating rather than actual inefficiency or materials wastage.
Students should recognize that in job shops of all kinds (including custom home and other
construction projects), personal observation and supervision tend to play a far greater role in cost
control than do cost accounting systems.
Conclusion
My own feeling is that Bennett should stay with its present system, except for changing to an annual
predetermined overhead rate so that bidding (pricing) decisions arent distorted by short-run, monthly
volume fluctuations. As suggested in number 5 above, it is difficult to implement an effective
responsibility accounting system in this kind of environment. Cost control must come primarily through
ongoing on-the-job supervision. Cost records are useful primarily for providing guidance in bidding on
similar jobs in the future.

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Case 19-2: Black Meter Company

Note: This case is unchanged from the Eleventh Edition.
Approach
The Black Meter Company description provides a useful vehicle for understanding a standard cost
system, and it may be desirable to discuss it in considerable detail. The description in the text does not
cover every number, but it should be adequate so that the students can deduce for themselves where each
number on the exhibits comes from, and in particular, how one exhibit relates to others. Questions 1
through 4 are designed to facilitate and build on this detailed analysis and should be assigned only if the
instructor intends to spend considerable time (a large fraction of one class meeting) on the Black Meter
case. Question 5 asks for a consultants appraisal of the system, and raises the discussion to a more
managerial level. With all five questions, a full class period is definitely required.
Question 1
This question (and questions 2 through 4) should be used only if the instructor wants to go into the Black
Meter Company description in detail. Students can answer it based on information in the text and tracing
the numbers from one illustration to the next.
Question 2
In a standard cost system, the calculations in Illustrations 19-6 through 19-8 are made once a year, or
whenever standard costs are changed. The resulting cost, $5,035.29 for 100 meters (Illustration 19-8) is
used without change for carrying these meters in inventory and for calculating cost of goods sold.
Similarly, the cost of each component is derived from this calculation and used for carrying these
components in inventory. If an actual cost system were used, records similar to those in Illustrations 19-6
through 19-8 would have to be maintained for each meter order and each part production order, with
actual costs being collected on such records. This would probably require much more recordkeeping than
the standard cost system requires. An actual cost system would provide one piece of information that the
standard cost system does not provide, namely the actual cost of specific production orders. This might be
useful to management if, for example, it showed that actual costs were tending to drift upward throughout
the year. However, there are other ways of identifying possible inefficiencies, such as the difference
between actual and standard direct labor cost, as indicated in Illustration 19-9.
Question 3
This question is more difficult than it may appear, as it entails developing the flowchart shown in Exhibit
A on page 56. The greatest subtlety in Exhibit A is the accounting for Materials Inventory. This account is
debited based on actual quantities at standard prices but is credited based on standard quantities at
standard prices. If you ask students to assume a month where purchased quantities and standard quantities
issued are equal, they should see that any material usage variance will be buried in this account. You
can then explain (or get them to realize) that when a physical count is taken and costed at standard, then
the difference between this amount and the book value of materials inventory includes material usage
variance. (It will also include accounting errors and pilferage.) This inventory adjustment restores this
accounts beginning balance for the next period to actual quantity at standard prices, and the debit or
credit which makes this adjustment has its counterpart in an entry to Cost of Sales. We know from the text
that this inventory is taken semiannually, and from Illustration 19-11 that this usage variance is closed
to the income statement. This is a difficult concept, which can be reviewed in the C.F. Church case in
Chapter 20.
Similarly students should see that the direct labor variance account combines efficiency and rate
variances. These components of total labor variance are not mentioned in the text, but I have found that

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Chapter 19

better students can invent them prior to their formal presentation in Chapter 20. By the same token,
some students can see intuitively that the overhead variance combines spending and volume effects.
Comparing Exhibit A with the texts Illustration 19-2, one sees the two flowcharts are the same except for
materials usage variance. In Illustration 19-2, this variance falls out explicitly, since Materials
Inventory is credited at actual quantity issued costed at standard prices whereas Work in Process is
debited at standard quantity at standard prices. Both methods are seen in practice; the texts method seems
superior to Black Meters, in that usage variance is identified in a more timely fashion and is not
muddied by pilferage and accounting errors.
Question 4
This question illustrates the work involved in changing standard costs, and is also helpful in tracing
amounts from one illustration to another.
In Illustration 19-6, the cost of chamber rings would be increased by 1.76 hours * $1 = $1.76. The cost
therefore becomes $249.24 + $1.76 = $251. This increase carries through to Illustration 19-7, making the
cost $861.34 + $1.76 = $863.10. Finally, it carries through to Illustration 19-8.
In addition, Illustration 19-8 is increased by the $1 per hour increase in labor for Department 131. Since
there are 10.2 hours of labor, the increase is $10.20. The total cost for 100 meters in Illustration 19-8
therefore becomes:

As given...................................................................................................................................
$5,035.29
Add from 120A........................................................................................................................
1.76
Add from 131...........................................................................................................................
10.20
Adjusted costs...........................................................................................................................
$5,047.25

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Chapter 19

Accounts Payable
Act. Qty. @
Act. Price
Material Price Variance
Balance to Cost of Sales

Materials Inventory
Act. Qty. Std.
Std. Qty. @
Price
Std. Price
Inventory
Adjustment
Every 6 mos. a physical inventory is taken and
costed at standard. Any difference between this
amount and the book balance is an inventory
adjustment which is closed to Cost of Sales
Work in Process Inventory*
Material
Sales
(@ Std.)
@ Std.

Wages Payable
Act. Hrs. @
Act. Rate

Actual

Overhead
Std. Hrs. x
Overhead Rate

Direct Labor Variance

Balance to Cost of Sales

Labor
(Std. Hrs. @
Std. Rate)
Overhead (@
Std.)

Overhead Variance
Any month-end balance in this
account closed to Overhead
Variance

Balance to Cost of Sales

*For meter parts, costs flow at standard from Work in Process to Finished Goods, and then to Cost of Sales. The diagram
here is descriptive of complete meters, which are made to order and hence are not inventoried prior to shipment to the
customer.

Sales
@ Std.

Cost of Sales
To Revenue
and Expense
Summary

Variances:
-Material price
-Materials inventory
adjustments (usage)
-Direct Labor
-Overhead

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Question 5
This or any other system cannot be evaluated without identifying the purposes the system is supposed to
fulfill. Although not explicitly stated, I think it is reasonable to impute the following purposes: (1) to
provide monthly operating statements; (2) to control costs; and (3) to help on a variety of necessary
chores that have to be done, such as paying employees what is due them, keeping track of orders and
material, paying suppliers, and billing customers. Since these jobs have to be done anyway, we may be
able to get figures that will help accomplish the first two purposes as an inexpensive by-product of doing
them.
Monthly Operating Statements
If we hew strictly to the definition that net profit is the difference between sales and the cost of making
and selling the same goods that are in the sales figure, this system does not provide net profit because:
a. The purchase price variance is related to material purchased in the month.
b. The labor and overhead variances are related to the products worked on in the month.
c. Various discrepancies creep in that are uncovered by a physical inventory only every six months
If, however, we ask: How could you get the actual profit if you wanted to? we find the answer is
difficult, if not impossible. Suppose an actual cost system were used. Then, for each production order of
each item there would have to be a set of calculations similar to those in Illustrations 19-6 to 19-8,
whereas under the standard cost system, these calculations are made only once a year. (Students usually
find it hard to believe that a standard cost system is much simpler than an actual cost system and requires
much less paperwork in a situation of the kind described.)
If we try to find actual profit by the direct determination of inventories, we could throw out the cost
accounting system entirely but would have to take a physical inventory every month; the job of costing
the work in process would be significant.
Furthermore, even if the profit resulting from this system differs somewhat from the strict definition
above, the income statement may, nevertheless, be a useful device, since it reports the variances that
occurred during the month (except material usage). This is earlier than they would be reported according
to the strict definition, and of course, these variances would not show up at all if a standard cost system
were not used.
Control
No system controls costs. At best, a system provides information that responsible people can use in the
control process. People control.
The system provides no summary figure on material usage in a month when no physical inventory of
materials is taken, and the June and December income statements are distorted by including usage
variance for the previous six months.
This situation could be improved quite easily as follows: if material in excess of standard is needed, a
requisition should be filled out for this excess. The amounts of such requisitions can be totaled monthly,
with Materials Inventory credited by this amount, and true Materials Usage Variance account debited.
Then the semiannual physical inventory will result in a variance including accounting errors and
pilferage, but not usage. This should largely eliminate the distortions in the monthly income statements

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which are created by the current procedure. Alternatively, Materials Inventory could be credited at actual
quantity times standard price, and Work in Process debited at standard quantity times standard price (as in
Illustration 19-2).
The system provides a total figure on the direct labor variance. Although there is no routine report that
breaks this variance down, it would be possible to reclassify with little difficulty. Labor rate and
efficiency variances could also be broken down from timecards by department, by job, or even by
operation, but management apparently feels that this is not worth the effort
Because the overhead costs are allocated and because expected costs will not vary proportionately with
production volume, the overhead variance is not of much use for control purposes. This is characteristic
of overhead costs in a standard full cost system, and some students may see the need for special devices
(variable budgets and collection of costs by responsible department) to handle this situation. At this stage,
however, we can only touch on this matter.
The key control is collecting actual costs by responsibility center, not by product. I illustrate this with a
matrix, both in this case and Bennett Body Company. Both Black Meter and Conley can determine
variances by responsibility center, whereas it is not clear that Bennett can. Similarly, Bennett needs actual
product costs for frequent pricing decisions, whereas Black Meter and Conley do not.

Case 19-3: Brisson Company

Note: This case is unchanged from the Eleventh Edition.
Approach
This problem takes the student through a complete cycle of transactions in a standard cost system in a
simple setting. It shows how such a system works, including the development of variances, and ties cost
accounting to the accounting cycle the student learned in Part 1 of the book. (Brissons system is the same
as the one depicted in Illustration 19-2.) This seems to be a valuable exercise, especially in helping to
minimize the omnipresent problems students have with production cost variance analysis in the next
chapter. If not assigned for class, this makes a good exam case. (For ease in grading, I suggest you
prepare forms with all needed T accounts preprinted on them.)
Question 1

Bal.
(2)
Bal.
Bal.
(9)
Bal.

Materials Inventory
50,250 (4)
104,980
36,420

118,810
36,420

Bal.
(4)
(5a,8)
(8)
Bal.

Finished Goods Inventory

155,400 (10b)
232,602
267,684
190,482
190,482

11

Work in Process Inventory

75,600 (9)
267,684
116,696
79,200
99,000
102,812
102,812

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(3a)

(5a)
(6)
(11)

Accounts Payable
102,300 Bal.
(2)
143,435 (6)
Bal.

104,700
103,535
37,500
143,435

Bal.
(3b)
(10a)

All Other Liabilities

Bal.

47,250

Bal.

99,000

(5b)

Overhead
40,500 (8)
55,800
2,700

(14)

Overhead Variance
2,700 (11)

2,700

(16)

Labor Variance
6,900 (5a,8)

6,900

(12)

(7)

(10b)

Anthony/Hawkins/Merchant

Sales
375,150 (10a)

375,150

102,300
192,000
116,700
18,300
78,750
384,600

384,600
Wages Payable
116,700 Bal.
2,250 (5a)
Bal.
Shareholders Equity
Bal.
521,379 (19)
Bal.

Selling and Admin. Expense

78,750 (18)
78,750
Cost of Sales
232,602 (13)

All Other Assets

325,500 (3a)
192,000 (3b)
375,150 (5b)
(6)
(7)

6,150
112,800
2,250

448,650
72,729
521,379

(15)

Material Price Variance

1,445 (2)

1,445

(4)

Material Usage Variance

2,114 (17)

2,114

(13)
(17)
(18)
(19)

Income Summary
232,602 (12)
2,114 (14)
78,750 (15)
72,729 (16)

375,150
2,700
1,445
6,900

232,602

Notes on entries (numbered to correspond to the case transactions):

(2) 2,500 @ $29.80 + 1,000 @ $30.48 = $104,980 @ std.
$104,980 - $103,535 = $1,445 credit (favorable) price variance. Favorable price variances often
arise in the first half of the year; the standard is set to represent the annual average, and with
inflation, prices will tend to be below this average for the first 6 months and above it in the latter
half of the year.
(3b)

The debit reflects an increase in Cash; the credit represents the decrease in Accounts Receivable.

(4)

3,200 @ $29.80 + 700 @ $30.48 = $116,696 for original issues; plus extra (replacement) issues
as follows: 100 @ $12.37 + 20 @ $11.25 + 45 @ $10.80 + 20 @ $6.63 + 4 @ $8.43 = $2,114 (an

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unfavorable usage variance); giving total issues of $118,810. (Note: Some students may claim
that the $2,114 in extra materials issues were to replace materials that were defective, as opposed
to replacing good items that were spoiled in the production places. Such students may treat this
$2,114 as an overhead cost; if so, they will have $0 material usage variance and $586 favorable
overhead variance.)
(5a)

This entry stumps many students, at least temporarily. Some will cleverly set up a labor clearing
account analogous to the overhead clearing account, and then charge the standard labor to this
account at entry (8) the balance in this labor clearing account will be $6,900 dr., which is closed
to Labor Variance. Other students will do what Ive done hereread ahead to entry (8), and
deduce the labor variance as part of the entry.

(9)

3,000 @ $70.30 + 800 @ $70.98 = $267,684

(10b)

2,400 @ $70.30 + 900 @ $70.98 = $232,602 cost of sales

(11)

This closes the overhead clearing account.

(12)-(19)

These entries close the temporary accounts and income summary.

Question 2

BRISSON COMPANY
Income Statement Month of April
Sales revenue......................................................................................................................................................................
$375,150
Cost of sales @ standard....................................................................................................................................................
232,602
Standard gross margin........................................................................................................................................................
142,548
Production cost variances*.................................................................................................................................................
8,931
Actual gross margin...........................................................................................................................................................
151,479
Selling and administrative expense....................................................................................................................................
78,750
Income
$ 72,729

*Production cost variances:

Martial price................................................................................................................................................................................................................
$1,445F
Material usage.............................................................................................................................................................................................................
2,114U
Labor...........................................................................................................................................................................................................................
6,900F
Overhead.....................................................................................................................................................................................................................
2,700F
$8,931F

Question 3

BRISSON COMPANY
Balance Sheet
As of April 30
Assets
Liabilities and Shareholders Equity
Materials inventory............................................................................................................................................................
$ 36,420
Accounts payable.................................................................
$143,435
Work in process inventory..................................................................................................................................................
102,812
Wages payable......................................................................
2,250
Finished goods inventory...................................................................................................................................................
190,482
All other liabilities................................................................
47,250
All other asses....................................................................................................................................................................
384,600
Shareholders equity.............................................................
521,379
$714,314
$714,314

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Case 19-4: Landau Company*

Note: This case is unchanged from the Eleventh Edition. The commentary to the Cotter Company case
(case 20-3) explains how Cotter and Landau can be used as a two-case sequence.
Approach
I spend about the first half of class working through the comprehensive examples shown below. This 9column table covers every possible relationship among sales volume, production volume, and normal
volume. Even if students have not been formally exposed to overhead volume variance, they quickly pick
it up. Before class I put on the blackboard the headings of the nine columns and the first two lines of data
(sales and production), as well as the assumptions. (If the instructor has limited board space, this can be
prepared as a handout, and filled out by each student as you do so on a transparency.)

Assume:

Full vs. Direct (Variable) Costing Illustration

Unit price
$5.00
N = Normal volume
Unit variable costs = $3.00
= 100 units
Fixed costs
= $100.00
$100
Full cost per unit = $3.00 +
= $4.00 (Assume no spending variances)
100 units

S=P
S>P
S<P
Sales (S)
100
80
110
115
90
125
90
75
100
units
Pdn. (P)
100
80
110
100
80
110
100
80
110
Revenue..........................................................................................................................................................................................
$500
$400
$550
$575
$450
$625
$450
$375
$500
Full Costing
Cost of Goods Sold.........................................................................................................................................................................
400
320
440
460
360
500
360
300
400
Gross Margin...................................................................................................................................................................................
100
80
110
115
90
125
90
75
100
Volume Variance.............................................................................................................................................................................
-(20)
10
-(20)
10
-(20)
10
Profit...............................................................................................................................................................................................
$100
$ 60
$120
$115
$ 70
$135
$ 90
$ 55
$110
Variable Costing
Cost of Goods Sold.........................................................................................................................................................................
300
240
330
345
270
375
270
225
300
Contribution....................................................................................................................................................................................
200
160
220
230
180
250
180
150
200
Fixed Costs.....................................................................................................................................................................................
100
100
100
100
100
100
100
100
100
Profit...............................................................................................................................................................................................
$100
$60
$120
$130
$80
$150
$ 80
$50
$100

Observe: S = P, no difference; S > P, greater profit with variable costing; S < P, greater profit with full
costing. Compare columns and ; same sales, but different profits with full costing; same profit with
variable costingditto for and .
I then complete column I for full costs only, then have students do the remaining eight. Next, I raise this
board and extend the nine columns for variable costing, again doing the first column myself and having
students try the others. When all nine columns are completed, I think even the weakest students
understand the different mechanics of the two systems.
Next, I ask them to generalize about which system shows the greater profit if S=P, if S > P, and if S < P
(shown as Observe in the table). I also have them compare columns 1 and 9, and then 5 and 7. In both
instances sales were equal; but full costing showed different profits, whereas variable costing showed
equal profits. I then proceed to discuss the Landau case.
*

This teaching note was written by James S. Reece. Copyright by James S. Reece.

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The central issue is the desirability of variable costing from the point of (1) the users of balance sheet and
income statement information (management, stockholders, creditors, etc.), (2) as an aid in pricing, and
(3) as an aid in control.
Income Statements. It is instructive to reconcile the difference in pretax income under the methods for at
least one of the two months. I begin by noting that the difference between the two systems is in how
budgeted fixed overhead costs find their way to the income statement. With variable costing, budgeted
fixed costs (and actual, for that matter) for a given month are charged to that months income statement;
this is simple, but clearly a violation of both the cost concept for asset (inventory) valuation and the
matching concept. With full costing, budgeted fixed costs are charged to income in two pieces: the
standard fixed costs in cost of sales (consistent with the matching concept) and the over- or
underabsorbed budgeted fixed costs in that months overhead volume variance (not consistent with the
matching concept if closed to the monthly P&L, which is the usual practice). Thus, to reconcile the
difference in reported income, we need to identify the amount of budgeted fixed costs in the months
income statement for each method. For June and July, the reconciliation is:

June
July
Full standard cost of sales..................................................................................................................................................
$484,640
$521,758
Variable standard cost of sales............................................................................................................................................
337,517
363,367
Budgeted fixed costs in cost of sales..................................................................................................................................
147,123
158,391
Overhead volume variance.................................................................................................................................................
(1,730)
63,779
Budgeted fixed costs charged to income with absorption costing......................................................................................
145,393
222,170
Budgeted fixed costs charged to income with variable costing..........................................................................................
192,883
192,883
Difference..........................................................................................................................................................................
($ 47,490)
$ 29,287
Check:
Pretax income, variable costing.....................................................................................................................................
$ 33,539
$65,099
Pretax income, absorption costing.................................................................................................................................
81,029
35,812
Difference.................................................................................................................................................................
$ (47,490)
$29,287
Of course, the above calculations can be performed using actual fixed costs charged to the income
statement rather than budgeted. But since both costing approaches treat the overhead spending variance
the same way, the difference in profit must be a function of the treatment of budgeted fixed costs. Also,
some students will ask how we know that the $192,883 is a budget figure rather than actual. There are
two reasons: (1) it seems too great a coincidence for the actual amount to be exactly the same in both
months; and (2), more important, it wouldnt make sense to show an overhead spending variance if the
amount shown for overhead were an actual amount.
Students should also be prepared to explain to Silver why the sum of the two months absorption costing
net incomes is $60,757, whereas for variable costing it is $51,291. As stated in the text (and proven in
Appendix B), for any period in which production volume exceeds sales volume, full costing reports
higher income than variable costing. Thus, for the combined June-July period, Landaus production
volume must have exceeded its sales volume. (This was also true for June, but not for July.) Over the
course of an entire year, if (but only if) the annual sales and production volumes are equal the month-tomonth income differences will wash out i.e., annual income will be the same under either method.
Comments on Questions
Question 1
In the order of their being mentioned in the case, the various stated pros and cons of variable costing,
together with my reactions to them, are as follows:
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1. Pro: Terry Silver doesnt understand income changes in absorption costing attributable solely to
production volume changes. To me, this is an important reason to consider seriously the introduction
of variable costing for monthly management reports.
2. Pro: It eliminates time-consuming and argumentative fixed overhead allocations. This is only a partial
truth. Absorption costing statements would need to be prepared at least annually, and perhaps
quarterly, for shareholder reporting and income tax calculations. However, this restatement could be
done using a plant-wide, after-the-fact overhead rate. Departmental predetermined overhead rates
would not need to be developed as part of the process of preparing the standard cost sheet for each
product.
3. Pro: Cost control will be improved. I dont feel this is necessarily the case. Certainly a clear
segregation of fixed and variable costs aids in cost control, because variable costs are controlled
essentially on a unit-of-product basis (e.g., did we spend more or less than $17.63 per unit for raw
materials?), whereas fixed costs are controlled on an amount-per-time-period basis (e.g., was our July
factory supervision cost above or below budget?) However, absorption costing does not preclude this
sort of cost analysis in any way. The chief advantage of variable costing is that it eliminates the oftenconfusing overhead volume variance.
4. Pro: Contribution margin data are better signals of product profitability than are gross margin data.
Silvers contention here is only a partial truth. In the example given, it is true that if a customer were
indifferent between buying $1,000 worth of 129 or $1,000 worth of 243 then Landau would be $84
better off selling $1,000 worth of 129. However, if the allocations of fixed costs are reasonably
equitable, then 129 is causing more fixed costs to be incurred per dollar of sales [($2.54 - $1.38) /
$4.34 = 26.7%] than is 243 [($3.05 - $2.37) / $5.89 = 11.5%]. Even though these fixed costs may be
sunk costs in the short run, in the longer run they are not. Thus, which of the two products is more
profitable is a matter of the time horizon being considered.
Students can understand this better if you use an exaggerated example. Suppose that products X and
Y are substitutes in the eyes of the customer, and that they have the same selling price per unit, $10.
Both have the same material costs, but X is made with a manual process whereas Y is made by highly
automated equipment. Thus X has a much smaller contribution margin per unit than does Y. Can we
say that Y is more profitable?
5. Con: Marketing will underprice products if only the variable cost per unit is emphasized. I cant agree
with the treasurers condescending attitude about marketing managers understanding of the business
as a whole. In marketing, as in other areas of the company, variable cost data are useful for some
decisions, whereas full cost data are useful for others. If top management believes that marketers (or
any other decision makers) will misuse variable cost data, this argues for educating the decision
makers, not suppressing the data.
6. Con: Lack of control over long-run costs can bankrupt a company. This is true, but really has nothing
to do with the variable costing proposal. It is equally true that if short-run costs get out of control, the
company wont have a long run to worry about. If in this company the introduction of variable
costing will introduce for the first time the routine separation of fixed and variable costs, then it is
quite possible that control over all costs will be enhanced, as the controller is asserting.
7. Con: Lower profits will be worrisome to shareholders and bankers (even though lower profits are
desirable for union negotiations and income taxes). This is a totally fallacious argument. Variable
costing is not permitted under either GAAP or income tax regulations. Moreover, the president
doesnt understand that, if for the year, the sales and production volumes are equal, then both methods
report the same income.
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To me, the key point is that this is not an either-or issue. Companies should consider designing their
account structure so that variable costs are segregated from fixed costs. These cost data represent a
data base, the elements of which can be put together in different ways for different purposes. As
stressed in Chapter 17, full cost data are useful for certain purposes; and as stressed in Chapters 26
and 27, they are not useful for other purposes. That is the overall point I try to make with the Landau
case.
Question 2
Covered in above comments.
Additional Question
If using the case (as I do) with Chapter 20 after the Cotter case, I assign this additional question: How
busy (relative to normal volume) was Landaus factory in June and July?
As demonstrated to students in the Cotter Case, we know that:
Actual volume as % of normal

Absorbed fixed costs

Budgeted fixed costs

We also know that the overhead volume variance equation is equivalent to:
Absorbed fixed costs = Budgeted fixed cost + Volume variance
Thus for Landau we have:
June : Volume

192,833 1,730
100.9% of normal
192,883

June : Volume

192,833 (63,779)
66.9% of normal
192,883

Case 19-5: Lynchs Chicken Ranch

Note: This case is new in the Twelfth Edition.
Discussion
This case raises two cost-related issues: joint- (or by-) product costing and transfer pricing. The issues are
salient in the case because the accounting treatments affect division profits and, consequently, the division
managers bonuses.
It is useful to start the class by clarifying the interdependencies among the divisions. They are illustrated
in Figure TN-1 below.

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Figure TN-1
Division Interdependencies

Feed Division
Ron Johnson

Feed: Corn,
soybeans

Corn
mulch

Egg Division
Gary Dawson

Chicken droppings

Fertilizer Division
Judy Smith

The issue that provoked the discussion is the cost of feed, which has risen by 20% recently. This rise has
caused the Egg Division to become unprofitable. Gary Dawson, the Egg Division manager, points out in
the case that while the market prices of corn feed have increased, due to a drought in corn-growing
regions, Ron Johnsons Feed division was not affected by the drought. Hence, the cost of corn feed
produced by Lynchs Chicken Ranch have not increased, and Gary does not want to have to absorb feed
cost increases.
In his search to stem his losses, Gary is attempting to boost his bottom-line by capturing some of the
gains from the sale of fertilizer stemming from reprocessing of chicken droppings. Egg Division
employees collect the waste and deliver it to the Fertilizer Division, which uses automated digesters to
convert the waste into a marketable product.
The current transfer price of the waste is zero. Gary Dawson argues that the waste obviously has value,
and that value stems from his chickens inefficient digestive processes. Forty percent of the nutrients the
chickens eat is excreted in the waste. Hence, he wants the Fertilizer Division to pay for 40% of the cost of
feeding the chickens. Judy replies that Gary is already getting a large benefit from her converting the
waste to fertilizer. He formerly had to pay $200,000-250,000 to have the droppings removed.
In this example, the chicken droppings can be seen as a by-product of producing the eggs, or eggs and
fertilizer can be seen as joint products.
While it is generally desirable to use market-based transfer pricing in situations like this, where products
are undifferentiated and markets are competitive (see Chapter 22), in this case the use of market-based
transfer prices allow Ron Johnsons Feed Division to reap windfall gains. Gary is requesting a reduction
in the prices his division has to pay for feed. Ron Johnson says that he can sell the feed outside at the
market price, so he should not be forced to transfer it internally at an artificially reduced price.
Rons logic is correct. The opportunity cost for Lynchs Chicken Ranch is the current market price.
Hence, that is the price that the Egg Division should pay for the feed. If that makes the Egg Division look
unprofitable, so be it. Maybe the price of eggs should rise to offset the increase in the operating costs. But
what if the competitors dont follow the price increase?
There is no simple answer to the joint-costing problem. The profits on the fertilizer produced from the
chicken waste can be attributed solely to the Fertilizer Division or the Egg Division, or the profits can be
shared. If the profits from this type of fertilizer become highly significant to both divisions, then it might
make sense to combine the Egg and Fertilizer Divisions into one. It would be a division with two products
eggs and fertilizer. If these profits are relatively small, then fixing a transfer pricing policy and setting
budgets accordingly should provide a reasonably good solution to an intractable problem.

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