Absorption and Variable Costing PAUL ANTHONY DE JESUS

Problem 1. AAA makes a state of the art toy. Each toy gun sells for 1,000 each. Data for 2015’s operations are as
follows:
Units Variable Costs:
Beginning Inventories 5 Direct Materials P24,000
Production 80 Direct Labor 16,000
Ending Inventory 15 FOH 8,000
Unit Sold 70 Selling and Admin 4,000
Fixed Cost:
FOH 20,000`
Selling and Admin 2,000

Required:
1. Determine the inventory cost per unit under:
A. Absorption Costing
B. Variable Costing
2. Determine the cost of ending inventories under:
A. Absorption Costing
B. Variable Costing
3. Prepare income statement under Absorption and variable costing
4. How much is the difference in income between the costing methods?
5. What causes the difference in income between the costing methods?

Problem 2: the following information are taken from the books of AAA, which assumes FIFO for inventory flow:

Inventory (in units) 2014 2015

BI None ?
Production 10,000 units 9,000 units
EI 3,500 units 1,000 units

Sales (P2 per unit)

Variable manufacturing costs (P0.75 per unit) P7,500 P6,750
Fixed manufacturing costs P5,000 P5,400
Selling and Admin costs (50% variable) P4,500 P7,500

Required:
1. Determine 2014 profit under variable and absorption costing
2. Reconcile the two income figures in no. 1
3. Determine 2015 profit under variable and absorption costing
4. Reconcile the two figures in no. 3

Problem 3: MMM produces and sells bags. Its production , sales and cost data for a three year period are shown below:
Year 1 Year 2 Year 3
Manufacturing Costs:
Materials (per unit) P3 P3 P3
Labor (per unit) 2 2 2
Variable FOH (per unit) 1 1 1
Fixed FOH P2,000 P2,000 P2,000
Selling and Admin Exp.
Variable (per unit sold) P1.50 P1.50 P1.50
Fixed (total) P800 P800 P800
Production (in units) 1,000 1,000 1,000
Sales (in units) 1,000 800 1,100
Selling Price (per unit) P15 P15 P15

1. The underlying difference between absorption costing and variable costing lies in the treatment of:
a. Direct labor c. Fixed Seli=ling and Admin Exp.
b. Fixed FOH d. Variable Selling and Admin Exp.

2. Under Absorption costing, Fixed manufacturing overhead costs are best described as
a. Direct Product costs c. Direct period costs
b. Indirect Product costs d. Indirect Period costs
3. Under variable costing, all product cost are variable.

4. Absorption costing differs from variable costing in that

a. Variable costing treats all variable costs as product costs
b. Variable costing treats selling costs as period costs
c. Inventory cost is higher under absorption costing
d. Profit is higher under absorption costing

AAA manufactures a single product. Unit variable production costs are P20 and fixed production costs are P150,000. AAA
uses normal activity of 10,000 units. AAA began the year with no inventory, produced 12,000 units and sold 7,500 units.

5. What is the unit product cost under variable costing?

a. 20 c. 35
b. 32.50 d. 40

6. What is the unit product cost under absorption costing?

a. 20 c. 35
b. 32.50 d. 40

7. What is volume variance under absorption costing?

a. 24,000 U c. 30,000 U
b. 24,000 F d. 30,000 F

8. There is no volume variance under variable costing

9. If production is higher than sales, then absorption costing income is expected to be:
a. Lower than variable income c. Equal to variable income
b. Higher than variable income d. Incomparable with variable income

10. NNN produced 10,000 units and sold 9,000 units. Fixed FOH costs were P20,000 and variable FOH P3 per unit. Which
of the following best describes the net income under absorption costing method?
a. 2,000 more than net income under variable costing method
b. 2,000 lower than net income under variable costing method
c. 5,000 more than net income under variable costing method
d. 5,000 lower than net income under variable costing method

11. MMM has operating income of P50,000 using direct costing for a given period. Beginning and Ending inventories for
that period were 13,000 and 18,000 units, respectively. If the fixed FOH application rate is P2 per unit, then what is the
operating income using the absorption costing?
a. 70,000 c. 50,000
b. 60,000 d. 40,000

12. HHH had 16,000 units in its beginning inventory. During the year, the company’s variable production costs were P6
per unit and fixed manufacturing overhead costs were P4 per unit. The company’s net income for the year was P24,000
lower under absorption costing than it was under variable costing. How many units does the company have in its ending
inventory?
a. 22,000 units c. 6,000 units
b. 10,000 units d. 4,000 units

13. Variable costing is unacceptable for

a. Financial reporting c. Transfer pricing
b. CVP analysis d. Short term planning

14. Variable costing income fluctuates with production and does not react to changes in sales.
15. ABC manufactures a small part that is widely used in various electronic products such as home computers. Operating
results for the first three years of activity were as follows;
Year 1 Year 2 Year 3
Sales 800,000 640,000 800,000
COGS:
Beginning Inventory - - 200,000
Add: COGM 580,000 600,000 560,000
TGAS 580,000 600,000 760,000
Less: Ending Inventory - 200,000 140,000
Total 580,000 400,000 620,000
Gross Profit 220,000 240,000 180,000
Less: Selling and Admin Expenses 190,000 180,000 190,000
Net Operating Income 30,000 60,000 (10,000)

In the latter part of year 2, a competitor went out of business and in the process dumped a large number of units in the market. As a
result, ABC’s sales dropped by 20% during year 2 even though production increased during the year. Management had expected
sales to remain constant at 50,000 units; the increased production was designed to provide the company with a buffer of protection
against unexpected spurts in demand. By the start of year 3, management could see that inventory was excessive and that spurt in
demand were unlikely. To reduce the excessive inventories, ABC cut back production during year 3, as shown below:

Year 1 Year 2 Year 3

Production in units 50,000 60,000 40,000
Sales in units 50,000 40,000 50,000

Additional Information:
a. The company’s plant is highly automated. Variable manufacturing costs (DM, DL and variable FOH) total only P2 per unit, and fixed
manufacturing FOH costs total P480,000 per year.

b. Fixed FOH costs are applied to units of product on the basis of each year’s production (that is, a new Fixed FOH rate is computed
each year)

c. Variable selling and administrative expenses were P1 per unit sold in each year. Fixed selling and administrative expenses totaled
P140,000 per year.

d. The company uses a FIFO inventory flow assumption.

ABC’s management can’t understand why profits doubled during year 2 when sales dropped by 20% and why a loss was incurred
during year 3 when sales recovered to previous levels.
Required:
1. Prepare variable costing income statement for each year using the contribution approach.
2. Refer to the absorption costing income statements above
a. Compute the unit product cost in each year under absorption costing. (show how much of this cost is variable and how much is
fixed)
b. Reconcile the variable costing and absorption costing income figures for each year.

3. Refer to absorption costing income statement. Explain why net operating income was higher in year 2 than it was in year 1 under
the absorption costing approach, in light of the fact that fewer units were sold in year 2 that in year 1.

4. Refer to absorption costing income statement. Explain why the company suffered a lost in year 3 but reported a profit in year 1
although the same number of units was sold in each year.

5. a. Explain how operations would have differed in year 2 and year 3 if the company had been using JIT inventory methods.
b. If JIT had been used during year 2 and year 3, what would the company’s net operating income (loss) have been in each year
under absorption costing? Explain the reason for any difference between these income figures and the figures reported by the
company in the statement above.

Variable cost per unit: Problem 17. ABC manufactures and sells a single product.
Cost data for the product are given below:
Direct materials 7
Direct labor 10
Variable FOH 5
Variable Selling and Admin 3
Total VC per unit 25

The product sells for P60 per unit. Production and

Fixed costs per month:
sales data for July and August follow:
Fixed FOH 315,000
Fixed selling and Admin 245,000
Total 560,000
 Units Produced Units Sold
July 17,500 15,000
August 17,500 20,000

The company’s accounting department has prepared absorption costing income statement for July and August as
presented below:
Year 1 Year 2
Sales 900,000 1,200,000
COGS:
Beginning Inventory - 100,000
Add: COGM 700,000 700,000
TGAS 700,000 800,000
Less: Ending Inventory 100,000 -
Total 600,000 800,000
Gross Profit 300,000 400,000
Less: Selling and Admin Expenses 290,000 305,000
Net Operating Income 10,000 95,000

Required:
1. Determine the unit cost under:
a. Absoprtion costing b. Variable costing
2. Prepare variable costing income statement
3. Reconcile the Variable costing and absorption costing operating income.
4. The company’s accounting department has determined the company’s break even point is 16,000 units per month,
computed as follows
Fixed cost per month = 560,000 = 16,000 units
CM/unit 35
I’m confused said the president. The accounting people say that our break even point is 16,000 units per month, but we sold only
15,000 units in July, and the income statement they prepared shows a P10,000 profit for the month. Either the income statement is
wrong or the break even point is wrong. Prepare a brief memo for the president, explaining what happened on the July income
statement.