Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
Chapter 9 Income Effects of Denominator Level on Inventory Valuation
9.1 Identify the factors important to choosing the denominator level used to calculate
fixed overhead allocation rates.
1) Using either the theoretical capacity or practical capacity as the denominator-level concept will result
in the same production-volume variance.
2) Determining the “right” level of capacity is one of the most strategic and difficult decisions managers
face.
3) Both theoretical and practical capacity measure capacity in terms of demand for the output.
4) Normal capacity utilization is the expected level of capacity utilization for the current budget period,
which is typically one year.
5) Normal capacity utilization is not the same as master-budget capacity utilization.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
6) ________ is the level of capacity based on producing at full efficiency all the time.
A) Practical capacity
B) Theoretical capacity
C) Normal capacity
D) Demand capacity
E) Master-budget capacity
7) Theoretical capacity is based on which of the following assumptions?
A) that absorption costing is used
B) that variable costing is used
C) production will occur at peak efficiency all the time
D) production will occur at peak capacity where feasible (e.g., except for maintenance downtime)
E) production can never occur at peak capacity
8) Practical capacity is based on which of the following assumptions?
A) that absorption costing is used
B) that variable costing is used
C) Production will occur at peak efficiency all the time.
D) Production will occur at peak capacity where feasible (e.g., except for maintenance downtime, repairs,
holidays, etc.).
E) Production can never occur at peak capacity.
9) The denominator-level concept based on capacity utilization that satisfies average customer demand
that includes seasonal and cyclical factors is called
A) theoretical capacity.
B) practical capacity.
C) normal capacity.
D) master-budget capacity.
E) supply capacity.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
10) The denominator-level concept based on capacity utilization for the anticipated level of output that
will satisfy customer demand for a single operating cycle, and complies with the Canada Revenue
Agency for tax purposes, is the
A) theoretical budget capacity.
B) practical budget capacity.
C) normal capacity.
D) master-budget capacity.
E) supply capacity.
11) A major reason for choosing ________ utilization over ________, is the difficulty in forecasting.
A) theoretical capacity; master-budget
B) practical capacity; master-budget
C) normal capacity utilization; master-budget
D) master-budget; theoretical capacity
E) master-budget; normal capacity utilization
12) A manufacturing firm is able to produce 2,000 pairs of shoes per hour, at maximum efficiency. There
are three eight-hour shifts each day. Production is actually 1,600 pairs of shoes per hour due to
unavoidable operating interruptions. The plant is expected to run every day but was only able to operate
for 27 days in September.
What is the theoretical capacity for the month of September?
A) 1,488,000 shoes
B) 1,440,000 shoes
C) 1,036,800 shoes
D) 1,296,000 shoes
E) 1,152,000 shoes
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
13) A manufacturing firm is able to produce 2,000 pairs of shoes per hour, at maximum efficiency. There
are three eight-hour shifts each day. Production is actually 1,600 pairs of shoes per hour due to
unavoidable operating interruptions. The plant is only able to operate for 27 days per month due to
scheduled maintenance.
What is the practical capacity for the month of September?
A) 1,488,000 pairs of shoes
B) 1,440,000 pairs of shoes
C) 1,036,800 pairs of shoes
D) 1,296,000 pairs of shoes
E) 1,152,000 pairs of shoes
14) The budgeted fixed manufacturing cost rate is the lowest for
A) practical capacity.
B) supply capacity.
C) master-budget capacity utilization.
D) normal capacity utilization.
E) theoretical capacity.
15) ________ provides the lowest estimate of denominator-level capacity.
A) Practical capacity
B) Theoretical capacity
C) Master-budget capacity utilization
D) Normal capacity utilization
E) Supply capacity
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
Answer the following question(s) using the information below.
A manufacturing firm is able to produce 1,000 pairs of shoes per hour, at maximum efficiency. There are
three eight-hour shifts each day. Due to unavoidable operating interruptions, production averages 800
units per hour. In the month of June the plant actually operated only 25 days.
16) What is the theoretical capacity for the month of April?
A) 600,000 units
B) 720,000 units
C) 744,400 units
D) 576,000 units
E) 480,000 units
17) What is the practical capacity for the month of April?
A) 600,000 units
B) 720,000 units
C) 744,400 units
D) 576,000 units
E) 480,000 units
18) From the perspective of long-run product costing it is best to use
A) master-budget capacity utilization to highlight unused capacity.
B) normal capacity utilization for benchmarking purposes.
C) practical capacity for pricing decisions.
D) theoretical capacity for performance evaluation.
E) supply capacity to satisfy customer demand.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
19) Betts Wrench Company manufactures socket wrenches. For next month the vice-president of
production plans on producing 4,400 wrenches per day. The company can produce as many as 5,000
wrenches per day, but are more likely to produce 4,500 per day. The demand for wrenches for the next
three years is expected to average 4,250 wrenches per day. Fixed manufacturing costs per month total
$336,600. The company works 20 days a month due to local zoning restrictions. Fixed manufacturing
overhead is charged on a per wrench basis.
Required:
a. What is the theoretical fixed manufacturing overhead rate per wrench?
b. What is the practical fixed manufacturing overhead rate per wrench?
c. What is the normal fixed manufacturing overhead rate per wrench?
d. What is the master-budget fixed manufacturing overhead rate per wrench?
9.2 Explain how the choice of denominator affects capacity management, costing,
pricing, and performance evaluation.
1) The Canada Revenue Agency requires companies to use practical capacity as the denominator-level
concept.
2) Theoretical capacity is rarely used to calculate the budgeted fixed manufacturing cost per case because
it departs significantly from the real capacity available to a company.
3) The downward demand spiral for a company is the continuing reduction in the demand for its
products that occurs when prices of competitors’ products are not met and higher unit costs result in
more reluctance to meet competitors’ prices.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
4) Using practical capacity is best for evaluating the marketing manager’s performance for a particular
year.
5) Master-budget capacity utilization can be more reliably estimated than normal capacity utilization.
6) Unused capacity is considered wasted resources and the result of poor planning.
7) Which denominator-level concept results in the highest amount of fixed manufacturing overhead costs
per unit of ending inventory?
A) theoretical capacity
B) practical capacity
C) normal capacity
D) master-budget capacity
E) supply capacity
8) The Canada Revenue Agency effectively eliminates the use of certain denominator-level concepts
through its income tax rulings. The accepted concept(s) for tax purpose is(are)
A) theoretical capacity and practical capacity.
B) master-budget capacity and theoretical capacity.
C) practical capacity.
D) master-budget capacity.
E) normal capacity or master-budget capacity.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
9) Master-budget capacity utilization
A) hides the amount of unused capacity.
B) represents the maximum units of production for current capacity.
C) provides the best cost estimate for benchmarking purposes.
D) when used for product costing results in the lowest cost estimate of the four capacity options.
E) represents the long-term utilization expected to meet customer demand.
10) Using ________ capacity fixes the cost of capacity at the cost of supplying the capacity regardless of
the demand for capacity.
A) practical
B) theoretical
C) supply
D) demand
E) master-budget
11) ________ utilization is an average that provides no meaningful feedback to the marketing manager for
a particular year.
A) Normal capacity
B) Master-budget capacity
C) Practical capacity
D) Flexible budget capacity
E) Planned unused capacity
12) The marketing manager’s performance evaluation is most fair when based on a denominator level
using
A) practical capacity.
B) theoretical capacity.
C) master-budget capacity.
D) normal capacity.
E) supply capacity.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
13) Explain how using master-budget capacity utilization for setting prices can lead to a downward
demand spiral.
14) Should a company with high fixed costs and unused capacity raise selling prices to try to fully recoup
its costs?
15) How does the capacity level chosen to compute the budgeted fixed overhead cost rate affect the
production-volume variance?
16) a. List the four different measures of capacity.
b. Which measure of capacity is best for setting prices? Why?
c. Which measure of capacity is best for evaluating the performance of the marketing manager for the
current year? Why?
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
9.3 Distinguish absorption from variable costing; prepare and explain the differences
in operating income under each costing policy.
1) Full product costs under absorption costing include only inventoriable costs and upstream costs.
2) Variable costing includes all direct manufacturing costs and all manufacturing overhead costs.
3) Many companies using absorption costing do not make any distinction between variable and fixed
costs in their accounting system.
4) The difference between variable costing and absorption costing centres on accounting for variable
costs.
5) Another common term used by some companies for variable costing is direct costing.
6) The distinction between variable costs and fixed costs is highlighted in variable costing via the
contribution-margin format while the distinction between manufacturing and nonmanufacturing costs is
central to absorption and is highlighted by the gross-margin format.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
7) Variable manufacturing costs are accounted for in the same manner on the income statement
regardless of whether absorption or variable costing is used.
8) Direct costing is not truly synonymous with variable costing since variable costing does not include all
direct costs as inventorial costs.
9) Variable costing does not include variable indirect manufacturing costs as inventorial costs.
10) Variable costs of value chain areas other than manufacturing are typically written off as period costs
regardless of the costing method used.
11) Absorption-costing income statements cannot easily differentiate between variable and fixed costs.
12) The period–to-period change in operating income under variable costing is driven by unit level of
sales, if the contribution margin is constant.
13) Variable costing will generally report less operating income than absorption costing when the
inventory level decreases.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
14) Absorption costing defers the fixed manufacturing costs in ending inventory to a future period, but
variable costing expenses these costs in the current period.
15) Changes in inventory levels do not affect income amounts between variable and absorption costing
because the difference in accounting for fixed manufacturing overhead offsets the affect.
16) Absorption costing prevents managers from increasing production to levels above customer demand,
as a means of inflating operating income.
17) Each unit in inventory under absorption costing absorbs fixed manufacturing costs.
18) Absorption costing can be criticized as a method that encourages managers to make decisions that
may be contrary to the long-term interest of the company.
19) The main difference between variable costing and absorption costing is the way in which fixed
manufacturing costs are accounted.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
20) The gross-margin format of the income statement highlights the lump sum of fixed manufacturing
costs.
21) In absorption costing, all nonmanufacturing costs are subtracted from gross margin.
22) Direct costing is a perfect way to describe the variable-costing inventory method.
23) The distinction between absorption costing and variable costing is most important for which type of
industry?
A) manufacturing
B) marketing
C) retail
D) service
E) educational
24) When all fixed manufacturing costs and variable manufacturing costs are included as inventorial
costs, the method being used is
A) absorption costing.
B) fixed overhead costing.
C) manufacturing overhead costing.
D) variable costing.
E) direct costing.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
25) The method of costing that excludes fixed manufacturing costs from inventorial costs is known as
A) absorption costing.
B) fixed overhead costing.
C) manufacturing overhead costing.
D) variable costing.
E) full manufacturing costing.
Use the information below to answer the following question(s).
Honda Heaven produces and sells an auto part for $20.00 per unit. Direct materials are $8 per unit, while
direct manufacturing labour averages $1.50 per unit. Variable manufacturing overhead is $0.50 per unit
and fixed manufacturing overhead is $250,000 per year. Administrative expenses, all fixed, run $90,000
per year, with sales commissions of $2 per part. Production is 100,000 parts per year. And this year,
75,000 boxes were sold.
26) What is Honda Heaven’s inventory cost per box using variable costing?
A) $9.50
B) $10.00
C) $12.50
D) $13.40
E) $15.40
27) What is Honda Heaven’s inventorial cost per box using absorption costing?
A) $9.50
B) $10.00
C) $12.50
D) $13.40
E) $15.40
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
28) Under variable costing, which of the following expenses is inventoriable?
A) variable manufacturing overhead
B) direct manufacturing labour and fixed manufacturing overhead
C) marketing and direct manufacturing labour
D) variable manufacturing overhead and administrative
E) variable and fixed manufacturing overhead
29) Absorption costing is also known as
A) direct costing.
B) full absorption costing.
C) non-traditional costing.
D) manufacturing costing.
E) variable costing.
30) Variable costing regards fixed manufacturing overhead as
A) an unexpired cost.
B) an inventoriable cost.
C) a period expense.
D) a product cost.
E) a deferred asset.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
9-16
Use the information below to answer the following question(s).
Beauty Supply Company manufactures shampoo. The supervisor has provided the following information
and stated that standard costing is used for manufacturing, marketing, and administrative costs.
January
February
Beginning inventory
0
—
Production
2,500
3,000
Sales
2,250
3,025
Other information:
Selling price
$20.00
Standard variable manufacturing cost/unit
$8.00
Standard variable market/admin. cost/unit
$4.00
Standard fixed manufacturing overhead cost/month
$40,000
Standard fixed market/admin. cost/month
$20,000
Budgeted denominator level per month (output units)
4,000
There were no beginning or ending inventories of materials or work–in-process.
31) What is the per unit variable cost?
A) $22.00
B) $18.00
C) $14.00
D) $12.00
E) $11.00
32) What is the per unit manufacturing cost using absorption costing?
A) $23.00
B) $18.00
C) $27.00
D) $12.00
E) $10.00
33) What would Beauty Supply Company’s operating income (loss) be for January and February,
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
respectively, using the variable costing approach?
A) $18,000 and $24,200
B) $(45,000) and $(35,500)
C) $(44,000) and $(33,809)
D) $(42,000) and $(35,800)
E) $18,000 and $(35,800)
34) Advanced Lighting’s total variable costs are $102 and total manufacturing costs are $98. Standard
variable marketing/administrative costs constitute 20 percent of the total variable costs. Respectively,
what are Advanced Lighting’s standard variable manufacturing costs and standard fixed manufacturing
costs?
A) $77.60 and $81.60
B) $78.40 and $98.00
C) $81.60 and $16.40
D) $81.60 and $77.60
E) $78.40 and $16.40
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
35) When the distinction between variable and fixed costs is one of the important elements in the
preparation of the income statement, the method used should be the
A) capitalization method.
B) contribution margin method.
C) gross margin method.
D) inventorial method.
E) absorption method.
36) Which of the following is correct concerning variable vs absorption costing?
A) Absorption costing income statement classifies fixed costs as period costs.
B) The absorption costing income statement combines costs by cost behaviour.
C) Absorption costing income statements need to differentiate between variable and fixed costs.
D) The difference in operating income between the two approaches is captured by the difference between
fixed manufacturing costs in ending inventory minus fixed manufacturing costs in opening inventory.
E) The difference in operating income between the two approaches is captured by the difference between
fixed manufacturing costs in ending inventory minus variable manufacturing costs in ending inventory.
37) Which of the following variances exists only under absorption costing?
A) spending variance
B) efficiency variances
C) sales-volume variance
D) variable overhead flexible budget variance
E) production-volume variance
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
Use the information below to answer the following question(s).
Car Tunes produces car radios. Actual fixed manufacturing overhead is the same as the budgeted
amount, $330,000. Production in September increased by 10% over the previous month’s production.
August production was 5,000 radios. The production level is the same as the budgeted denominator level.
At the end of September, 1,000 radios remained in stock. In August, all of the radios were sold by the end
of the month and there was no remaining work in process inventory.
38) What are Car Tune’s appropriate period costs for September if variable costing is used?
A) $330,000
B) $363,000
C) $550,000
D) $583,000
E) $630,000
39) What is the Car Tune’s September cost of goods sold amount if absorption costing is used?
A) $300,000
B) $266,000
C) $270,000
D) $258,600
E) $630,000
40) When large differences exist between practical capacity and master-budget capacity utilization,
companies can classify part of the large difference as
A) production-volume variance.
B) sales volume variance.
C) normal capacity utilization.
D) theoretical capacity utilization.
E) planned unused capacity.
Cost Accounting: A Managerial Emphasis, 6e
Chapter 9 – Income Effects of Denominator Level on Inventory Valuation
41) For Consumer Lumber what would be the total difference between operating incomes under
absorption costing and variable costing?
Beginning fixed manufacturing overhead in inventory
$47,500
Fixed manufacturing overhead in production
$37,500
Ending fixed manufacturing overhead in inventory
$12,500
Beginning variable manufacturing overhead in inventory
$5,000
Variable manufacturing overhead in production
$25,000
Ending variable manufacturing overhead in inventory
$7,500
A) $35,000
B) $25,000
C) $20,000
D) $2,500
E) $1,500
42) One possible means of determining the difference between absorption and variable costing based
operating incomes is
A) to add fixed manufacturing cost to the variable costing operating income.
B) by subtracting the variable overhead rate from the fixed overhead rate and then multiplying the
difference by the number of units in inventory.
C) by subtracting fixed manufacturing overhead in beginning inventory from fixed manufacturing
overhead in ending inventory.
D) by multiplying the number of units produced by the budgeted fixed manufacturing overhead rate.
E) by adding fixed manufacturing overhead in beginning inventory to income.