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CHAPTER 9
INVENTORY COSTING AND CAPACITY ANALYSIS
9-1 Differences in operating income between variable costing and absorption costing are due
solely to accounting for fixed costs. Do you agree? Explain.
9-2 Why is the term direct costing a misnomer?
The term direct costing is a misnomer for variable costing for two reasons:
9-3 Do companies in either the service sector or the merchandising sector make choices about
absorption costing versus variable costing?
9-4 Explain the main conceptual issue under variable costing and absorption costing
regarding the timing for the release of fixed manufacturing overhead as expense.
Variable costing uses (a) and absorption costing uses (b).
9-5 “Companies that make no variable-cost/fixed-cost distinctions must use absorption
costing, and those that do make variable-cost/fixed-cost distinctions must use variable costing.”
Do you agree? Explain.
9-6 The main trouble with variable costing is that it ignores the increasing importance of
fixed costs in manufacturing companies. Do you agree? Why?
9-7 Give an example of how, under absorption costing, operating income could fall even
though the unit sales level rises.
9-8 What are the factors that affect the breakeven point under (a) variable costing and (b)
absorption costing?
(a) The factors that affect the breakeven point under variable costing are:
(b) The factors that affect the breakeven point under absorption costing are:
9-9 Critics of absorption costing have increasingly emphasized its potential for leading to
undesirable incentives for managers. Give an example.
9-10 What are two ways of reducing the negative aspects associated with using absorption
costing to evaluate the performance of a plant manager?
Approaches used to reduce the negative aspects associated with using absorption costing include:
a. Change the accounting system:
inventory.
b. Extend the time period used to evaluate performance. By evaluating performance
9-11 What denominator-level capacity concepts emphasize the output a plant can supply?
What denominator-level capacity concepts emphasize the output customers demand for products
produced by a plant?
9-12 Describe the downward demand spiral and its implications for pricing decisions.
9-13 Will the financial statements of a company always differ when different choices at the
start of the accounting period are made regarding the denominator-level capacity concept?
9-14 What is the IRS’s requirement for tax reporting regarding the choice of a
denominator-level capacity concept?
For tax reporting in the U.S., the IRS requires only that indirect production costs are “fairly”
apportioned among all items produced. Overhead rates based on normal or master-budget
9-15 “The difference between practical capacity and master-budget capacity utilization is the
best measure of management’s ability to balance the costs of having too much capacity and
having too little capacity.” Do you agree? Explain.
9-16 In comparing the absorption and variable cost methods, each of the following statements is
true except:
a. SG&A fixed expenses are not included in inventory in either method.
b. Only the absorption method may be used for external financial reporting.
c. Variable costing charges fixed overhead costs to the period they are incurred.
d. When inventory increases over the period, variable net income will exceed absorption net
income.
SOLUTION
Choice "d" is correct. Inventory under the absorption method includes fixed overhead costs,
while the variable cost method includes fixed overhead costs as period costs. Fixed overhead
9-17 Queen Sales, Inc. has just completed its first year of operations. The company has not had
any sales to date. Queen has incurred the following costs associated with its production as of
December 31, Year 1:
Direct materials $45,000
Production labor 35,000
Bookkeeper salary 28,000
Factory utilities 18,500
Office rent 12,000
Factory supervisor salary 9,600
Machine maintenance contract 7,500
Under absorption costing, what is the inventory amount shown on the balance sheet at December
31, Year 1?
a. $155,600
b. $115,600
c. $98,500
d. $80,000
SOLUTION
Choice "b" is correct. Absorption costing, which is required under U.S. GAAP, requires all
product costs to be included in inventory. No segregation is made between fixed and variable
costs, and the costs are expensed when the product is sold. All of the costs listed, except for the
bookkeeper salary and the office rent, are product costs.
9-18 King Tooling has produced and sold the following number of units of their only product
during their first two years in business:
Produced Sold
Year ended December 31, Year 1 50,000 40,000
Production costs per unit have not changed over the two-year period. Under variable costing,
what is the amount of cost of sales relative to the cost of sales shown on the GAAP income
statement of the company?
Year 1 Year 2
a. Higher Higher
b. Higher Lower
c. Lower Higher
d. Lower Lower
SOLUTION
Choice "b" is correct. When more units are produced in a period than sold, a portion of the fixed
Choice "a" is incorrect. The cost of sales under variable costing is less than the cost of sales
Choice "c" is incorrect. If units produced in any period exceed the units sold during that period,
Choice "d" is incorrect. The cost of sales under variable costing is more than the cost of sales
9-19 The following information relates to Drexler Inc.’s Year 3 financials:
Direct labor $420,000
Direct materials 210,000
Variable overhead 205,000
Fixed overhead 355,000
Variable SG&A expenses 150,000
Fixed SG&A expenses 195,000
Year 3 period costs for Drexler, under both the absorption and variable cost methods, will be
Absorption Cost Method Variable Cost Method
a. $345,000 $700,000
Absorption Cost Method Variable Cost Method
b. $345,000 $905,000
c. $550,000 $700,000
d. $550,000 $905,000
SOLUTION
Choice "a" is correct. Under the absorption method, only variable and fixed SG&A expenses are
Choice "b" is incorrect. This answer choice incorrectly adds variable overhead as a period cost
Choice "c" is incorrect. This answer choice incorrectly adds variable overhead as a period cost
Choice "d" is incorrect. This answer choice incorrectly adds variable overhead as a period cost
9-20 Which of the following statements is not true regarding the use of variable and absorption
costing for performance measurement?
a. The net income reported under the absorption method is less reliable for use in performance
evaluations because the cost of the product includes fixed costs, which means the level of
inventory affects net income.
b. The net income reported under the contribution income statement is more reliable for use in
performance evaluations because the product cost does not include fixed costs.
c. Variable costing isolates contribution margins to aid in decision making.
d. The Internal Revenue Service allows either absorption or variable costing as long as the
method is not changed from year to year, while U.S. GAAP only allows absorption costing.
SOLUTION
The answer is choice "d". This is not a true statement. The I.R.S. only allows absorption costing
Choice “a” is again a true statement. Under absorption costing, the choice of output and
9-21 Variable and absorption costing, explaining operating-income differences. Nascar
Motors assembles and sells motor vehicles and uses standard costing. Actual data relating to
April and May 2017 are as follows:
The selling price per vehicle is $24,000. The budgeted level of production used to calculate the
budgeted fixed manufacturing cost per unit is 500 units. There are no price, efficiency, or
spending variances. Any production-volume variance is written off to cost of goods sold in the
month in which it occurs.
Required:
1. Prepare April and May 2017 income statements for Nascar Motors under (a) variable costing
and (b) absorption costing.
2. Prepare a numerical reconciliation and explanation of the difference between operating
income for each month under variable costing and absorption costing.
SOLUTION
(30 min.) Variable and absorption costing, explaining operating-income differences.
1. Key inputs for income statement computations are
April May
Beginning inventory
Production
Goods available for sale
Units sold
Ending inventory
0
500
500
350
150
150
400
550
520
30
The budgeted fixed cost per unit and budgeted total manufacturing cost per unit under absorption
costing are
April May
(a) Budgeted fixed manufacturing costs
$2,000,000
$2,000,000
(a) Variable costing
April 2017 May 2017
Revenuesa $8,400,000 $12,480,000
Variable costs
(b) Absorption costing
April 2017 May 2017
Revenuesa$8,400,000 $12,480,000
Cost of goods sold
Beginning inventory $ 0 $2,100,000
Cost of goods sold 4 ,900,000 7 ,680,000
Operating costs
Variable operating costsf1,050,000 1,560,000
Total operating costs 1 ,650,000 2 ,160,000
2.
Absorption-costing
operating income
–
Variable-costing
operating income
=
Fixed manufacturing costs
in ending inventory
–
Fixed manufacturing costs
in beginning inventory
April:
The difference between absorption and variable costing is due solely to moving fixed
manufacturing costs into inventories as inventories increase (as in April) and out of inventories
as they decrease (as in May).
9-22 Throughput costing (continuation of 9-21). The variable manufacturing costs per unit
of Nascar Motors are as follows:
Required:
1. Prepare income statements for Nascar Motors in April and May 2017 under throughput
costing.
2. Contrast the results in requirement 1 with those in requirement 1 of Exercise 9-21.
3. Give one motivation for Nascar Motors to adopt throughput costing.
