SOLUTION
(25 min.) Cost allocation, downward demand spiral.
SOLUTION EXHIBIT 9-45
2017
Master
Budget
(1)
Practical
Capacity
(2)
2018
Master
Budget
(3)
Budgeted fixed cost per meal
Budgeted fixed costs
¸
Denominator level
¸
1. The 2017 budgeted fixed costs are $1,533,000. Mealman budgets for 1,050,000 meals in
2017, and this is used as the denominator level to calculate the fixed cost per meal. $1,533,000
¸
2. In 2018, 3 hospitals have dropped out of the purchasing group and the master budget is
912,500 meals. If this is used as the denominator level, fixed cost per meal = $1,533,000
¸
912,500 = $1.68 per meal, and the total budgeted cost per meal would be $6.38 (see column (3)
3. The basic problem is that Mealman has excess capacity and associated excess fixed costs.
If Wright uses the practical capacity of 1,460,000 meals as the denominator level, the fixed cost
per meal will be $1.05 (see column (2) in Solution Exhibit 9-45), and the total budgeted cost per
9-46 Cost allocation, responsibility accounting, ethics (continuation
of Problem 9-45). In 2018, only 876,000 Mealman meals were produced and sold to the
hospitals. Wright suspects that hospital controllers had systematically inflated their 2018 meal
estimates.
Required:
1. Recall that Mealman uses the master-budget capacity utilization to allocate fixed costs and to
price meals. What was the effect of production-volume variance on Mealman’s operating
income in 2018?
2. Why might hospital controllers deliberately overestimate their future meal counts?
3. What other evidence should Meals To Go’s president seek to investigate Wright’s concerns?
4. Suggest two specific steps that Wright might take to reduce hospital controllers’ incentives to
inflate their estimated meal counts.
SOLUTION
(20 min.) Cost allocation, responsibility accounting, ethics (continuation of 9-45).
1. (See Solution Exhibit 9-45). If Mealman uses the rate based on its master budget capacity
utilization to allocate fixed costs in 2018, it would allocate 876,000
´
$1.68 = $1,471,680.
Budgeted fixed costs are $1,533,000. Therefore, the production volume variance = $1,533,000 –
$1,471,680 = $61,320 U. An unfavorable production volume variance will reduce operating
income by this amount. (Note: in this business, there are no inventories. All variances are
written off to cost of goods sold).
2. Hospitals are charged a budgeted variable cost rate and allocated budgeted fixed costs.
By overestimating budgeted meal counts, the denominator-level is larger, hence the amount
charged to individual hospitals is lower. Consider 2018 where the budgeted fixed cost rate is
computed as follows:
If in fact, the hospital administrators had better estimated and revealed their true demand (say,
876,000 meals), the allocated fixed cost per meal would have been
3. Evidence that could be collected include:
(a) Budgeted meal-count estimates and actual meal-count figures each year for each
hospital controller. Over an extended time period, there should be a sizable number of both
underestimates and overestimates. Controllers could be ranked on both their percentage of
overestimation and the frequency of their overestimation.
(b) Look at the underlying demand estimates by patients at individual hospitals. Each
hospital controller has other factors (such as hiring of nurses) that give insight into their
4. (a) Highlight the importance of a corporate culture of honesty and openness. Wright
could institute a Code of Ethics that highlights the upside of individual hospitals providing
honest estimates of demand (and the penalties for those who do not).
(b) Have individual hospitals contract in advance for their budgeted meal count. Unused
9-47 Absorption, variable, and throughput costing. Tesla Motors
assembles the fully electric Model S-85 automobile at its Fremont, California, plant. The
standard variable manufacturing cost per vehicle in 2017 is $58,800, which consists of:
Direct materials $36,000
Direct manufacturing labor $10,800
Variable manufacturing overhead $12,000
Variable manufacturing overhead is allocated to vehicles on the basis of assembly time. The
standard assembly time per vehicle is 20 hours.
The Fremont plant is highly automated and has a practical capacity of 4,000 vehicles per
month. The budgeted monthly fixed manufacturing overhead is $45 million. Fixed manufacturing
overhead is allocated on the basis of the standard assembly time for the budgeted normal capacity
utilization of the plant. For 2017, the budgeted normal capacity utilization is 3,000 vehicles per
month.
Tesla started production of the Model S-85 in 2017. The actual production and sales figures for
the first three months of the year are:
January February March
Production 3,200 2,400 3,800
Sales 2,000 2,900 3,200
Franz Holzhausen is SVP of Tesla and director of the Fremont plant. His compensation
includes a bonus that is 0.25% of monthly operating income, calculated using absorption costing.
Tesla prepares absorption-costing income statements monthly, which include an adjustment for the
production-volume variance occurring in that month. There are no variable cost variances or fixed
overhead spending variances in the first three months of 2017.
The Fremont plant is credited with revenue (net of marketing costs) of $96,000 for the sale of
each Tesla S-85 vehicle.
Required:
1. Compute (a) the fixed manufacturing cost per unit and (b) the total manufacturing cost per
unit.
2. Compute the monthly operating income for January, February, and March under absorption
costing. What amount of bonus is paid each month to Franz Holzhausen?
3. How much would the use of variable costing change Holzhausen’s bonus each month if the
same 0.25% figure were applied to variable-costing operating income?
4. Explain the differences in Holzhausen’s bonuses in requirements 2 and 3.
5. How much would the use of throughput costing change Holzhausen’s bonus each month if
the same 0.25% figure were applied to throughput-costing operating income?
6. What are the different approaches Tesla Motors could take to reduce possible undesirable
behavior associated with the use of absorption costing at its Fremont plant?
SOLUTION
(60 min.) Absorption, variable, and throughput costing.
1.
(a)
Fixed manufacturing
overhead cost per unit
=
$45,000,000
3,000 vehicles 20 standard hours´
=
$45,000,000
60,000
= $750 per standard assembly hour or $15,000
per vehicle
(b) Direct materials per unit $ 36,000
Direct manufacturing labor per unit 10,800
2. Amounts in thousands.
Absorption Costing
January February March
Revenues ($96,000 × 2,000; 2,900; 3,200)
Cost of goods sold
Beginning inventory
Inventory Details (Units)
Beginning inventory
$192 ,000
$ 0
0
$278 ,400
$ 88,560
1,200
$307 ,200
$ 51,660
700
Computation of Bonus January February March
3. Amounts in thousands.
Variable Costing
January February March
Variable cost of goods sold
Beginning inventory
0
70,560
41,160
Computation of Bonus January February March
4.
January February March Total
The difference between absorption and variable costing arises because of differences in
production and sales:
January February March Total
With absorption costing, by building for inventory, Holzhausen can capitalize $15,000 of fixed
5. Amounts in thousands
Throughput Costing
January February March
Revenues
Direct material cost of goods sold
Beginning inventory ($36 × 0; 1,200; 700)
Other costs
Manufacturinga
$192 ,000
0
117,960
$278 ,400
43,200
99,720
$307 ,200
25,200
131,640
Marketing
0
0
0
a($22.8 3,200) + $45,000
($22.8 2,400) + $45,000
($22.8 3,800) + $45,000
Computation of Bonus January February March
A summary of the bonuses paid is:
January February March Total
6. Alternative approaches include:
(a) Careful budgeting and inventory planning,
(b) Use an alternative income computation approach to absorption costing (such as
variable costing or throughput costing),
9-48 Costing methods and variances, comprehensive. Rob Kapito, the
controller of Blackstar Paint Supply Company, has been exploring a variety of internal
accounting systems. Rob hopes to get the input of Blackstar’s board of directors in choosing one.
To prepare for his presentation to the board, Rob applies four different cost accounting methods
to the firm’s operating data for 2017. The four methods are actual absorption costing, normal
absorption costing, standard absorption costing, and standard variable costing.
With the help of a junior accountant, Rob prepares the following alternative income statements:
A B C D
Sales Revenue $
90
0,
00
0
$
9
0
0
,
0
0
0
$
90
0,
00
0
$
90
0,0
00
Cost of Goods Sold $
37
5,
00
0
$
2
5
0
,
0
0
0
$
42
0,
00
0
$
39
5,0
00
(+) Variances:
Direct Materials 15,000 15,000 — —
Direct Labor 5,000 5,000 — —
Manufacturing
Overhead
25,000 — — 25,000
(+) (All Fixed) 350,0
00
475,0
0
0
350,00
0
350,00
0
Total Costs $
77
0,
00
0
$
7
4
5,
0
0
0
$
77
0,
00
0
$
77
0,0
00
Net Income $
13
0,
$
1
5
$
13
0,
$
13
0,0
A B C D
00
0
5,
0
0
0
00
0
00
Where applicable, Rob allocates both fixed and variable manufacturing overhead using direct
labor hours as the driver. Blackstar carries no work-in-process inventory. Standard costs have been
stable over time, and Rob writes off all variances to cost of goods sold. For 2017, there was no
flexible budget variance for fixed overhead. In addition, the direct labor variance represents a price
variance.
Required:
1. Match each method below with the appropriate income statement (A, B, C, or D):
Actual Absorption costing
Normal Absorption costing
Standard Absorption costing
Standard Variable costing
2. During 2017, how did Blackstar’s level of finished-goods inventory change? In other words,
is it possible to know whether Blackstar’s finished-goods inventory increased, decreased, or
stayed constant during the year?
3. From the four income statements, can you determine how the actual volume of production
during the year compared to the denominator (expected) volume level?
4. Did Blackstar have a favorable or unfavorable variable overhead spending variance during
2017?
SOLUTION
(30 min.) Costing methods and variances, comprehensive.
1. Actual Absorption costing – C
2. The net income under standard variable costing (B; $155,000) exceeds that under
standard absorption costing (A; $130,000). Since there are no work-in-process inventories, this
3. From statement B, the aggregate variance for variable overhead is zero. So, the $25,000
variance for total overhead in A must all be for fixed overhead. We are told that there is no
4. The aggregate variable overhead variance of zero is the sum of the spending and
efficiency variances. Note that variable overhead is applied using direct labor hours as the
Try It! 9-1
(a) Under variable costing, all variable manufacturing costs are inventoriable costs. This
includes direct materials, direct manufacturing labor, and variable overhead. Therefore,
the inventoriable cost per unit under variable costing is $20 + $4 + $1 = $25.
(b) Absorption costing considers all variable manufacturing costs and all fixed
manufacturing costs as inventoriable costs. Therefore, the inventoriable cost per unit
Try It! 9-2
(a) Variable costing
Revenues: 24,000 × $50 $1,200,000
(b) Absorption costing
Revenues: 24,000 × $50 $1,200,000
Operating income $ 260,200
Absorption costing treats fixed manufacturing cost as a product cost, while variable costing treats
it as a period cost. ZB Toys has 6,000 units in ending inventory. Under absorption costing, these
Try It! 9-3
(a) Absorption costing: $87.50 + $50.00 + $62.50 = $200
Try It! 9-4
(a) Theoretical capacity: 1,000 × 3 × 8 × 30 = 720,000 units