Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
8-1
CHAPTER 8
Variable Costing and the Costs of Quality and
Sustainability
ANSWERS TO REVIEW QUESTIONS
8-1 Under absorption costing, fixed manufacturing-overhead costs are assigned to units
8-2 Timing is the key in distinguishing between absorption and variable costing. All
manufacturing costs will ultimately be expensed under either absorption costing or
8-3 The term direct costing is a misnomer. Variable costing is a better term for this
product-costing method. Under variable costing, the variable costs of direct material,
8-4 When inventory increases, the income reported under absorption costing will be
greater than the income reported under variable costing. This difference results from
8-5 Many managers prefer variable costing over absorption costing because income
statements prepared under variable costing more closely reflect operations. For
8-2
8-6 Some managerial accountants believe that absorption costing may provide an
8-7 Variable and absorption costing will not result in significantly different income
measures in a JIT setting. Under JIT inventory and production management,
8-8 Many managers prefer absorption-costing data for cost-based pricing decisions.
They argue that fixed manufacturing overhead is a necessary cost of production. To
8-9 Proponents of variable costing argue that a product’s variable cost provides a better
8-10 Variable costing is consistent with cost-volume-profit analysis because it properly
reflects the cost behavior of variable and fixed costs. Only variable manufacturing
8-11 An asset is a thing of value owned by the organization with future service potential.
By accounting convention, assets are valued at their cost. Since fixed costs
comprise part of the cost of production, advocates of absorption costing argue that
inventory (an asset) should be valued at its full (absorption) cost of production.
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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8-12 Four types of product quality costs are as follows:
8-13 Observable quality costs can be measured and reported, often on the basis of
information in the accounting records. For example, the cost of inspectors’ salaries
8-14 A product’s quality of design is how well it is conceived or designed for its intended
8-15 A product’s grade is the extent of its capability in performing its intended purpose,
viewed in relation to other products with the same functional use. An example in the
8-16 “An ounce of prevention is worth a pound of cure” can be interpreted in terms of
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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8-18 Private environmental costs are environmental costs borne by a company or
individual.
Social environmental costs are environmental costs borne by the public at large.
8-19 End–of-pipe strategies: Under this approach, a company produces a pollutant and
cleans it up before discharging it into the environment.
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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SOLUTIONS TO EXERCISES
EXERCISE 8-20 (15 MINUTES)
1. a. Inventory decreases by 3,000 units, so operating income is greater under variable
2. a. Inventory remains unchanged, so there is no difference in reported income under
3. a. Inventory increases by 1,200 units, so operating income is greater under
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-21 (20 MINUTES)
1. Cost-volume profit graph:
Dollars (in millions)
$25
$10
•
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-21 (CONTINUED)
2. Calculation of break-even point:
Break-even point
=
margin oncontributi unit
cost fixed
14,667 units (rounded)
3. Variable costing is more compatible with the cost-volume-profit chart, because it
maintains the distinction between fixed and variable costs as does CVP analysis.
EXERCISE 8-22 (15 MINUTES)
Inventory calculations (units):
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-22 (CONTINUED)
1.
Variable costing:
Inventoriable costs under variable costing:
Direct material used …………………………………………………………………….
$300,000
Direct labor incurred ……………………………………………………………………
Variable manufacturing overhead ………………………………………………..
Total …………………………………………………………………………………………..
$550,000
Cost per unit produced = $550,000/20,000 units = $27.50 per unit
$ 27,500
2. Absorption costing:
Predetermined fixed-overhead rate
=
production planned
overhead ingmanufactur fixed
=
units 000,20
000,210$
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-23 (15 MINUTES)
1. a. Inventory increases by 3,000 units, so operating income is greater under
2. a. Inventory decreases by 5,000 units, so operating income is greater under variable
3. a. Inventory remains unchanged, so there is no difference in reported income under
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-24 (10 MINUTES)
1.
Inventoriable costs under absorption costing:
Direct material used …………………………………………………………………….
$272,000
Direct labor …………………………………………………………………………………
Variable manufacturing overhead ………………………………………………..
Fixed manufacturing overhead …………………………………………………….
Total …………………………………………………………………………………………..
$560,000
2.
Inventoriable costs under variable costing:
Direct material used …………………………………………………………………….
$272,000
Direct labor …………………………………………………………………………………
Variable manufacturing overhead ………………………………………………..
Total …………………………………………………………………………………………..
$460,000
EXERCISE 8-25 (30 MINUTES)
The specifics of the answer will vary, depending on the company and product selected.
However, the relative merits of absorption and variable costing as the basis for pricing
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-26 (25 MINUTES)
Inventory calculations (units):
Finished-goods inventory, January 1 ……………………………………………
Add: Units produced …………………………………………………………………..
Less: Units sold ………………………………………………………………………….
Finished-goods inventory, December 31 ………………………………………
1.
Variable costing:
Inventoriable costs under variable costing:
Direct material used …………………………………………………………………….
$ 80,000
Variable manufacturing overhead ………………………………………………..
Total …………………………………………………………………………………………..
$144,000
Cost per unit produced = $144,000/10,000 units = $14.40 per unit
$ 14,400
2. Absorption costing:
Predetermined fixed-overhead rate
=
production planned
overhead ingmanufactur fixed
=
units 000,10
000,50$
= $5.00 per unit
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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Since units of inventory increased during the year, operating income reported under
absorption costing will be $5,000 higher than that reported under variable costing.
EXERCISE 8-27 (10 MINUTES)
1.
Inventoriable costs under variable costing:
Direct material used …………………………………………………………………….
$203,000
Direct labor …………………………………………………………………………………
Variable manufacturing overhead ………………………………………………..
Total …………………………………………………………………………………………..
$308,000
2.
Inventoriable costs under absorption costing:
Direct material used …………………………………………………………………….
$203,000
Direct labor …………………………………………………………………………………
Variable manufacturing overhead ………………………………………………..
Fixed manufacturing overhead …………………………………………………….
Total …………………………………………………………………………………………..
$364,000
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-28 (10 MINUTES)
Observable quality costs in the airline industry:
• Cost of repairing damaged luggage.
• Cost of providing lodging for passengers stranded when a flight is cancelled due to
• Cost of cleaning a passenger’s clothing when a flight attendant spills food or
Hidden quality costs in the airline industry:
• Cost of lost flight bookings when passengers judge in-flight service to be
substandard.
• Cost of lost flight bookings when potential passengers are unable to get through to
• Cost of lost flight bookings when passengers react to cancelled or late flights.
EXERCISE 8-29 (5 MINUTES)
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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EXERCISE 8-30 (20 MINUTES)
CERRITOS CIRCUITRY
QUALITY-COST REPORT
Costs
For
May
Percentage
of
Total
Prevention costs:
Training of quality-control inspectors …………………………………
$ 31,500
__22.2
Total ……………………………………………………………………………
$ 31,500
__22.2
Appraisal costs:
Tests of instruments ………………………………………………………….
Inspection of purchased electrical components ………………….
18,000
Total ……………………………………………………………………………
$ 63,000
__44.4
Internal failure costs:
Costs of rework …………………………………………………………………
$ 13,500
Costs of defective parts that cannot be salvaged ………………..
9,150
___6.5
Total ……………………………………………………………………………
$ 22,650
__16.0
External failure costs:
Replacement of instruments already sold …………………………..
$ 24,750
__17.4
Total ……………………………………………………………………………
$ 24,750
__17.4
EXERCISE 8-31 (45 MINUTES)
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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SOLUTIONS TO PROBLEMS
PROBLEM 8-32 (45 MINUTES)
1. a. Absorption-costing operating income statements:
Year 1
Year 2
Year 3
Sales revenue (at $25 per case) …………………………..
$2,000,000
$1,500,000
$2,250,000
Gross margin ……………………………………………………….
Less: Selling and administrative expenses:
Variable (at $ .50 per case) …………………………..
Fixed ……………………………………………………….
Operating income ……………………………………………………….
Less: Cost of goods sold (at
*The absorption cost per case is $21, calculated as follows:
production Planned
overheadingmanufactur fixed Budgeted
+
case per cost
ingmanufactur variable
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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PROBLEM 8-32 (CONTINUED)
b. Variable-costing operating income statements:
Year 1
Year 2
Year 3
Sales revenue (at $25 per case) ……………………………………………………
$2,000,000
$1,500,000
$2,250,000
Less: Variable expenses:
Variable selling and administrative
Contribution margin ……………………………………………………….
$ 680,000
$ 510,000
$ 765,000
Less: Fixed expenses:
Fixed manufacturing overhead …………………………..
Fixed selling and administrative
Operating income ……………………………………………………….
Variable manufacturing costs (at
2. Reconciliation:
Year
Reported Operating
Income
Difference
in
Reported
Operating
Income
Change in
Inventory
(in units)
Predetermined
Fixed
Overhead
Rate*
Difference In
Fixed Overhead
Expensed Under
Absorption and
Variable Costing
Absorption
Costing
Variable
Costing
1
$242,500
$242,500
-0-
-0-
$5
0
2
$100,000
20,000
3
PROBLEM 8-32 (CONTINUED)
3. a. In year 4, the difference in reported operating income will be $50,000, calculated
as follows:
Change in
inventory
(in units)
Predetermined
fixed overhead
rate
b. Over the four-year period, the total of all reported operating income will be the
same under absorption and variable costing. This result will occur because
8-18
PROBLEM 8-33 (45 MINUTES)
1. Sales during the year were:
Beginning inventory ……………………………………………………………………
0
units
Production ………………………………………………………………………………….
units
Ending inventory ………………………………………………………………………..
) units
Sales ………………………………………………………………………………………….
units
Since inventory increased during the year, reported operating income is higher
under absorption costing.
Difference in
reported
operating income
=
inventory
in change
unit per
overhead fixed
Reported operating income under variable costing ………………………
Fixed overhead …………………………………………………………………………..
Total contribution margin ……………………………………………………………
8-19
PROBLEM 8-33 (CONTINUED)
Contribution margin
per unit
=
units in sales
margin oncontributi total
=
=
Chapter 08 – Variable Costing and the Costs of Quality and Sustainability
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PROBLEM 8-33 (CONTINUED)
2. Profit-volume graph:
$(100,000)
Dollars
$500,000
$300,000
$200,000
$(200,000)
$(300,000)