Chapter 20 (5) Variable Costing for Management Analysis Study Guide
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Do You Know…? Learning Objective 1: Describe and illustrate reporting income from operations under absorption and variable costing.

• The difference in absorption and variable costing? (See exercises 1–3)

• How to calculate the manufacturing margin, contribution margin, and income from operations using variable costing? (See exercises 4–6)

• How to determine the difference in income from operations under variable and absorption costing when production exceeds sales? (See exercises 7–9)

• How to determine the difference in income from operations under variable and absorption costing when production is less than sales? (See exercises 10–12)

Learning Objective 2: Describe and illustrate the effects of absorption and variable costing on analyzing income from operations.

• The effect of differing production levels on income from operations under absorption costing? (See exercises 13, 15, and 17)

• The effect of differing production levels on income from operations under variable costing? (See exercises 14, 16, and 18)

Learning Objective 3: Describe management’s use of absorption and variable costing.

• How the use of absorption and variable costing is helpful to management when making decisions? (See exercises 19–21) Learning Objective 4: Use variable costing for analyzing market segments, including product, territories, and salesperson segments. • How to analyze a company’s profitability by segments using the contribution margin? (See exercises 22–24) Learning Objective 5: Use variable costing for analyzing and explaining changes in contribution margin as a result of quantity and price factors. • How to perform a contribution margin analysis? (See exercises 25–27)
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Learning Objective 6: Describe and illustrate the use of variable costing for service firms. • How to classify expenses using variable costing for a service firm? (See exercises 28–30)
Fill-in-the-Blank Equations 1. Manufacturing margin = Sales – _____________ 2. Contribution margin = _____________ – Variable selling and administrative expenses 3. ________________ = Contribution margin – Fixed costs 4. ________________ = Contribution margin/sales
Exercises 1. Determine if each description relates to the variable or absorption costing method. a. Cost of goods manufactured includes direct materials, direct labor, and variable factory overhead. b. The fixed overhead for a unit is expensed when the good is sold. c. All fixed overhead is expensed in the period incurred. 2. Finnegan’s management is deciding between the absorption costing and variable costing method. The company would like to treat the fixed and variable overhead costs the same, as a product cost. Which method should the company use? 3. In order to calculate income from operations, a company deducts the fixed costs from the contribution margin. Which type of costing method does management use in calculating income from operations? 4. Use the information shown to calculate Finnegan’s manufacturing margin, contribution margin, and income from operations. The company uses a variable costing system. Assume that the company sold all units produced. Sales $890,000 Direct materials 54,000 Direct labor 120,000 Variable overhead 18,000 Fixed overhead 23,500 Variable selling and administrative 12,400 Fixed selling and administrative 35,750
Variable Costing for Management Analysis 3
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5. For the month of August, Purple Sun generated sales of $400,000. The company’s variable cost of goods sold for the month totaled $175,000, including variable overhead of $25,600. Total overhead for the month was $56,200. The company also incurred variable selling and administrative costs of $13,200 and fixed selling and administrative costs of $45,000. a. Calculate the manufacturing margin. b. Calculate the contribution margin. c. Calculate the income from operations. 6. During the month of May, Rosie’s Shoe Supply incurs the following costs: variable cost of goods sold, $18,000; fixed manufacturing costs, $4,000; variable selling and administrative, $1,400; and fixed selling and administrative, $2,200. The sales for the month totaled $43,000. Determine the company’s manufacturing margin, contribution margin, and income from operations for the month. 7. Finnegan’s produces 400 units for the month of September but only sells 325 units. Each unit incurs fixed manufacturing costs of $10 and variable manufacturing costs of $25. Determine the difference in variable costing and absorption costing, indicating which income will be higher. 8. Purple Sun produced 15,500 units of product during the last quarter. Due to a decrease in sales, the company sold only 13,600 of these products. To manufacture each unit, the company incurs fixed manufacturing costs of $12. Under absorption costing, the income from operations totals $72,900. Determine the income from operations under variable costing. 9. The Rarebit incurs fixed manufacturing costs of $600,000 to produce 150,000 units during the year. The company sold 142,400 of these units during the year to produce income from operations of $164,000, using the variable costing method. Determine the company’s income from operations using the absorption costing method. 10. Rosie’s Shoe Supply produces and sells 30,000 units during the year. The company also sells 2,000 of the beginning inventory. To produce each unit, Rosie’s Shoe Supply incurs fixed manufacturing costs of $12 per unit. Determine if income from operations will be higher under the variable or absorption costing method and the difference. 11. Poe’s Candles has inventory of 4,000 units at the beginning of the year. The company produced 22,000 units during the year and had no units on hand at the end of the year. The company incurred fixed manufacturing costs of $8 per unit. Income from operations using the variable costing system totaled $92,700. Determine the income from operations using the absorption method.
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12. Cutty’s Scissors generated an income from operations of $71,600 using the absorption costing method. The company sold 41,000 units, although it produced 39,200 units. The fixed manufacturing costs totaled $9 per unit, while variable manufacturing costs totaled $15 per unit. Determine the income from operations using the variable costing method. 13. Management of The Rarebit expects to sell 14,000 units for $12 each in the upcoming year and is deciding between producing 14,000 or 16,000 units. The company will incur variable costs of $4 per unit and total fixed costs of $21,000. The company also incurs fixed selling costs of $12,000 annually and incurs variable selling costs of $2 per unit. Prepare absorption costing income statements for the two options to determine how many units the company should produce to generate the highest income from operations. Round fixed manufacturing costs per unit to two decimal places. 14. Use the information in Exercise 13 to determine how many units the company should produce to generate the highest income from operations using variable costing income statements. 15. Finnegan’s expects to sell 53,000 units in the upcoming year. The production manager has decided the company can produce 53,000 products to meet the demand, or 58,000 products. The company will sell the units for $50 each and incur variable costs of $14 per unit. The company will also incur a variable selling expense of $5 per unit sold. Fixed costs include manufacturing costs of $41,000 and selling and administrative costs of $22,000. Using the absorption costing method, prepare the income statement for both situations to determine the number of units to produce if the company would like to generate the highest income from operations. Round fixed manufacturing costs per unit to two decimal places. 16. Assume the same information as Exercise 15, except that the company uses the variable costing method to determine income from operations. 17. After estimating unit sales to be 32,000 units for $35 each, Rosie’s Shoe Supply is trying to decide whether to produce 32,000 units or 36,000 units. The company will incur variable costs of $22 per unit and fixed manufacturing costs of $67,000. Each unit sold has a variable selling and administrative cost of $4.50. The fixed selling and administrative expenses will be $25,000. Use absorption costing income statements to determine the number of units to produce that will result in the highest income from operations. Round fixed manufacturing overhead per unit to two decimal places. 18. Use the information in Exercise 17 for Rosie’s Shoe Supply assuming the company calculates income from operations using the variable costing method to determine the number of units to produce.
Variable Costing for Management Analysis 5
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19. The sales manager of a company is determining the best selling price for its new product. The manager expects that all costs incurred to make the product should be included in the decision. Should the manager use the variable or absorption costing method to determine the selling price? 20. In the past few years, a manufacturer has not produced sufficient units in order to meet the year’s sales. Management would like to produce enough products to meet demand and have an ending inventory. The company expects to incur additional fixed costs due to the increase in production. Should management use the variable or absorption costing method to determine the production planning for the upcoming years? 21. A manufacturing company promises a bonus to its production managers if they can increase profit in their department. Since the selling price is fixed, the managers must determine a way to decrease the costs to manufacture each unit. Would the variable or absorption costing method be more helpful to the managers? 22. Use the information below to calculate the contribution margin for the dog food and the Southern region. Pet Supply North South Sales volume (units): Dog food 15,000 19,200 Cat food 14,300 16,750 Sales price: Dog food $4.65 $4.50 Cat food $3.80 $3.95 Variable cost per unit: Dog food $2.80 $2.75 Cat food $1.15 $1.20
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23. Using the information below, determine the contribution margin ratio for the highlighters and Ross Thompson. Sales commissions are paid based on a percentage of total sales. Round the contribution margin ratio to two decimal places.
Study Better Supply Ross Thompson Sherry Zink Anna Mills Sales volume (units): Highlighters 12,600 14,750 14,900 Pens 17,800 14,300 18,150 Sticky Notes 12,300 11,980 12,500 Sales price: Highlighters $4.90 $4.90 $4.90 Pens $4.50 $4.50 $4.50 Sticky Notes $5.25 $5.25 $5.25 Variable cost per unit: Highlighters $1.85 $1.85 $1.85 Pens $1.50 $1.50 $1.50 Sticky Notes $2.15 $2.15 $2.15 Sales commission 5.00% 5.00% 5.00%
24. With the information below, calculate the contribution margin for the Western region and the water bottles.
Thirst Killers East West Sales volume (units): Water bottles 82,500 85,000 Energy drinks 65,000 61,800 Sports drinks 58,750 54,300 Sales price: Water bottles $10.50 $10.90 Energy drinks $15.75 $15.40 Sports drinks $14.30 $14.25 Variable cost per unit: Water bottles $3.65 $3.75 Energy drinks $4.50 $4.40 Sports drinks $4.20 $4.20 Promotion costs: Water bottles $1,200 $1,200 Energy drinks $4,750 $4,550 Sports drinks $4,500 $4,400
Variable Costing for Management Analysis 7
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25. During the year, Poe’s Candles expected to sell 40,000 units of goods for $15 each. The actual sales for the year totaled 41,400 units at $14.95 each. Calculate the quantity factor and price factor for sales. 26. Management of The Rarebit expected to produce 35,000 units for the last quarter and incur $6 per unit of variable costs. The company actually produced 37,000 units and incurred $225,700 of variable costs. Determine the variable cost quantity factor and the unit cost factor. 27. Rather than selling the budgeted 12,000 units for the month, Thirst Killer sold 11,000 units to customers. At the beginning of the month, the company expected for the selling price to be $5.10. Instead, the selling price was $5.08. Determine the quantity and price factor for sales. 28. Determine if each of the following would be considered a variable or fixed cost for a law firm. If the expense should be considered a variable cost, provide an example of the activity base. a. Office rental expense b. Advertising expenses c. Wages expense for intern d. Monthly subscription to a legal newsletter 29. Would each of the following expenses be considered a fixed or variable cost for an interior designer? If a variable cost, provide an example of the activity base. a. Commissions expense b. Office depreciation expense c. Travel and lodging expenses d. Insurance expense 30. Determine if each of the following should be considered a variable or fixed cost for a dry cleaner. If the expense is a variable cost, provide an example of the activity base. a. Detergent expense b. Salary for tailor c. Electricity expense d. Payroll taxes expense