Absorption (Variable) Costing and Cost-Volume-Profit Analysis

Chapter 11
Absorption/Variable Costing and Cost-Volume-Profit

Analysis
Questions
1. The two basic differences between absorption and variable

costing lie in the treatment of fixed factory overhead and the
presentation of costs/expenses on the income statement.
Absorption costing treats fixed factory overhead as a product
cost and allocates it to the units produced during the period;
variable costing treats fixed overhead as a period expense and
charges the full amount incurred to the income of the period.
Absorption costing presents costs on the income statement in
their functional categories without regard to cost behavior
while variable costing presents costs on the income statement
as either fixed or variable as well as product or period.
2. The underlying cause of the difference between absorption and

variable costing is the definition of an asset. Asset cost
should include all costs necessary to get an item into place
and ready for sale or use. Absorption costing considers fixed
overhead to be an inventoriable cost (asset) because products
could not be produced without the basic manufacturing capacity
represented by fixed overhead cost. Variable costing
proponents, however, believe that fixed overhead is not an
inventoriable cost because it is incurred regardless of
whether production is achieved. This is not a problem for
which there is a single correct answer since both positions
have logical and rational arguments to support them.
3. A functional classification requires cost to be classified

based on the reason it was incurred, i.e., selling,
administrative, or production. A behavioral classification of
costs requires costs to be classified according to the way the
cost behaves with changes in product volume, i.e., variable or
fixed.
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282 Chapter 11
Absorption/Variable Costing and Cost-Volume-Profit Analysis
4. Absorption costing is required for external reporting. The

rationale is that fixed manufacturing overhead is regarded as
a product cost and that it should therefore be included with
the variable production costs and be shown as an expense only
in the period in which the related products are sold.
5. Use of monetary, quantitative information varies greatly

between external and internal users. External users emphasize
profitability potential; internal users emphasize information
that helps make sales, production, and capital expenditure
decisions.
Both absorption and variable costing have a place in
decision making. Accountants and decision makers need to
understand the applications and limitations of the two
techniques within the context of past, present, and future
cost information needs. No matter which type of costing a
firm uses, the firm’s total revenue must cover all costs—both
variable and fixed—and also generate a satisfactory profit if
a firm is to survive in the long run.
The methods of cost accumulation and cost presentation
used for reporting are determined by what is acceptable to
those parties for whom the reports are intended. External
reporting is guided by the characteristics of reliability,
uniformity, and consistency. Internal reporting is guided by
flexibility in helping managers with planning, controlling,
decision making, and performance evaluation.
6. Absorption costing requires a functional classification of

costs, with two major cost groupings: product and period.
Variable costing requires costs to be classified according to
their behavior: fixed or variable. In addition, variable
costing can employ a dual categorization of costs; costs are
first classified by their behavior and then, within the
behavioral classes, costs are further classified as to their
function.
7. Variable overhead is highly correlated with production,

meaning that it statistically changes directly and
proportionately with production. Because it behaves with
respect to production the same way as direct material and
direct labor, and treats only these three costs as product
costs, many accountants have called it direct costing.
Variable costing is a better term because all three costs are
variable; however, variable overhead must be allocated and is,
therefore, not direct.
8. Many important organizational decisions involve a

consideration of impacts on volume of production and sales,
and/or tradeoffs between variable and fixed costs. A scheme
that requires costs to be classified by their behavior lends
itself to these types of decisions.
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284 Chapter 11
9. Student answers will vary. No solution provided.
10. When the production level exceeds the sales level, absorption
costing income will be higher than variable costing income
because some of the fixed factory overhead incurred during the
period will be deferred into inventory rather than going to
the income statement. Since no fixed overhead is inventoried
under variable costing, there will be more dollars of expense
on the income statement under variable costing than there will
be under absorption costing.
When the production level is less than the sales level,
some of the fixed overhead deferred in previous periods will
be charged against income as part of cost of goods sold under
absorption costing in addition to the current period fixed
overhead. Thus, there will be greater income charges under
absorption costing than under variable, resulting in a smaller
income amount.
11. The break-even point is the starting point for CVP analysis
because before a company can earn profits, it must first cover
all of its variable and fixed costs; the point at which all
costs are just covered is the break-even point.
12. Contribution margin is selling price minus variable cost.

Contribution margin is the amount that is available to cover
fixed costs and generate profits for the company. It
fluctuates in direct proportion with sales volume because the
two elements used in its computation (selling price and
variable cost) are both variable and, thus in total, fluctuate
directly with sales volume.
13. The usefulness of CVP analysis is its ability to clearly

forecast income expected to result from the short-run
interplay of cost, volume, price, and quality. It is often
useful in analyzing current problems regarding product mix,
make or buy, sell or process further, and pricing.
In the long run, however, all of these factors and their
relationships and the assumptions that underlie CVP regarding
these factors are likely to change. This emphasizes that CVP
only holds true for the short run. Results must be
recalculated periodically to maintain validity.
14. The variable costing income statement is depicted by the

following equation: Sales - variable costs - fixed costs =
pre-tax income. At any operating level, total revenues are
equal to total expenses plus profits (or minus losses). Total
expenses can be illustrated by the formula for a straight line
(y=a+bX). At the break-even point, y (total costs) is equal to
total revenues. By adding an additional amount for desired
profit, it is "as if another cost needs to be covered,
requiring revenues to increase to that extent."
Chapter 11 285
15. If fixed costs increase and selling price and variable costs
remain constant, contribution margin will not change because
fixed costs do not enter into the computation of contribution
margin. Because a larger amount of fixed costs must now be
covered by the same amount of contribution margin per unit,
the break-even point will rise.
16. Contribution margin per unit can be divided into fixed costs
to compute break-even point in units. Contribution margin
percentage can be divided into fixed costs to compute break-
even point in sales dollars.
17. The contribution margin ratio is simply the contribution

margin per unit divided by the sales price per unit. The
break-even point is obtained by dividing total fixed costs by
the contribution margin ratio.
18. Since taxes will reduce income before taxes by $.40 of each
dollar, the income that will remain to be considered net
income or profits will only be $.60 of each dollar. Therefore,
to generate $.60 of net income, the company will need to
produce $1.00 of income before taxes - dividing what is
desired by the remaining portion after taxes yields the
corresponding value before taxes.
19. The "bag" or "basket" assumption means that a multi-product

firm will consider that the products it sells are sold in a
constant, proportional sales mix - as if in a bag of goods. It
is necessary to make this assumption in order to determine the
contribution margin for the entire company product line, since
individual products' contribution margins may differ
significantly. A single contribution margin must be used in
CVP analysis so the "bag" or "basket" assumption allows CVP
computations to be made.
20. The margin of safety is a measure that presents the difference

between the actual or pro forma level of sales and its break-
even point, BEP. Remember that the BEP is not a commercial
objective, but rather a reference point against which actual
or pro forma sales can be compared, and the margin of safety
measures either the comfort or risk, depending on whether the
margin of safety is greater than or less than the BEP.
Therefore, the margin of safety is the relationship of actual
or pro forma sales to the BEP reference point.
286 Chapter 11
21. Operating leverage refers to the amount of fixed costs

relative to variable costs in a company's cost structure.
Higher operating leverage is associated with a higher
proportion of fixed costs; lower operating leverage is
associated with a lower level of fixed costs. The level of
operating leverage is dependent on the level of revenues.
Further, operating leverage provides information about how
profit will change when revenue changes. High operating
leverage indicates that the level of profit is very sensitive
to a change in revenue level. The reverse is true for low
operating leverage.
Margin of safety is the difference between actual or
projected sales and break-even level sales. It identifies the
amount by which sales could fall and still leave the firm's
bottom line in the black.
22. Break-even charts are prepared to show, in graphic form, the

relationships between revenues, expenses, volume, and profits
(losses). The traditional break-even chart does not present
contribution margin, whereas the contemporary break-even chart
does. On the contemporary break-even chart, contribution
margin is indicated by the area between the revenue line and
the variable cost line. The profit-volume graph plots profit
against volume.
Exercises
23. a. (20,000 - 18,400) × $8.50 = $13,600
b. (20,000 - 18,400) × ($8.50 - $1.50) = $11,200
c. Absorption costing would have produced the higher net

income because it would have required $2,400 (1,600 ×
$1.50) of fixed manufacturing overhead to be inventoried
rather than to be charged against income.
24. The only difference between variable and absorption net income
is due to the difference in treatment of fixed manufacturing
overhead.
Fixed overhead expensed:

Variable costing $500,000
Absorption costing ($500,000 × (37,500÷40,000)) 468,750
NI difference $ 31,250
The company's net income would have been $31,250 higher.

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25. a. Ingredients $28,000

Labor 13,000
Variable overhead 24,000
Total variable cost $65,000
Divided by units ÷100,000
Variable cost per unit $0.65
Total variable cost $65,000

Fixed overhead 12,000
Total cost $77,000
Divided by units ÷100,000
Absorption cost per unit $0.77
b. Variable cost of goods sold = 99,000 × $0.65 = $64,350
c. Cost of goods sold = 99,000 × $0.77 = $76,230
d. Ending inventory (variable costing) = 1,000 × $0.65

= $650
Ending inventory (absorption costing) = 1,000 × $0.77
= $770
e. Fixed overhead charged to expense (variable costing)
= $12,000
Fixed overhead charged to expense (absorption costing)
= 99,000 × ($12,000 ÷ 100,000) = 99,000 × $0.12 = $11,880
26. a. Income-variable costing $90,000

Deduct additional fixed cost ($6 × 2,000) 12,000
Income-absorption costing $78,000
b. Income-variable costing $ 90,000

Add inventoriable fixed cost ($6 × 3,000) 18,000
Income-absorption costing $108,000
27. a. 1. Charming Curios

Income Statement (Absorption Costing Basis)
For the Month ended April 2002
($000 omitted)
Sales $4,800
Less cost of goods sold:
Variable cost per unit $ 24
Fixed overhead cost per unit 10
Total unit cost $ 34
Times number of units sold × 100
Cost of goods sold at standard $3,400
Less production volume variance
(5,000 units @ $10) (50) (3,350)
Gross margin $1,450
Less fixed selling & administrative expenses (800)
Income before taxes $ 650
288 Chapter 11
2. Difference in incomes = $600 - $650 = ($50)

This amount is equal to the increase in inventory of
5,000 units × $10 per unit fixed overhead deferred
in ending inventory under absorption costing.
b. The vice-president of marketing should find the variable

costing approach to income determination desirable for
many reasons, including these:
•Variable costing income varies with units sold, not
units produced.
•Fixed manufacturing overhead costs are charged against
revenue in the period in which they are incurred;
consequently, manufacturing cost per unit does not
change with a change in production level.
•The contribution margin offers a useful tool for making
decisions that consider changes in relationships among
costs, volume levels, and profit figures.
(CMA adapted)
28. a. Estimated fixed overhead = $0.16 × 200,000 = $32,000
b. Actual (and estimated) fixed overhead $32,000

Applied fixed overhead (180,000 × $.16) 28,800
Underapplied fixed overhead (absorption) $ 3,200
There would be no under- or overapplied fixed overhead

under variable costing since fixed overhead is not
applied to units of product.
c. Direct materials $0.18

Direct labor 0.10
Variable overhead 0.05
Cost per unit (variable) $0.33
Fixed overhead 0.16
Cost per unit (absorption) $0.49
d. Absorption Cost of Goods Sold (195,000 × $0.49) $ 95,550

Plus underapplied overhead 3,200
Adjusted cost of goods sold $ 98,750
Selling and administrative costs:
Variable (195,000 × $0.14) $ 27,300
Fixed 150,000 177,300
Total period costs (absorption) $276,050
Variable cost of goods sold (195,000 × $0.33) $ 64,350

Variable selling expenses (195,000 × $0.14) 27,300
Fixed overhead 32,000
Fixed selling and administrative 150,000
Total period costs (variable) $273,650
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e. Income will be higher under variable costing because the

sales level is greater than the production level. It
will be higher by the fixed overhead per unit ($0.16)
times the change in inventory (15,000 unit decline) or
$2,400.
29. a. Total revenue rises by $50 + $42 = $92.
b. Total costs rise by the amount of variable costs, $42.
c. Total pretax profit rises at the rate of the CM per unit,

$50.
30. Breakeven in units = $120,875 ÷ ($60-$35) = 4,835 units; in

dollars breakeven = 4,835 × $60 = $290,100
31. Let Y = level of sales that generate pretax income = 30% of

sales, then:
Y - 0.60Y - ($50,000 × 12) = 0.30Y
0.10Y = $600,000
Y = $6,000,000.
Since existing sales are $2,500,000, sales would need to

increase by $6,000,000 - $2,500,000 = $3,500,000.
32. a. First, convert the desired after-tax income to a pretax

desired income:
$495,014 ÷ (1 - 0.35) = $761,560
Note that total variable costs per unit = $1,800, and
total fixed costs = $280,420.
Next, let P represent the number of playhouses that must
be sold to generate $761,560 in pretax income:
$3,000P - $1,800P - $280,420 = $761,560
$1,200P = $1,041,980
= 869 playhouses
(rounded)
b. Find after-tax equivalent of 20%: 20% ÷ (1 - 0.35) =

30.77%. Variable costs as a percentage of sales: $1,800
÷ $3,000 = 60%.
Let R = the level of revenue that generates a pretax
return of 30.77%:
R - 0.60R - $280,420 = 0.3077R
0.0923R = $280,420
R = $3,038,137 (rounded)
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33. a. Sales ($4.50 × 200,000) $900,000

Variable Costs ($2.70 × 200,000) (540,000)
Contribution Margin $360,000
Fixed Costs (316,600)
Net Income $ 43,400
BEP = $316,600 ÷ .4 = $791,500

Margin of safety, dollars: $900,000 - $791,500 = $108,500
Margin of safety in units: $108,500 ÷ $4.50 = 24,111
units
b. $360,000 ÷ $43,400 = 8.29
c. Income will increase by: 8.29 × 30% = 249%

Proof:
Sales ($4.50 × 200,000 × 1.30) $1,170,000
Variable Costs ($2.70 × 200,000 × 1.30) (702,000)
Contribution Margin $ 468,000
Net Income $ 151,400
($151,400 - $43,400) ÷ $43,400 = 249%
d. BEP = ($316,600 + $41,200) ÷ 0.4 = $894,500
Sales ($4.50 × 200,000 × 1.15) $1,035,000

Variable Costs ($2.70 × 200,000 × 1.15) (621,000)
Net Income $ 56,200
Operating leverage = $414,000 ÷ $56,200 = 7.37
34. a. Each "bag" contains 2 units of M and 4 units of N. Thus,

each bag generates contribution margin of:
(2 × $10) + (4 × $5) = $40. The break-even point would
be: $90,000 ÷ $40 = 2,250 bags. Since each bag contains
4 units of N, at the break-even point 2,250 × 4 = 9,000
units of N would be sold.
b. At the break-even point, total CM = total FC; and the CM

per unit would be $800 ÷ 2,000 = $0.40. If one unit is
sold beyond the break-even point, net income would rise
by $0.40.
c. $5X - 0.40($5X) - $108,000 = 0.25($5X)

$1.75X = $108,000
X = 61,715 units
d. In units: 1,600 - 1,400 = 200 units

In dollars: 200 units × $65 per unit = $13,000
Percentage: $13,000 ÷ ($65 X 1,600) = 12.5%
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35. a. Each bag contains 3 gloves and 1 bat. Each bag generates
(3 × $4) + (1 × $5) = $17 of contribution margin.
BEP = $200,000 ÷ $17 = 11,764.71, or 11,765 bags.
11,765 bags contain 11,765 × 3 = 35,295 bats and 11,765
gloves.
Bat revenue: 11,765 × 3 × $10 = $352,950
Glove revenue: 11,765 × 1 × $15 = 176,475
Total revenue $529,425
Alternatively, the BEP can be computed based on dollars

rather than units. Total revenue per bag is (3 × $10) +
(1 × $15) = $45. The CM% = $17 ÷ $45 = 37.78%
BEP = $200,000 ÷ 0.3778 = $529,381. Note that due to
rounding, this answer differs slightly from the answer
obtained using the units approach.
b. 0.3778X - $200,000 = $90,000; X = $767,601.91
c. Convert after-tax revenue to pretax revenue:
$90,000 ÷ (1 - .40) = $150,000

X - .3778 - $200,000 = $150,000
X = $926,416.09
d. First, determine how many bags were sold:
$767,601.91 ÷ $35 = 21,931 bags

Total CM:
Bats: 21,931 × 2 × $4 = $175,448
Gloves: 21,931 × 1 × $5 = 109,655 $285,103
Fixed costs 200,000
Profit $ 85,103
The actual profit is lower than the expected profit

because each dollar of sales generated less contribution
margin than the planned sales. This is proven below:
Actual Bag Planned Bag
Sales $35 $45
CM 13 17
CM% 37.14% 37.78%
292 Chapter 11
36. a.
Traditional CVP Graph Total

revenue
curve
200000
Breakeven
180000
Point
160000
Profit
140000 area
120000
100000
$
Total
80000 costs
60000 Loss
area
40000
20000
Fixed Cost
0
0 7500 15000 22500
Units of production
Chapter 11 293
b.
Breakeven Point
Total
Contemporary CVP Graph revenue
curve
200000
Breakeven
point Profit
180000
area
160000
140000 Total
costs
120000
100000
$
80000
Fixed
costs
60000
40000
Variable
20000
costs
0
0 7500 15000 22500
Units of production Loss area
294 Chapter 11
c.
Breakeven point
Profit-Volume Graph Profit

curve
80000
60000 Profit
area
40000
20000
$
0
0 7500 15000 22500
-20000 Loss area
-40000
Units of production
d. Graph (a) demonstrates how total costs and total revenues

behave as volume changes. In graph (a), variable costs
are not explicitly shown but can be inferred as the
distance between the total cost and fixed cost lines.
Profit or loss is the distance between the total revenue
and total cost lines. Graph (b) is similar to graph (a)
but it doesn't explicitly show fixed costs; however the
amount of fixed costs can be determined by looking at the
area between the total cost line and the variable cost
line. Graph (c) shows only how profit changes with
changes in volume. The shaded area to the right of the
profit curve is the profit area; the shaded area to the
left is the loss area. No actual revenues or costs can
be determined by looking at this graph.
Chapter 11 295
Problems
37. a. George Jones Enterprises

Income Statement (Absorption)
For the Year Ended December 31, 2002
Sales $3,750,000
Cost of goods sold - Variable (1,950,000)
Fixed overhead $1,500,000 × (1,500 ÷ 1,750) (1,285,714)
Gross profit $ 514,286
Variable selling & administrative $270,000
Fixed selling & administrative 190,000 (460,000)
Net income $ 54,286
b. The difference in the amounts is equal to the fixed

overhead of ($1,500,000 ÷ 1,750 units) approximately
$857.14 per unit times the 250 units produced but not
sold during the year. This $214,286 is contained in
ending inventory under absorption costing, whereas it
appears as part of total fixed overhead expense on the
variable costing income statement.
c. It is not only ethical, it is required for the statements

to be in conformity with generally accepted accounting
principles.
d. 1. George Jones Enterprises

Income Statement (Variable)
Sales $4,625,000
Variable cost of goods sold (1,850 × $1,300) (2,405,000)
Product contribution margin $2,220,000
Variable selling & administrative ($180 × 1,850) (333,000)
Contribution margin $1,887,000
Fixed overhead $1,500,000
Fixed selling & administrative 190,000 (1,690,000)
Net income $ 197,000
2. George Jones Enterprises

For the Year Ended Dec. 31, 2003
Sales $4,625,000
Cost of goods sold - Variable 2,405,000
Fixed overhead $1,500,000 × (1,850 ÷ 1,750) (1,585,714)
Gross profit $ 634,286
Variable selling & administrative $333,000
Fixed selling & administrative 190,000 (523,000)
Net income under variable costing $197,000

Net income under absorption costing (111,286)
Difference in net incomes $ 85,714
296 Chapter 11
3. The difference in the net incomes is equal to the

incremental decrease in the ending balances of the
inventory accounts when compared to the beginning
balances. Another way to look at this more easily is
to multiply the 100 units sold in excess of the
1,750 units produced by the fixed overhead
application rate.
38. a. Direct material $1.20

Direct labor 1.50
Total cost $3.10
b. Direct material $1.20

Direct labor 1.50
Fixed overhead 0.16
Total cost $3.26
c. Net income under variable costing $223,000

Inventory incr. (10,000 units × $0.16 fixed OH) 1,600
Net income under absorption costing $224,600
39. a. Kirkfield Fashions

Sales (20,000  $40) $800,000

Variable cost of goods sold
(20,000 x $15) $300,000
Manufacturing variances (variable) 4,000 (304,000)
Contribution margin $496,000
Fixed costs:
Production $117,000
Selling & administrative 125,000 (242,000)
Income before taxes $254,000
b. Kirkfield Fashions
Sales (20,000  $40) $800,000

Cost of goods sold (20,000 x $18.90) $378,000
Manufacturing variances (unfavorable) 27,400* 405,400)
Gross margin $394,600
Less Selling and administrative costs (125,000)
Income before taxes $269,600
*From before $ 4,000 variable
Underapplied OH 23,400 [(30,000 - 24,000) × $117,000 ÷
Chapter 11 297
$27,400 U 30,000]
298 Chapter 11
c. Inventory increased 4,000 units. Each added unit absorbs

$3.90 in allocated fixed overhead or a total of $15,600.
The presumption in the problem is that the books are
maintained on a variable costing basis. Assuming only
the current year needs to be adjusted (the beginning
inventory of 2003 was charged with the appropriate fixed
overhead), then the entry would be:
Inventory 15,600
Cost of Goods Sold 78,000
Underapplied Overhead 23,400
Factory Overhead 117,000
d. Advantages:
The fixed costs are reported at incurred values (and not
applied), thus increasing the likelihood of better
control of those costs.
Profits are directly influenced by changes in sales
volume (and not influenced by building inventory).
The impact of fixed costs on profits is emphasized.
Product line, territory, etc., marginal contribution is
emphasized and more readily ascertainable.
The income statements are in the same form as the
cost-volume- profit relationships.
Disadvantages:
Total costs may be overlooked when considering problems.
Distinction between fixed and variable cost is arbitrary
for many costs.
Emphasis on variable cost may cause managers to ignore
fixed costs.
e. Advantages:
Statements would readily reflect the direct impact of
sales volume on profits.
The consequences of fixed costs would be more obvious.
Inventory swings would not influence profits.
Disadvantages:
Costs are not matched with revenues.
The difficulty in separating fixed and variable costs
might cause statements to be misleading.
Statements would confuse investors used to absorption
costing statements.
Confidential information (on the nature of costs) could
be disclosed to competitors.
(CMA adapted)
Chapter 11 299
40. Babbage Digital

Income Statements (Absorption)
For the Years Ended December 31, 2002 and 2003
2002 (20,000 units) 2003 (24,000 units)

Sales (units × $190) $3,800,000 $4,560,000
Cost of Goods Sold:
(units × $130) $2,600,000 $3,120,000
Underapplied FOH 0 2,600,000 90,000 3,210,000
Gross Profit $1,200,000 $1,350,000
S&A:
Variable
(units × $20) $ 400,000 $ 480,000
Fixed 180,000 580,000 180,000 660,000
Income before taxes $ 620,000 $ 690,000
Babbage Digital
Income Statements (Variable)
For the Years Ended December 31, 2002 and 2003
2002 (20,000 units) 2003 (24,000 units)

Sales (units × $190) $3,800,000 $4,560,000
Cost of Goods Sold:
(units × $100) 2,000,000 2,400,000
Product contribution
margin $1,800,000 $2,160,000
Variable SG&A:
(units × $20) 400,000 480,000
Total contribution
margin $1,400,000 $1,680,000
Fixed costs
Factory $750,000 $750,000
S&A 180,000 930,000 180,000 930,000
Income before taxes $ 470,000 $ 750,000
2002 2003
Net income (absorption) $620,000 $690,000
Net income (variable) 470,000 750,000
Difference $150,000 $(60,000)
Difference is equal to inventory change +5,000 -2,000

Times FOH application rate × $30 × $30
$150,000 $(60,000)
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41. a.
Revenues:
Airline bookings ($30,000 × 0.08) $2,400
Rental car bookings ($4,500 × 0.10) 450
Hotel bookings ($7,000 × 0.20) 1,400 $4,250
Costs:
Advertising $1,100
Rent 900
Utilities 250
Other 2,200 (4,450)
Net loss $ (200)
b.
Increase in revenues $30,000 × 0.40 × 0.08 = $960
Increase in costs (600)
Increase in profits $360
Yes, Mr. Hand should incur the $600 of advertising expense

because it would generate $360 of new profits.
c.
Increase in revenues:
Airline bookings ($10,000 × .08) $ 800
Rental car bookings ($1,500 × .10) 150
Hotel bookings ($4,000 × 0.20) 800 $1,750
Increase in costs:
Kyle's commission ($1,750 × .50) 875
Kyle's wage 300
Additional utility cost 300 (1,475)
Increase in profits $ 275
Yes, Joseph should hire Kyle because doing so would increase

his profits by $275.
d.
Increase in revenues:
Airline bookings ($8,000 × .08) $ 640
Increase in costs:
Kyle's commission ($640 × .50) $320
Kyle's wage 300
Additional fixed cost 400 (1,020)
Increase in losses $ (380)
No. The decision to hire Kyle, in retrospect, was unwise

because the commissions he generated were insufficient to
cover the additional costs he generated.
Chapter 11 301
42. a. Total variable costs = $28 + $12 + $8 = $48

CM per unit = $70 - $48 = $22 per unit
CM% = $22 ÷ $70 = 31.43%
Total fixed costs = $20,000 + $48,000 = $68,000
BEP, units = $68,000 ÷ $22 per unit = 3,091 units

(rounded)
BEP, dollars = $68,000 ÷ 0.3143 = $216,354
b. ($80,000 + $68,000) ÷ .3143 = $470,888, this is ($470,888

÷ $70) = 6,727 units (rounded).
c. Convert after-tax earnings to pretax earnings:

$80,000 ÷ (1 - .40) = $133,333.
Required sales = ($133,333 + $68,000) ÷ .3143 = $640,577;
$640,577 ÷ $70 = 9,151 units.
d. Convert the after-tax rate of earnings to a pretax rate

of earnings: (20% ÷ (1-.40) = 33.33%.
Because the CM% is only 31.43%, no level of sales would
generate net income equal, on a pretax basis, to 33.33%
of sales.
e. Variable cost savings (5,000 × $6) = $30,000

Additional fixed costs (8,000)
Additional profit $22,000
Yes, she should add the lab.
f. Existing CM per unit = $22

CM under proposal = ($70 × 0.90) - $48 = $15
Total CM under proposal (3,000 × 1.30) × $15 = $ 58,500

Existing CM (3,000 × $22) (66,000)
Change in CM $ (7,500)
Change in fixed costs (20,000)
Change in net earnings before taxes $(27,500)
No, these two changes should not be made because they

would lower pretax profits by $27,500 relative to
existing levels.
302 Chapter 11
43. a. Dollars per unit Percent

Sales $25 100%
Variable costs 12 48
Contribution margin $13 52%
b. BEP = $589,550  $13 per unit = 45,350 mice
c. BEP = $589,550  0.52 = $1,133,750
d. MS, in units = 120,000 - 45,350 = 74,650 mice

MS, in dollars = ($25×120,000) - $1,133,750 = $1,866,250
MS, percentage = $1,866,250  $3,000,000 = 62.21%
e. Current sales (120,000 × $25) $3,000,000

Variable costs (120,000 × $12) 1,440,000
Contribution margin $1,560,000
Fixed costs 589,550
Income before taxes $ 970,450
DOL = $1,560,000  $970,450 = 1.61 (rounded)

Percentage increase in income = 25% X 1.61 = 40.25%
f. Required sales = ($589,550 + $996,450)  $13 per mouse

= 122,000 mice
g. Pretax equivalent of $657,800 = $657,800  (1 - .20)
= $822,250
Required sales = ($589,550 + $822,250)  $13 per mouse
= 108,600 mice
h. BEP = ($589,550 + $7,865)  $13 per mouse = 45,955 mice
i. Additional sales ($20 × 4,000) $80,000

Additional VC: ($12.60 × 4,000) (50,400)
Additional Contribution margin $29,600
Additional fixed costs (18,000)
Additional pretax income $11,600
Chapter 11 303
44. a. Hun Company

First Qtr. Second Qtr.
Sales $2,250,000 $2,625,000
Cost of Goods Sold
Beginning FG $ 0 $ 309,000
CGM
Variable costs 2,058,000 1,764,000
Fixed costs 105,000 90,000
Available goods $2,163,000 $2,163,000
Ending FG (309,000) 0
Volume Var. (7,500) (1,846,500) 7,500 (2,170,500)
Gross Margin $ 403,500 $ 454,500
Operating expenses
Variable $ 171,000 $ 199,500
Fixed 21,400 (192,400) 21,400 (220,900)
Operating income $ 211,100 $ 233,600
Income taxes (73,885) (81,760)
Net income $ 137,215 $ 151,840
b. Hun Company
First Qtr. Second Qtr.
Sales $2,250,000 $2,625,000
Variable Costs
Cost of Goods Sold
Beginning FG $ 0 $ 294,000
CGM
Variable prod. 2,058,000 1,764,000
Available goods $2,058,000 $2,058,000
Ending FG (294,000) 0
Other variable 171,000 (1,935,000) 199,500 (2,257,500)
Contribution Margin $ 315,000 $ 367,500
Fixed expenses
Production $ 97,500 $ 97,500
Operating 21,400 (118,900) 21,400 (118,900)
Pretax income $ 196,100 $ 248,600
Income taxes (68,635) (87,010)
Net income $ 127,465 $ 161,590
c. 1. $75 - ($58.80 + $5.70) = $10.50
2. $10.50  $75 = 14%
3. 130,000 × $10.50 = $1,365,000
4. Contribution margin $1,365,000

Fixed costs (($97,500 + $21,400) X 4) 475,600
Pretax income $ 889,400
Income taxes 311,290
304 Chapter 11
Chapter 11 305
5. $1,365,000  $889,400 = 1.53 rounded
6. $475,600  $10.50 per unit = 45,295 units (rounded)
7. $475,600  0.14 = $3,397,143 (rounded)
8. (130,000 × $75) - $3,397,143 = $6,352,857

$6,352,857  (130,000 × $75) = 65% (rounded)
45. a.
Total sales price per bag:
Encyclopedias ($1,200 × 3) $3,600
Dictionaries ($240 × 5) 1,200 $4,800
Total variable costs per bag:
Encyclopedias ($480 × 3) $1,440
Dictionaries ($160 × 5) 800 (2,240)
Total CM $2,560
BEP, units = $1,800,000 ÷ $2,560 = 703 bags

Encyclopedias: 703 × 3 = 2,109
Dictionaries: 703 × 5 = 3,515
b. ($1,800,000 + $800,000) ÷ $2,560 = 1,016 bags

Encyclopedias: 1,016 × 3 = 3,048
Dictionaries: 1,016 × 5 = 5,080
c. Pretax equivalent of $800,000 after-tax

= $800,000 ÷ (1 - .30) = $1,142,857
($1,800,000 + $1,142,857) ÷ $2,560 = 1,150 bags
Dictionaries: 1,150 × 5 = 5,750
d. Let X = number of bags that must be sold to produce

pretax earnings equaling 12% of sales revenue, then:
$2,560X - $1,800,000 = .12($4,800X)
X = 907.25, or 907 bags
Encyclopedias: 907 × 3 = 2,721
Dictionaries: 907 × 5 = 4,535
e. Convert the after-tax return to a pre-tax rate of return:

12% ÷ (1-0.30) = 17.14%. Then, solve:
$2,560X - $1,800,000 = 0.1714($4,800X)
X = 1036.10, or 1,036 bags
Dictionaries: 1,036 × 5 = 5,180
306 Chapter 11
46. a. & b.
Total variable costs:
Tile Carpet Parquet
Direct materials $5.20 $3.25 $ 8.80
Direct labor 1.80 0.40 6.40
Variable overhead 1.00 0.15 1.75
Variable selling expenses 0.50 0.25 2.00
Variable general and
administrative 0.20 0.10 0.30
Total $8.70 $4.15 $19.25
Determination of sales ratio:

Sales in yards % of Sales Per "Bag"*
Tile 18,000 10.34 3
Carpet 144,000 82.76 24
Parquet 12,000 6.90 2
Total 174,000 100.00 29
*The content per bag is determined by dividing the sales
in yards by 6,000.
Tile Carpet Parquet
Sales $16.40 $8.00 $25.00
Variable costs (8.70) (4.15) (19.25)
CM $ 7.70 $3.85 $ 5.75
Contribution Margin Sales

Tile $7.70 × 3 = $ 23.10 $16.40 × 3 = $ 49.20
Carpet $3.85 × 24 = 92.40 $8.00 × 24 = 192.00
Parquet $5.75 × 2 = 11.50 $25.00 × 2 = 50.00
Total $127.00 $291.20
Total fixed costs = $760,000 + $240,000 + $200,000

= $1,200,000
BEP = $1,200,000 ÷ $127 = 9,448.82, or 9,449 bags

Tile: 9,449 × 3 = 28,347 yards
Carpet: 9,449 × 24 = 226,776 yards
Parquet: 9,449 × 2 = 18,898 yards
CM% per bag = $127  $291.20 = 0.4361 (rounded)
BEP in dollars = $1,200,000 ÷ 0.4361 = $2,751,663
c. ($1,200,000 + $800,000) ÷ $127 = 15,748 bags
yards Revenue
Tile: 15,748 × 3 = 47,244 × $16.40 = $ 774,801.60
Carpet: 15,748 × 24 = 377,952 × 8.00 = 3,023,616.00
Parquet: 15,748 × 2 = 31,496 × 25.00 = 787,400.00
Total $4,585,817.60
d. Revenue per bag:
Tile $16.40 × 3 = $ 49.20
Carpet $ 8.00 × 24 = 192.00
Parquet $25.00 × 2 = 50.00
Total $291.20
CM% = $127 ÷ $291.20 = 43.61%
Chapter 11 307
($1,200,000 + ($680,000 ÷ (1-0.40))) ÷ .4361 = $5,350,455

308 Chapter 11
e. 1. BEP = $1,200,000 ÷ 0.4361 = $2,751,663

Margin
of safety = $5,350,455 - $2,751,663 = $2,598,792
2. Margin of
safety % = $2,598,792 ÷ $5,350,455 = 48.57%
47. a.
Traditional Break-even Chart Revenue

curve
70 00
Break-even
60 00 point Profit
area
50 00
40 00
$
30 00 Total cost
curve
20 00
Loss area
10 00
0
0 40 80 12 0 16 0 20 0 24 0 28 0
Number of m em be rs
Chapter 11 309
b.
Contemporary Break-even Chart

70 00 Revenue
curve
Break-even
60 00 point Profit
area
50 00 Total cost
curve
40 00 Fixed
$ costs
30 00 Total
variable
20 00
cost
Loss area
10 00
0
0 40 80 12 0 16 0 20 0 24 0 28 0
310 Chapter 11
c.
Profit-volume Graph
20 00
Break-even Revenue
15 00 point curve
10 00
Profit
50 0 area
$ 0
0 40 80 12 0 16 0 20 0 24 0 28 0
-5 00
Loss area
-1 000
-1 500
-2 000
d. Graph (c) would be effective since it clearly indicates

that with only 120 members the club is operating at a
loss.
Chapter 11 311
Cases
48. a. Marwick Manufacturing

Sales $1,015,000
Variable Cost of Goods Sold:
Finished goods 1/1/02 $ 16,950
Work in Process 1/1/02 46,400
Manufacturing costs incurred 650,600
Total costs available $713,950
Work in process 12/31/02 (61,900)
Finished goods 12/31/02 (13,180) (638,870)
Product Contribution Margin $ 376,130
Variable Selling Expenses (50,750)
Fixed Expenses
Factory overhead $ 42,300
Selling 44,250
Administrative 75,000 (161,550)
Operating Income $ 163,830
Supporting calculations
Variable finished goods inventory at 1/1/02:

Absorption finished goods inventory $18,000
Less fixed overhead (1,050 hours × $1 per hour) 1,050
Variable finished goods inventory $16,950
Variable work in process inventory at 1/1/02:

Absorption work in process inventory $48,000
Less fixed overhead (1,600 hours × $1 per hour) 1,600
Variable work in process $46,400
Variable manufacturing costs incurred during 2002:

Direct materials $370,000
Direct labor (23,000 hours × $6 per hour) 138,000
Variable overhead (23,000 hours × $6.20 per hour) 142,600
Variable manufacturing costs $650,600
The direct labor rate is ($150,000 ÷ 25,000 hours) $6.00

per hour
The variable overhead rate is ($155,000 ÷ 25,000 hours) $6.20

per hour
312 Chapter 11
Variable work in process inventory at 12/31/02:

Absorption work in process inventory $64,000
Less fixed overhead (2,100 hours × $1) (2,100)
Variable work in process inventory $61,900
Variable finished goods inventory at 12/31/02:

Absorption finished goods inventory $14,000
Less fixed overhead (820 hours × $1) (820)
Variable finished goods inventory $13,180
Variable selling expenses:

Sales of $1,015,000 × 5% $50,750
Fixed selling expenses:

Total selling expenses $95,000
Less variable selling expenses (50,750)
Fixed selling expenses $44,250
b. The difference in the operating income of $270 is caused

by the different treatment of fixed manufacturing
overhead. Under absorption costing, fixed overhead costs
are assigned to inventory and are not expensed until the
goods are sold. Under variable costing, these costs are
treated as expenses in the period incurred. Since the
direct labor hours in the work in process and finished
goods inventories had a net increase of 270 hours, the
absorption costing operating profit is higher because the
fixed factory overhead associated with the increased
labor hours in inventory is not expensed when absorption
costing is used.
1/1/02 12/31/02
Inventories Inventories Differences
Work in process 1,600 2,100 500
Finished goods 1,050 820 (230)
Total 2,650 2,920 270
The increase in hours (270) times the fixed overhead rate

($1 per hour) equals the difference in operating incomes
($270).
Chapter 11 313
c. The advantages of using variable costing are as follows:

• The fixed manufacturing costs are reported at
incurred values, not at absorbed values, which
increases the likelihood of better control over
fixed costs.
• Profits are directly influenced by changes in sales
volume and not by changes in inventory levels.
• Contribution margin by product line, territory,
department, or division is emphasized and more
readily ascertainable.
The disadvantages of using variable costing are as

follows:
• Variable costing is not acceptable for tax
reporting, for SEC reporting, nor for external
financial reporting; therefore, companies need to
adjust variable costing amounts for these purposes.
• Costs other than variable costs(i.e., fixed costs
and total production costs) may be ignored when
making decision, especially long-term decisions.
• With the advancement of factory technology and the
movement toward a fully automated factory, the fixed
factory overhead may be a significant portion of the
production costs. To ignore these significant costs
in inventory valuation may not be acceptable.
(CMA adapted)
49. a. Because Delaware Company uses absorption costing, the net

income is influenced by both sales volume and production
volume. Sales volume was increased by 10% [($294,800 -
$268,000)  $268,000] in the 11/30/02 forecast and, at
standard gross profit rates, this would increase gross
margin by $5,600. However, during this same period,
production volume was below the 1/1/02 forecast causing
an unplanned volume variance of $6,000. The volume
variance and the increased selling expenses (due to the
10% increase in sales) overshadowed the added profits
from sales as shown below:
Increased sales $26,800

Increased cost of sales at standard (21,200)
Increased gross margin at standard $ 5,600
Less:
Volume variance $6,000
Increased selling expenses 1,340 (7,340)
Decrease in earnings $ 1,740
b. The basic cause of the lower forecast of profits is low

production. If raw material can be obtained, and if it is
reasonable in light of expected future sales, Virginia
Company could schedule heavy production which would
314 Chapter 11
reduce the volume variance.

Chapter 11 315
c. Delaware Company could adopt variable costing. Under

variable costing fixed manufacturing costs would be
treated as period costs and would not be assigned to
production. Consequently, earnings would not be
affected by production volume but only by sales volume.
Statements prepared on a variable costing basis are
illustrated below.
Delaware Company
Forecasts of Operating Results
Forecasts as of
1/1/02 11/30/02
Sales $268,000 $294,800
Variable costs
Manufacturing $182,000 $200,200
Selling expenses 13,400 14,740
Total variable costs $195,400 $214,940
Contribution margin $ 72,600 $ 79,860
Fixed costs
Manufacturing $ 30,000 $ 30,000
Administrative 26,800 26,800
Total fixed costs $ 56,800 $ 56,800
Earnings before taxes $ 15,800 $ 23,060
d. Variable costing would not be acceptable for financial

reporting purposes because generally accepted accounting
principles seem to require the allocation of some fixed
manufacturing costs to inventory.
(CMA adapted)
316 Chapter 11
50. a. Fixed costs:

Depreciation $ 8,000
Labor 16,000
Utilities 7,900
Miscellaneous 5,000
Total $36,900
Variable costs: Dogs Cats

Labor $0.25 $0.25
Utilities 0.05 0.05
Miscellaneous 0.30 0.30
Food 2.00 0.75
Total $2.60 $1.35
Total fixed costs $36,900

Total variable costs
Cats: (15 × $1.35 × 360) $ 7,290
Dogs: (15 × $2.60 × 360) 14,040 21,330
Desired profit 12,000
Total required revenue $70,230
Animal days:
Cats: 15 × 360 = 5,400
Dogs: 15 × 360 = 5,400
Total 10,800
Required charge per animal day: $70,230 ÷ 10,800 = $6.50
b. 1. Dogs Cats
Sales price per day $12.00 $10.00
Variable costs 2.60 1.35
CM $ 9.40 $ 8.65
CM per "bag" of animal days = $9.40 + $8.65 = $18.05
BEP, bags = $36,900 ÷ $18.05 per bag = 2,044 bags,

which represents 2,044 dog-days and 2,044 cat-days.
2. ($36,900 + $20,000) ÷ $18.05 per bag = 3,152 bags,

which represents 3,152 dog-days and 3,152 cat-days.
3. ($36,900 + ($20,000 ÷ (1 - 0.35))) ÷ $18.05 per bag

= 3,749 bags, which represents 3,749 dog-days and
3,749 cat-days.
c. $25,000 ÷ (2,044 + 2,044) = $6.12 per animal day

Chapter 11 317
51. a. CM = $70 - $30 = $40 per passenger, or 57.14%

BEP = FC ÷ CM = $1,200,000 ÷ $40 per passenter
= 30,000 passengers
BEP = FC ÷ CM% = $1,200,000 ÷ 0.5714 = $2,100,105
b. 120 × 0.75 = 90 seats per plane filled

30,000 ÷ 90 = 333 flights (rounded)
c. CM = $85 - $30 = $55 per passenger

120 X .60 = 72 filled seats
BEP = FC ÷ CM = $1,200,000 ÷ $55 per passenger
= 21,818 passengers (rounded)
d. CM = $70 - $40 = $30 per passenger

BEP = FC ÷ CM = $1,200,000 ÷ $30 per pasenger
= 40,000 passengers
e. After-tax income = $400,000 ÷ (1 - tax rate)

= $400,000 ÷ (1 - 0.4)
= $400,000 ÷ 0.6
= $666,667
$80X - $1,500,000 - $35X = $666,667
$45X = $2,166,667
X = 48,148 (rounded)
f. CM for discounted fares = $50 - $30 = $20 × 6 discounted

seats = $120 each flight × 40 flights per day × 30 days
per month = $144,000 minus $80,000 additional fixed costs
= $64,000 additional pretax income.
g. 1. No. CM = $75 - $30 = $45 per passenger

120 × 0.60 = 72 seats × $45 × 15 flights =$ 48,600
Increased fixed costs (100,000)
pretax loss on new route $ (51,400)
2. $75X - $100,000 - $30X = $50,500

$45X = $150,500
X = 3,344 passengers (rounded)
3,344 ÷ 72 = 46.44 flights (rounded)
3. 120 X .75 = 90 seats filled

318 Chapter 11
4. Reliable should consider such things as:

 connections to other Reliable flights that might
be made by these passengers
 long-range potential for increased load factors
 increased customer goodwill in this new market
 increased employment opportunities for labor in
the area
 competition in the market
Reality Check
52. Substantial cost structure implications must be considered in

selecting from the alternative production technologies.
Machine-based technologies will tend to have much higher
levels of fixed costs and lower levels of variable costs than
labor-intense technologies. Accordingly, the machine-based
technologies will have higher operating leverage. Having
higher operating leverage means that the firm’s income will be
much more sensitive to changes in level of sales.
Because higher operating leverage is associated with
higher income sensitivity to volume changes, high operating
leverage is desired if future sales are expected to be
increasing. Higher leverage allows net income to grow at a
higher rate as sales increase. Alternatively, if the future
portends decreasing sales, firms will prefer to have low
operating leverage because costs will tend to fall more
rapidly as sales diminish. With high operating leverage,
costs will remain more constant as sales drop causing net
income to drop very rapidly.
In an ideal world, one would desire to have a very low
level of fixed costs below the break-even point and only fixed
costs above the break-even point. If the cost structure
contained only fixed costs, then each dollar of revenue above
the break-even point would generate a dollar of income before
profit. CVP analysis is useful to determine when a firm
should consider trading variable costs for fixed costs in
order to shift the cost structure from more variable to more
fixed, or vice versa.
For a given level of sales, a company with mostly
variable costs will have a higher margin of safety than a
similar firm with mostly fixed costs. If a firm had only
variable costs, its sales could fall to zero without causing
the firm to incur a loss. Consequently, its break-even point
is zero. The firm with a high level of fixed costs would have
a much higher break-even point.
Chapter 11 319
53. An issue in the use of CVP analysis is that CVP analysis

requires costs to be classified as either variable or fixed.
The outcome of CVP analysis is sensitive to variations in this
classification. In making decisions that rely on CVP analyses,
it is important to be mindful of the requirement to
dichotomize costs between these two categories (fixed and
variable). Further, it is important to recognize that in the
long term all costs are variable. A problem arises when
short-term decisions have long-term consequences. In this
circumstance, costs will have been incorrectly considered in
the CVP analysis because too many of the costs would have been
classified as fixed. Accordingly, the greatest potential for
problems arises in situations in which a long-term decision is
made on the basis of a short-term classification of costs. A
further observation is that CVP decisions are made in an
incremental fashion. This means that each decision is made
independently of all other decisions. The reality is that
past decisions affect future decisions and short-term
decisions can affect long-term decisions.
CVP analysis can be used in long-, medium-, and short-
term decision making. The key is to use a classification of
costs that is appropriate for the time horizon. For longer-
term decisions, newer cost control technologies such as
activity-based costing can be used to determine which costs
are likely to vary with decision alternatives being
considered. By relating the cost drivers to the decision at
hand, managers can determine which costs are likely to be
affected, and by how much, by the decision being made.
54. The debate surrounding the use of variable costing versus

absorption costing for valuing inventory hinges on whether the
incurrence of fixed overhead creates an asset. A cost incurred
to create an asset, as opposed to a cost that is an expense of
the period, must be capitalized and should not be charged
against revenues (expensed) until its related benefit is
recognized in income. Since inventory is an asset, any costs
that are incurred to create that asset, including fixed
overhead, should be considered for capitalization. This is
the argument for use of absorption costing.
However, proponents of variable costing argue that the
incurrence of fixed overhead relates more to the capacity to
produce than production per se. Accordingly, these people
argue that fixed overhead is not directly related to
production sufficiently to be considered an inventoriable
cost.
320 Chapter 11
55. a. Fixed costs that would increase include the additional

equipment costs and salaries for testing, treating,
storage and disposal of treated waste. Increased variable
costs would include labor wages, the treatment supplies,
and energy costs of performing the treatment and
disposing of the neutralized waste. The increases in
these variable costs would lower the product contribution
margin unless prices are raised to compensate.
b. After determining that the substance is toxic, the

president has to consider business as usual versus the
costs of treatment and/or proper disposal which may make
product prices uncompetitive, preserving the health of
humans downriver, the effects on fish, wildlife and the
environment, maintaining the good name and reputation of
the company, the impact on the stakeholders should the
dumping be discovered, the legality of falsifying the
reports, the impact on the employees should the plant be
closed from lack of profitability, the economic stability
of the town, and its dependence on the plant for
survival.
c. The employees are implying that not addressing the

problem is the lesser of evils because there is no proof
that the waste causes cancer; (2) to clean up the problem
may cause the company to become uncompetitive; (3) 10,000
employees could lose their jobs; and (4) the town's
economy could collapse.
The fault with the above rationalizations about the
waste not being toxic to humans lies partially in the
fact that the company failed to recognize the damage to
other nonhuman environmental participants. The waste may
be potentially harmful to the fish and other organisms in
the river and the polluted water is absorbed by the
surrounding land (thus polluting the land). Furthermore,
the fishermen sell their polluted catches to outside
markets, thus spreading the effects of the pollution even
further.
Fault is also seen in the rationalization because
the company falsified the levels of suspected cancer-
causing materials in its reports to authorities. If the
company truly believed that no harm was being done to
either the people downstream or the environment, why were
the reports falsified? Doing so instilled a false sense
of security in the members of its society (both employees
and townspeople) regarding their general welfare. If the
company had provided accurate disclosure of toxicity
levels, the public would have had the opportunity to
decide whether to remain on their jobs or in the vicinity
of the polluters, look for work elsewhere or relocate to
an area where better conditions exist, or to seek the
necessary assistance in requiring the company to take
Chapter 11 321
corrective action.
These rationalizations seem to indicate that
unhealthy and unethical acts can be permitted and
tolerated if a large number of directly affected people
benefit without regard for the effects on persons or
entities that are indirectly affected. While
utilitarianism does look at the greatest good for the
greatest number, it considers all parties-directly and
indirectly affected-in making that cost-benefit analysis.
The company in this case is not considering the indirect
effects of its actions.
d. The president must take some action to deal with the

problem. First, the dumping should be discontinued
altogether until the waste is tested to determine if it
is cancer causing. If it is not, obtain information on
the environmental effects of the dumping and, if
unharmful, continue to dump. The company should then
report its findings to the authorities and discontinue
falsifying its reports.
If the waste is cancer causing or causes significant
environmental damage, the company should immediately
issue a policy statement that no additional dumping shall
take place. Then the costs of treating the waste to
neutralize it should be compared to other alternatives
that might exist or could be created such as using it as
a raw material in another product or introducing
alternative processing methods. The company could solicit
the employees' and townspeople's assistance since all
have a large vested interest in finding a solution to the
problem. Investigation of how other companies producing
the same waste handle the problem would be helpful; some
of this type of information should be available from EPA
or state environmental agencies. If other companies are
handling the waste in a similar manner, all companies
could be liable for the costs of cleanup, which would
disallow any economic advantage to the other companies.
In addition, the company should investigate the costs of
(if possible) cleaning up the waste that has already been
dumped. Since all of these options take time, however,
the company will most likely have to incur additional
short-run costs so that the long-run effects can be
minimized.

Absorption (Variable) Costing and Cost-Volume-Profit Analysis

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Absorption (Variable) Costing and Cost-Volume-Profit Analysis

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Chapter 11

Absorption/Variable Costing and Cost-Volume-Profit

1. The two basic differences between absorption and variable

2. The underlying cause of the difference between absorption and

3. A functional classification requires cost to be classified

4. Absorption costing is required for external reporting. The

5. Use of monetary, quantitative information varies greatly

6. Absorption costing requires a functional classification of

7. Variable overhead is highly correlated with production,

8. Many important organizational decisions involve a

9. Student answers will vary. No solution provided.

12. Contribution margin is selling price minus variable cost.

13. The usefulness of CVP analysis is its ability to clearly

14. The variable costing income statement is depicted by the

17. The contribution margin ratio is simply the contribution

19. The "bag" or "basket" assumption means that a multi-product

20. The margin of safety is a measure that presents the difference

21. Operating leverage refers to the amount of fixed costs

22. Break-even charts are prepared to show, in graphic form, the

23. a. (20,000 - 18,400) × $8.50 = $13,600

b. (20,000 - 18,400) × ($8.50 - $1.50) = $11,200

c. Absorption costing would have produced the higher net

Fixed overhead expensed:

The company's net income would have been $31,250 higher.

25. a. Ingredients $28,000

Total variable cost $65,000

b. Variable cost of goods sold = 99,000 × $0.65 = $64,350

c. Cost of goods sold = 99,000 × $0.77 = $76,230

d. Ending inventory (variable costing) = 1,000 × $0.65

26. a. Income-variable costing $90,000

b. Income-variable costing $ 90,000

27. a. 1. Charming Curios

2. Difference in incomes = $600 - $650 = ($50)

b. The vice-president of marketing should find the variable

28. a. Estimated fixed overhead = $0.16 × 200,000 = $32,000

b. Actual (and estimated) fixed overhead $32,000

There would be no under- or overapplied fixed overhead

c. Direct materials $0.18

d. Absorption Cost of Goods Sold (195,000 × $0.49) $ 95,550

Variable cost of goods sold (195,000 × $0.33) $ 64,350

e. Income will be higher under variable costing because the

29. a. Total revenue rises by $50 + $42 = $92.

b. Total costs rise by the amount of variable costs, $42.

c. Total pretax profit rises at the rate of the CM per unit,

30. Breakeven in units = $120,875 ÷ ($60-$35) = 4,835 units; in

31. Let Y = level of sales that generate pretax income = 30% of

Since existing sales are $2,500,000, sales would need to

32. a. First, convert the desired after-tax income to a pretax

b. Find after-tax equivalent of 20%: 20% ÷ (1 - 0.35) =

33. a. Sales ($4.50 × 200,000) $900,000

BEP = $316,600 ÷ .4 = $791,500

b. $360,000 ÷ $43,400 = 8.29

c. Income will increase by: 8.29 × 30% = 249%

($151,400 - $43,400) ÷ $43,400 = 249%

d. BEP = ($316,600 + $41,200) ÷ 0.4 = $894,500

Sales ($4.50 × 200,000 × 1.15) $1,035,000

Operating leverage = $414,000 ÷ $56,200 = 7.37

34. a. Each "bag" contains 2 units of M and 4 units of N. Thus,

b. At the break-even point, total CM = total FC; and the CM

c. $5X - 0.40($5X) - $108,000 = 0.25($5X)

d. In units: 1,600 - 1,400 = 200 units

Alternatively, the BEP can be computed based on dollars