STRATEGIC COST MANAGEMENT - Solutions Manual

CHAPTER 10

VARIABLE COSTING: A TOOL FOR EVALUATING MANAGEMENT PERFORMANCE

Answer to Questions
1. The variable costing technique does not consider fixed costs as unimportant or irrelevant, but it
maintains that the distinction between behaviors of different costs is crucial for certain decisions.
2. The central issue in variable costing is what is the proper timing for release of fixed
manufacturing overhead as expense: at the time of incurrence, or at the time the finished units to
which the fixed overhead relates are sold.
3. Direct costing would be more accurately called variable or marginal costing because in substance
it is the inventory costing method which applies only variable production costs to product; fixed
factory overhead is not assigned to product.
4. Marketing and administrative costs are treated as period costs under both variable costing and
absorption costing methods of product costing.
5. Under absorption costing, as a company manufactures units of product, the fixed manufacturing
overhead costs of the period are added to the units, along with direct materials, direct labor, and
variable manufacturing overhead. If some of these units are not sold by the end of the period,
then they are carried into the next period as inventory. The fixed manufacturing overhead cost
attached to the units in ending inventory follow the units into the next period as part of their
inventory cost. When the units carried over as inventory are finally sold, the fixed manufacturing
overhead cost that has been carried over with the units is included as part of that period’s cost of
goods sold.
6. Many accountants and managers believe absorption costing does a better job of matching costs
with revenues than variable costing. They argue that all manufacturing costs must be assigned to
products to properly match the costs of producing units of product with the revenues from the
units when they are sold. They believe that the fixed costs of depreciation, taxes, insurance,
supervisory salaries, and so on, are just as essential to manufacturing products as are the variable
costs.
7. If fixed manufacturing overhead cost is released from inventory, then inventory levels must have
decreased and therefore production must have been less than sales.
8. Under absorption costing it is possible to increase net operating income without increasing sales
by increasing the level of production. If production exceeds sales, units of product are added to
inventory. These units carry a portion of the current period’s fixed manufacturing overhead costs
into the inventory account, thereby reducing the current period’s reported expenses and causing
net operating income to rise.
9. Generally speaking, variable costing cannot be used externally for financial reporting purposes
nor can it be used for tax purposes.
10. If production exceeds sales, absorption costing will show higher net operating income than
variable costing. The reason is that inventories will increase and therefore part of the fixed
manufacturing overhead cost of the current period will be deferred in inventory to the next period
under absorption costing. By contrast, all of the fixed manufacturing overhead cost of the current
period will be charged immediately against revenues as a period cost under variable costing.

10-1
Exercises

Exercise 1 (Variable and Absorption Costing Unit Product Costs and Income Statements)

Requirement 1
a. The unit product cost under absorption costing would be:
Direct materials...................................................................................... P18
Direct labor............................................................................................. 7
Variable manufacturing overhead..........................................................     2
Total variable manufacturing costs........................................................ 27
Fixed manufacturing overhead (P160,000 ÷ 20,000 units)....................     8
Unit product cost.................................................................................... P35

b. The absorption costing income statement:

Sales (16,000 units × P50 per unit)................................ P800,000
Less cost of goods sold:
Beginning inventory.................................................... P         0
Add cost of goods manufactured
(20,000 units × P35 per unit)..................................  700,000
Goods available for sale............................................. 700,000
Less ending inventory
(4,000 units × P35 per unit)....................................  140,000  560,000
Gross margin.................................................................. 240,000
Less selling and administrative expenses......................  190,000*
Net operating income...................................................... P 50,000
*(16,000 units × P5 per unit) + P110,000 = P190,000.

Requirement 2
a. The unit product cost under variable costing would be:
Direct materials............................................................................................ P18
Direct labor.................................................................................................. 7
Variable manufacturing overhead................................................................     2
Unit product cost.......................................................................................... P27

b. The variable costing income statement:

Sales (16,000 units × P50 per unit)............................... P800,000
Less variable expenses:
Variable cost of goods sold:
Beginning inventory.............................................. P         0
Add variable manufacturing costs
(20,000 units × P27 per unit)............................  540,000
Goods available for sale....................................... 540,000
Less ending inventory
(4,000 units × P27 per unit)..............................  108,000
Variable cost of goods sold....................................... 432,000 *
Variable selling expense    80,000  512,000

10-2
 (16,000 units × P5 per unit)..................................
Contribution margin....................................................... 288,000
Less fixed expenses:
Fixed manufacturing overhead................................. 160,000
Fixed selling and administrative................................  110,000  270,000
Net operating income.................................................... P 18,000
* The variable cost of goods sold could be computed more simply as: 16,000 units × P27 per unit
= P432,000.

Exercise 2 (Variable and Absorption Costing Unit Product Costs)

Requirement 1
Sales (40,000 units × P33.75 per unit)............................................... P1,350,000
Less variable expenses:
Variable cost of goods sold
(40,000 units × P16 per unit*).................................................... P640,000
Variable selling and administrative expenses
(40,000 units × P3 per unit).......................................................  120,000    760,000
Contribution margin............................................................................ 590,000
Less fixed expenses:
Fixed manufacturing overhead...................................................... 250,000
Fixed selling and administrative expenses....................................  300,000     550,000
Net operating income......................................................................... P    40,000

*Direct materials P10

Direct labor 4
Variable manufacturing overhead    2
Total variable manufacturing cost P16

Requirement 2
The difference in net operating income can be explained by the P50,000 in fixed manufacturing
overhead deferred in inventory under the absorption costing method:
Variable costing net operating income.................................................... P40,000
Add: Fixed manufacturing overhead cost
deferred in inventory under absorption
costing: 10,000 units × P5 per unit in fixed
manufacturing overhead cost...............................................................  50,000
Absorption costing net operating income................................................ P90,000

Exercise 3 (Variable Costing Unit Product Cost and Income Statement; Break-even)

Requirement 1

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Under variable costing, only the variable manufacturing costs are included in product costs.
Direct materials........................................................................................ P 600
Direct labor.............................................................................................. 300
Variable manufacturing overhead............................................................     100
Unit product cost...................................................................................... P1,000
Note that selling and administrative expenses are not treated as product costs; that is, they are not
included in the costs that are inventoried. These expenses are always treated as period costs and are
charged against the current period’s revenue.

Requirement 2
The variable costing income statement appears below:
Sales................................................................................ P18,000,000
Less variable expenses:
Variable cost of goods sold:
Beginning inventory............................................... P            0
Add variable manufacturing costs
(10,000 units × P1,000 per unit)........................  10,000,000
Goods available for sale........................................ 10,000,000
Less ending inventory (1,000 units × P1,000
per unit)...........................................................     1,000,000
Variable cost of goods sold*........................................ 9,000,000
Variable selling and administrative (9,000 units ×
P200 per unit).............................................................     1,800,000  10,800,000
Contribution margin.......................................................... 7,200,000
Less fixed expenses:
Fixed manufacturing overhead......................................... 3,000,000
Fixed selling and administrative.......................................     4,500,000     7,500,000
Net operating loss............................................................ P  (300,000)

* The variable cost of goods sold could be computed more simply as: 9,000 units sold × P1,000 per unit =
P9,000,000.

Requirement 3
The break-even point in units sold can be computed using the contribution margin per unit as follows:
Selling price per unit...............................................................................................................
P2,000
Variable cost per unit..............................................................................................................
  1,200
Contribution margin per unit...................................................................................................
P 800
Fixed expenses
Break-even unit sales = Unit contribution margin
P7,500,000
= P800 per unit

= 9,375 units

Exercise 4 (Absorption Costing Unit Product Cost and Income Statement)

Requirement 1

10-4
Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs.
Direct materials............................................................................ P 600
Direct labor.................................................................................. 300
Variable manufacturing overhead............................................... 100
Fixed manufacturing overhead (P3,000,000 ÷ 10,000 units)......    300
Unit product cost.......................................................................... P1,300

Requirement 2
The absorption costing income statement appears below:
Sales (9,000 units × P2,000 per unit)............................................. P18,000,000
Cost of goods sold:
Beginning inventory.................................................................... P            0
Add cost of goods manufactured (10,000 units × P1,300 per unit)  13,000,000
Goods available for sale............................................................. 13,000,000
Less ending inventory (1,000 units × P1,300 per unit)...............     1,300,000  11,700,000
Gross margin.................................................................................. 6,300,000
Selling and administrative expenses:
Variable selling and administrative (9,000 units × P200 per unit) 1,800,000
Fixed selling and administrative.................................................     4,500,000     6,300,000
Net operating income..................................................................... P             0

Note: The company apparently has exactly zero net operating income even though its sales are below
the break-even point computed in Exercise 3. This occurs because P300,000 of fixed manufacturing
overhead has been deferred in inventory and does not appear on the income statement prepared using
absorption costing.

Exercise 5 (Variable Costing Income Statement; Explanation of Difference in Net Operating

Income)

Requirement 1
2,000 units × P60 per unit fixed manufacturing overhead = P120,000

Requirement 2
The variable costing income statement appears below:

Sales........................................................................................ P4,000,000
Variable expenses:
Variable cost of goods sold:

10-5
 Beginning inventory........................................................ P            0
Add variable manufacturing costs (10,000 units × P310 per unit)  3,100,000
Goods available for sale................................................. 3,100,000
Less ending inventory (2,000 units × P310 per unit)......     620,000
Variable cost of goods sold*................................................ 2,480,000
Variable selling and administrative (8,000 units × P20 per unit)     160,000  2,640,000
Contribution margin................................................................. 1,360,000
Fixed expenses:
Fixed manufacturing overhead........................................... 600,000
Fixed selling and administrative..........................................     400,000  1,000,000
Net operating income.............................................................. P  360,000

* The variable cost of goods sold could be computed more simply as: 8,000 units sold × P310 per unit
= P2,480,000.

The difference in net operating income between variable and absorption costing can be explained by
the deferral of fixed manufacturing overhead cost in inventory that has taken place under the
absorption costing approach. Note from part (1) that P120,000 of fixed manufacturing overhead cost
has been deferred in inventory to the next period. Thus, net operating income under the absorption
costing approach is P120,000 higher than it is under variable costing.

Exercise 6 (Evaluating Absorption and Variable Costing as Alternative Costing Methods)

Requirement 1
a. By assumption, the unit selling price, unit variable costs, and total fixed costs are constant from
year to year. Consequently, variable costing net operating income will vary with sales. If sales
increase, variable costing net operating income will increase. If sales decrease, variable costing
net operating income will decrease. If sales are constant, variable costing net operating income
will be constant. Because variable costing net operating income was P16,847 each year, unit sales
must have been the same in each year.
The same is not true of absorption costing net operating income. Sales and absorption costing net
operating income do not necessarily move in the same direction because changes in inventories
also affect absorption costing net operating income.
b. When variable costing net operating income exceeds absorption costing net operating income,
sales exceeds production. Inventories shrink and fixed manufacturing overhead costs are released
from inventories. In contrast, when variable costing net operating income is less than absorption
costing net operating income, production exceeds sales. Inventories grow and fixed
manufacturing overhead costs are deferred in inventories. The year-by-year effects are shown on
the next page.

Year 1 Year 2 Year 3

Variable costing NOI = Variable costing NOI < Variable costing NOI >
Absorption costing NOI Absorption costing NOI Absorption costing NOI
Production = Sales Production > Sales Production < Sales
Inventories remain the same Inventories grow Inventories shrink

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 Requirement 2
a. As discussed in part (1 a) above, unit sales and variable costing net operating income move in the
same direction when unit selling prices and the cost structure are constant. Because variable
costing net operating income declined, unit sales must have also declined. This is true even
though the absorption costing net operating income increased. How can that be? By manipulating
production (and inventories) it may be possible to maintain or increase the level of absorption
costing net operating income even though unit sales decline. However, eventually inventories will
grow to be so large that they cannot be ignored.
b. As stated in part (1 b) above, when variable costing net operating income is less than absorption
costing net operating income, production exceeds sales. Inventories grow and fixed
manufacturing overhead costs are deferred in inventories. The year-by-year effects are shown
below.

Year 1 Year 2 Year 3

Variable costing NOI = Variable costing NOI < Variable costing NOI <
Absorption costing NOI Absorption costing NOI Absorption costing NOI
Production = Sales Production > Sales Production > Sales
Inventories remain the same Inventories grow Inventories grow

Requirement 3
Variable costing appears to provide a much better picture of economic reality than absorption costing
in the examples above. In the first case, absorption costing net operating income fluctuates wildly
even though unit sales are the same each year and unit selling prices, unit variable costs, and total
fixed costs remain the same. In the second case, absorption costing net operating income increases
from year to year even though unit sales decline. Absorption costing is much more subject to
manipulation than variable costing. Simply by changing production levels (and thereby deferring or
releasing costs from inventory) absorption costing net operating income can be manipulated upward
or downward.

Note: This exercise is based on the following data:

Common data:
Annual fixed manufacturing costs......................................... P153,153
Contribution margin per unit.................................................. P35,000
Annual fixed SGA costs......................................................... P180,000

Part 1:
Year 1 Year 2 Year 3
Beginning inventory....................................................................... 1 1 2
Production...................................................................................... 10 11 9
Sales.............................................................................................. 10 10 10
Ending............................................................................................ 1 2 1

Variable costing net operating income........................................... P16,847 P16,847 P16,847

Fixed manufacturing overhead in beginning inventory*.................. P15,315 P15,315 P27,846

Fixed manufacturing overhead in ending inventory........................ P15,315 P27,846 P17,017
Absorption costing net operating income....................................... P16,847 P29,378 P6,018

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* Fixed manufacturing overhead in beginning inventory is assumed in both parts 1 and 2 for Year 1. A FIFO
inventory flow assumption is used.

Part 2:
Year 1 Year 2 Year 3
Beginning inventory............................................................ 1 1 4
Production.......................................................................... 10 12 20
Sales.................................................................................. 10 9 8
Ending................................................................................ 1 4 16

Variable costing net operating income (loss)...................... P16,847 (P18,153) (P53,153)

Fixed manufacturing overhead in beginning inventory*...... P15,315 P15,315 P51,051

Fixed manufacturing overhead in ending inventory............ P15,315 P51,051 P122,522
Absorption costing net operating income........................... P16,847 P17,583 P18,318

* Fixed manufacturing overhead in beginning inventory is assumed in both parts 1 and 2 for Year 1. A FIFO
inventory flow assumption is used.

Answer to Problems

Problem 1

Requirement 1: Variable Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing
For the Year Ended December 31, 20X3

Sales P20,700,000
Less: Variable Cost of Sales
Inventory, Jan. 1 P1,155,000
Current Production 7,700,000
Total Available for Sale P8,855,000
Inventory, Dec. 31 805,000 8,050,000
Contribution Margin P12,650,000
Less Fixed Costs and Expenses 6,000,000
Net Income P 6,650,000

Requirement 2: Absorption Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing
For the Year Ending December 31, 20X4

10-8
 Sales P26,100,000
Less Cost of goods sold:
Inventory, Jan. 1 P 1,380,000
Current Production 16,100,000
Total Available for Sale P17,480,000
Inventory, Dec. 31 747,500
Cost of Sales - Standard P16,732,500
Favorable Capacity Variance 900,000 15,832,500
Income from Manufacturing P10,267,500

Requirement 3: Variable Costing Method

Romero Parts, Inc.
Income Statement - Manufacturing
For the Year Ending December 31, 20X4
Sales P26,100,000
Less Variable Cost of Sales:
Inventory, Jan. 1 P 805,000
Production 9,800,000
Total Available for Sale P10,605,000
Inventory, Dec. 31 455,000 10,150,000
Contribution Margin - Manufacturing P15,950,000
Less Fixed Cost 5,400,000
Income from Manufacturing P10,550,000

Reconciliation
Net Income, absorption costing P10,267,500
Add Fixed Factory Overhead Inventory, 1/1 575,000
Total P10,842,500
Less Fixed Factory Overhead Inventory, 12/31 292,500
Net Income, direct costing P10,550,000

Problem 2
Requirement 1
Honey Company
Income Statement - Direct Costing
For the Year Ended December 31, 20X3

10-9
Sales P280,000
Less Variable Cost of Sales:
Finished Goods Inventory, 1/1 P 4,000
Current Production 120,000
Total Available for Sale P124,000
Finished Goods Inventory, 12/31 12,000
Variable Cost of Sale - Standard P112,000
Unfavorable Variance 5,000 117,000

Contribution Margin - Manufacturing P163,000

Less Variable Marketing Expenses 28,000
Contribution Margin - Final P135,000
Less Fixed Costs and Expenses:
Fixed Factory Overhead P 54,000
Fixed Marketing and
Administrative Expenses 20,000 74,000
Net Income P 61,000

Requirement 2
Honey Company
Income Statement - Absorption Costing
For the Year Ended December 31, 20X3
Sales P280,000
Less: Cost of Sales
Finished goods inventory, Jan. 1 (1,000 x P5.50) P 5,500
Current production costs
Variable (30,000 x P4.00) P120,000
Fixed (30,000 x P1.50) 45,000 165,000
P170,500
Less: Finished goods inventory, Dec. 31
(3,000 x P5.50) 16,500
Cost of Sales - at Standard P154,000
Add (Deduct) Variance
Unfavorable variable manufacturing
costs variances 5,000
Underapplied fixed factory overhead
(6,000 x P1.50) 9,000
Cost of Sales - Actual P168,000
Gross Profit P112,000
Less: Selling and administrative expenses
Variable 28,000
Fixed 20,000
P 48,000
Net Income P 64,000
Problem 3 (Variable Costing Income Statement; Reconciliation)

Requirement 1
The unit product cost under the variable costing approach would be computed as follows:

10-10
 Direct materials......................................................................................................................
P 8
Direct labor.............................................................................................................................
10
Variable manufacturing overhead..........................................................................................
    2
Unit product cost....................................................................................................................
P20

With this figure, the variable costing income statements can be prepared:
Year 1 Year 2
Sales P1,000,000 P1,500,000
Less variable expenses:
Variable cost of goods sold @ P20 per unit 400,000 600,000
Variable selling and administrative @ P3 per unit       60,000       90,000
Total variable expenses     460,000     690,000
Contribution margin     540,000     810,000
Less fixed expenses:
Fixed manufacturing overhead 350,000 350,000
Fixed selling and administrative     250,000     250,000
Total fixed expenses     600,000     600,000
Net operating income (loss) P   (60,000) P  210,000

Requirement 2
Variable costing net operating income (loss)........................P   (60,000) P   210,000
Add: Fixed manufacturing overhead cost deferred in
inventory under absorption costing (5,000 units ×
P14 per unit)..................................................................... 70,000
Deduct: Fixed manufacturing overhead cost released
from inventory under absorption costing (5,000
units × P14 per unit).........................................................                      (70,000)
Absorption costing net operating income..............................P    10,000 P   140,000

Problem 4 (Prepare and Interpret Statements; Changes in Both Sales and Production; JIT)
Requirement 1
Year 1 Year 2 Year 3
Sales P1,000,000 P  800,000 P1,000,000
Less variable expenses:
Variable cost of goods sold @ P4 per unit 200,000 160,000 200,000
Variable selling and administrative @ P2 per unit     100,000      80,000    100,000
Total variable expenses     300,000    240,000    300,000
Contribution margin     700,000    560,000    700,000
Less fixed expenses:
Fixed manufacturing overhead 600,000 600,000 600,000
Fixed selling and administrative       70,000       70,000       70,000
Total fixed expenses     670,000     670,000     670,000
Net operating income (loss) P    30,000 P(110,000) P    30,000
Requirement 2
a.
Year 1 Year 2 Year 3
Variable manufacturing cost P 4 P 4 P 4
Fixed manufacturing cost:
P600,000 ÷ 50,000 units 12

10-11
 P600,000 ÷ 60,000 units 10
P600,000 ÷ 40,000 units                 15
Unit product cost P16 P14 P19

b.
Variable costing net operating income (loss) P30,000 P(110,000) P 30,000
Add (Deduct): Fixed manufacturing overhead
cost deferred in inventory from Year 2 to
Year 3 under absorption costing (20,000
units × P10 per unit) 200,000 (200,000)
Add: Fixed manufacturing overhead cost
deferred in inventory from Year 3 to the
future under absorption costing (10,000 units
× P15 per unit)                            150,000
Absorption costing net operating income (loss) P30,000 P  90,000 P(20,000)

Requirement 3
Production went up sharply in Year 2 thereby reducing the unit product cost, as shown in (2a). This
reduction in cost, combined with the large amount of fixed manufacturing overhead cost deferred in
inventory for the year, more than offset the loss of revenue. The net result is that the company’s net
operating income rose even though sales were down.

Requirement 4
The fixed manufacturing overhead cost deferred in inventory from Year 2 was charged against Year 3
operations, as shown in the reconciliation in (2b). This added charge against Year 3 operations was
offset somewhat by the fact that part of Year 3’s fixed manufacturing overhead costs was deferred in
inventory to future years [again see (2b)]. Overall, the added costs charged against Year 3 were
greater than the costs deferred to future years, so the company reported less income for the year even
though the same number of units was sold as in Year 1.

Requirement 5
a. Several things would have been different if the company had been using JIT inventory methods.
First, in each year production would have been geared to sales so that little or no inventory of
finished goods would have been built up in either Year 2 or Year 3. Second, unit product costs
probably would have been the same in all three years, since these costs would have been
established on the basis of expected sales (50,000 units) for each year. Third, since only 40,000
units were sold in Year 2, the company would have produced only that number of units and
therefore would have had some underapplied overhead cost for the year. (See the discussion on
underapplied overhead in the following paragraph.)
b. If JIT had been in use, the net operating income under absorption costing would have been the
same as under variable costing in all three years. The reason is that with production geared to
sales, there would have been no ending inventory on hand, and therefore there would have been
no fixed manufacturing overhead costs deferred in inventory to other years. Assuming that the
company expected to sell 50,000 units in each year and that unit product costs were set on the
basis of that level of expected activity, the income statements under absorption costing would
have appeared as follows:
Year 1 Year 2 Year 3
Sales P1,000,000 P 800,000 P1,000,000
Less cost of goods sold:

10-12
 Cost of goods manufactured @ P16 per unit 800,000 640,000 * 800,000
Add underapplied overhead                     120,000 **                
Cost of goods sold     800,000     760,000     800,000
Gross margin 200,000 40,000 200,000
Selling and administrative expenses     170,000    150,000     170,000
Net operating income (loss) P    30,000 P(110,000) P    30,000

* 40,000 units × P16 per unit = P640,000.

** 10,000 units not produced × P12 per unit fixed manufacturing overhead cost = P120,000 fixed
manufacturing overhead cost not applied to products.

Problem 5 (Contrasting Variable and Absorption Costing)

Requirement 1 (a)
Under absorption costing, all manufacturing costs, variable and fixed, are included in unit product
costs:
Year 1 Year 2
Direct materials P11 P11
Direct labor 6 6
Variable manufacturing overhead 3 3
Fixed manufacturing overhead
(P120,000  10,000 units) 12
(P120,000  6,000 units) 20
Unit product cost P32 P40

Requirement 1 (b)
The absorption costing income statements follow:
Year 1 Year 2
Sales (8,000 units x P50 per unit) P400,000 P400,000
Cost of goods sold:
Beginning inventory P 0 P 64,000
Add cost of goods manufactured (10,000 units x
P32 per unit; 6,000 units x P40 per unit) 320,000 240,000
Goods available for sale 320,000 304,000
Less ending inventory
(2,000 units x P32 per unit; 0 units x P40 per
unit) 64,000 256,000 0 304,000
Gross margin 144,000 96,000
Selling and administrative expenses (8,000 units x
P4 per unit + P70,000) 102,000 102,000
Net operating income P 42,000 P (6,000)

Requirement 2 (a)
Under variable costing, only the variable manufacturing costs are included in unit product costs:
Year 1 Year 2
Direct materials P11 P11
Direct labor 6 6

10-13
 Variable manufacturing overhead 3 3
Unit product cost P20 P20

Requirement 2 (b)
The variable costing income statements follow. Notice that the variable cost of goods sold is
computed in a simpler, more direct manner than in the examples provided earlier. On a variable
costing income statement, this simple approach or the more complex approach illustrated earlier is
acceptable for computing the cost of goods sold.
Year 1 Year 2
Sales (8,000 units x P50 per unit) P400,000 P400,000
Variable expenses:
Variable cost of goods sold (8,000 units x P20 per unit) P160,000 P160,000
Variable selling and administrative (8,000 units x P4 per unit) 32,000 192,000 32,000 192,000
Contribution margin 208,000 208,000
Fixed expenses:
Fixed manufacturing overhead 120,000 120,000
Fixed selling and administrative expenses 70,000 190,000 70,000 190,000
Net operating income P 18,000 P 18,000

Requirement 3

The reconciliation of the variable and absorption costing net operating incomes follows:
Year 1 Year 2
Variable costing net operating income P18,000 P18,000
Add fixed manufacturing overhead costs deferred in inventory under
absorption costing (2,000 units x P12 per unit) 24,000
Deduct fixed manufacturing overhead costs released from inventory
under absorption costing (2,000 units x P12 per unit) (24,000)
Absorption costing net operating income P42,000 P(6,000)

Problem 6 (Variable Costing Income Statement; Reconciliation)

Requirement 1

Sales (40,000 units × P33.75 per unit)...................................................... P1,350,000

Variable expenses:
Variable cost of goods sold (40,000 units × P16 per unit*)................... P640,000
Variable selling and administrative expenses (40,000 units × P3 per unit)  120,000    760,000
Contribution margin................................................................................... 590,000

Fixed expenses:
Fixed manufacturing overhead............................................................. 250,000
Fixed selling and administrative expenses...........................................  300,000     550,000
Net operating income................................................................................ P    40,000

* Direct materials........................................................ P10

Direct labor.............................................................. 4
Variable manufacturing overhead.............................    2
Total variable manufacturing cost............................ P16

Requirement 2

10-14
 The difference in net operating income can be explained by the P50,000 in fixed manufacturing
overhead deferred in inventory under the absorption costing method:

Variable costing net operating income............................................................................... P40,000

Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing:
10,000 units × P5 per unit in fixed manufacturing overhead cost..................................  50,000
Absorption costing net operating income........................................................................... P90,000

Answer to Multiple Choice Questions

1. D 11. B
2. B 12. A
3. B 13. C
4. B 14. D
5. B 15. B
6. C 16. A
7. A 17. C
8. B 18. C
9. A 19. B
10. A 20. C

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