Cost Analysis and Organisational Decisions

ACCT1064 / ACCT1068 / ACCT2242

Question 1 Variable and absorption costing, explaining operating profit differences:

1. Key inputs for income statement computations are:
April May
Beginning inventory 0 150
Production 500 400
Goods available for sale 500 550
Units sold 350 520
Ending inventory 150 30

The budgeted fixed cost per unit and budgeted total manufacturing cost per unit under absorption
costing are:
Item Particulars April May
(a) Budgeted fixed manufacturing costs A$2 000 000 A$2 000 000
(b) Budgeted production 500 500
(c)=(a)/(b) Budgeted fixed manufacturing cost per unit A$4 000 A$4 000
(d) Budgeted variable manufacturing cost per unit A$10 000 A$10 000
(e)=(c)+(d) Budgeted total manufacturing cost per unit A$14 000 A$14 000

a. Variable costing:
April 2015 May 2015

Revenuesa A$8 400 000 A$12 480 000

Variable costs:
Beginning inventory A$ 0 A$1 500 000
Variable manufacturing costsb 5 000 000 4 000 000
Cost of goods available for sale 5 000 000 5 500 000
Deduct ending inventoryc 1 500 000 300 000
Variable cost of goods sold 3 500 000 5 200 000
Variable operating costsd 1 050 000 1 560 000
Total variable costs 4 550 000 6 760 000
Contribution margin 3 850 000 5 720 000
Fixed costs:
Fixed manufacturing costs 2 000 000 2 000 000
Fixed operating costs 600 000 600 000
Total fixed costs 2 600 000 2 600 000
Operating income A$1 250 000 A$3 120 000
a A$24 000 × 350; A$24 000 × 520 c A$10 000 × 150; A$10 000 ×30
b A$10 000 × 500; A$10 000 × 400 d A$3000 × 350; A$3 000 × 520

b.Absorption costing:
 April 2015 May 2015
a
Revenues A$8 400 000 A$12 480 000
Cost of goods sold:
Beginning inventory A$ 0 A$2 100 000
Variable manufacturing costsb 5 000 000 4 000 000
Allocated fixed manufacturing
costsc 2 000 000 1 600 000
Cost of goods available for sale 7 000 000 7 700 000
Deduct ending inventoryd 2 100 000 420 000
Adjustment for production
volume variancee 0 400 000 U
Cost of goods sold 4 900 000 7 680 000
Gross margin 3 500 000 4 800 000
Operating costs:
Variable operating costsf 1 050 000 1 560 000
Fixed operating costs 600 000 600 000
Total operating costs 1 650 000 2 160 000
Operating income A$1 850 000 $2 640 000

a A$24 000 × 350; A$24 000 × 520

b
A$10 000 × 500; A$10 000 × 400– A$1 600 000
c
A$4 000 × 500; A$4,000 × 400
d
A$14 000 × 150; A$14,000 × 30
e
A$2 000 000 – A$2 000 000; A$2 000 000
f
A$3000 × 350; A$3000 × 520

2.

– = –

April:
A$1 850 000 – A$1 250 000 = (A$4000 × 150) – (A$0)
A$600 000 = A$600 000
May:
A$2 640 000 – A$3 120 000 = (A$4000 × 30) – (A$4000 × 150)
– A$480 000 = A$120 000 – A$600 000
– A$480 000 =– A$480 000

The difference between absorption and variable costing is due solely to moving fixed manufacturing
costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as
in May).
Question 2 Variable costing versus absorption costing

1. Absorption Costing:
Mavis Ltd Income Statement
For the Year Ended 31 December 2014

Revenues (540 000 × A$5.00) A$2 700 000

Cost of goods sold:
Beginning inventory (30 000 × A$3.70a) A$ 111 000
Variable manufacturing costs (550 000 ×A$3.00) 1 650 000
Allocated fixed manufacturing costs (550 000 × A$0.70) 385 000
Cost of goods available for sale 2 146 000
Deduct ending inventory (40 000 × A$3.70) 148 000
Add adjustment for prod.-vol. variance (50 000 b × A$0.70) 35 000 U
Cost of goods sold 2 033 000
Gross margin 667 000
Operating costs:
Variable operating costs (540 000 × A$1) 540 000
Fixed operating costs 120 000
Total operating costs 660 000
Operating income A$ 7 000
a A$3.00 + (A$7.00 ÷ 10) = A$3.00 + A$0.70 = A$3.70
b [(10 units per mach. hr. × 60 000 mach. hrs.) – 550 000 units)] = 50 000 units unfavourable

2. Variable Costing:
Mavis Ltd Income Statement
For the Year Ended 31 December 2014

Revenues A$2 700 000

Variable cost of goods sold:
Beginning inventory (30 000 × $3.00) A$ 90 000
Variable manufacturing costs
(550 000 × $3.00) 1 650 000
Cost of goods available for sale 1 740 000
Deduct ending inventory (40 000 × $3.00) 120 000
Variable cost of goods sold 1 620 000
Variable operating costs 540 000
Contribution margin 540 000
Fixed costs:
Fixed manufacturing overhead costs 420 000
Fixed operating costs 120 000
Total fixed costs 540 000
Operating income A$ 0

3. The difference in operating income between the two costing methods is:

A$7 000 – A$0 = [(40 000 × A$0.70) – (30 000 × A$0.70)]

A$7 000 = A$28 000 – A$21 000
A$7 000 = A$7 000

The absorption-costing operating income exceeds the variable costing figure by A$7000
because of the increase of A$7000 during 2014 of the amount of fixed manufacturing
costs in ending inventory vis-à-vis beginning inventory.
 4. Absorption costing is more likely to lead to build-ups of inventory than does
variable costing. Absorption costing enables managers to increase reported
operating income by building up inventory which reduces the amount of fixed
manufacturing overhead included in the current period’s cost of goods sold.

Ways to reduce this incentive include:

(a) Careful budgeting and inventory planning.
(b) Change the accounting system to variable costing or throughput costing.
(c) Incorporate a carrying charge for carrying inventory.
(d) Use a longer time period to evaluate performance than a quarter or a year.
(e) Include nonfinancial as well as financial measures when evaluating
management performance.