Variable Costing

Using variable costing, service company 

Professional Pool Cleaning Service provides pool cleaning services to residential customers. The company has three employees, each assigned to specific customers. The company considers each employee’s territory as a business segment. The company incurs variable costs that include the employees’ wages, pool chemicals, and gas for the service vans. Fixed costs include depreciation on the service vans. Following is the income statement for the month of July:

Requirements

1. Calculate the contribution margin ratio for each business segment. 
2. The business segments had the following numbers of customers: Birman, 60; Meech, 70; and Frond, 40. Compute the service revenue per customer, variable cost per customer, and contribution margin per customer for each business segment. 
3. Which business segment was most profitable? List some possible reasons why this segment was most profitable. How might the various reasons affect the company in the long term?

Preparing variable and absorption costing income statements 

Claudia’s Foods produces frozen meals that it sells for \(11 each. The company computes a new monthly fixed manufacturing overhead allocation rate based on the planned number of meals to be produced that month. Assume all costs and production levels are exactly as planned. The following data are from Linda’s Foods’s first month in business:

 January 2018 Units produced and sold: Sales 850 meals Production 1,050 meals Variable manufacturing cost per meal \) 5Sales commission cost per meal 1 Total fixed manufacturing overhead 315Total fixed selling and administrative costs 450 Requirements 

1. Compute the product cost per meal produced under absorption costing and under variable costing. 

2. Prepare income statements for January 2018 using: a. absorption costing. b. variable costing. 

3. Is operating income higher under absorption costing or variable costing in January?

Preparing variable and absorption costing income statements 

Game Source manufactures video games that it sells for \(43 each. The company uses a fixed manufacturing overhead allocation rate of \)5 per game. Assume all costs and production levels are exactly as planned. The following data are from Game Store’s first two months in business during 2018: 

October November Sales 1,500 units 2,900 units Production                                                           2,500 units         2,500 units Variable manufacturing cost per game                \( 17                      \) 17Sales commission cost per game                            7                           7Total fixed manufacturing overhead12,500                   12,500

Total fixed selling and administrative costs            11,500                   11,500 Requirements 

1. Compute the product cost per game produced under absorption costing and under variable costing. 

2. Prepare monthly income statements for October and November, including columns for each month and a total column, using these costing methods: 

a. absorption costing. 

b. variable costing. 

3. Is operating income higher under absorption costing or variable costing in October? In November? Explain the pattern of differences in operating income based on absorption costing versus variable costing. 

4. Determine the balance in Finished Goods Inventory on October 31 and November 30 under absorption costing and variable costing. Compare the differences in inventory balances and the differences in operating income. Explain the differences in inventory balances based on absorption costing versus variable costing.

Analyzing profitability Father Furniture Company manufactures and sells oak tables and chairs. Price and cost data for the furniture follow:

Tables Chairs Sales Price \( 800   \) 70 Variable manufacturing costs 60025Sales  commission (10%)                           807Relative Furniture has three sales representatives: Adam, Ben, and Caleb. Adam sold 100 tables with 6 chairs each. Ben sold 110 tables with 4 chairs each. Caleb sold 80 tables with 8 chairs each. 

Requirements 

1. Calculate the total contribution margin and the contribution margin ratio for each sales representative (round to two decimal places). 

2. Which sales representative has the highest contribution margin ratio? Explain why.

Using variable and absorption costing, making decisions The 2018 data that follow pertain to Eli’s Electric Eyewear, a manufacturer of swimming goggles. (Eli’s Electric Eyewear had no beginning Finished Goods Inventory in January 2018.)

Number of goggles produced 245,000 Number of goggles sold 215,000 Sales price per unit \( 22Variable manufacturing cost per unit 8Sales commission cost per unit                  5Fixed manufacturing overhead 1,470,000 Fixed selling and administrative costs 250,000 Requirements 

1. Prepare both conventional (absorption costing) and contribution margin (variable costing) income statements for Eli’s Electric Eyewear for the year ended December 31, 2018.

 2. Which statement shows the higher operating income? Why?

3. Eli’s ElectricEyewear’s marketing vice president believes a new sales promotion that costs \)60,000 would increase sales to 220,000 goggles. Should the company go ahead with the promotion? Give your reasoning.

Question: Using variable costing, service company 

Divine Pool Cleaning Service provides pool cleaning services to residential customers. The company has three employees, each assigned to specific customers. The company considers each employee’s territory as a business segment. The company incurs variable costs that include the employees’ wages, pool chemicals, and gas for the service vans. Fixed costs include depreciation on the service vans. Following is the income statement for the month of August:

Requirements 

1. Calculate the contribution margin ratio for each business segment. 

2. The business segments had the following number of customers: Byson, 80; Moore, 50; and Freeman, 110. Compute the service revenue per customer, variable cost per customer, and contribution margin per customer for each business segment. 

3. Which business segment was most profitable? List some possible reasons why this segment was most profitable. How might the various reasons affect the company in the long term?

Using Excel for variable costing

Download an Excel template for this problem online in MyAccountingLab or at http://www.pearsonhighered.com/Horngren. Tiger Mountain Gelato incurs the following costs for its premium ice cream in May 2018:

Direct materials cost per pint                               $ 2.50 per pint

Direct labor cost per pint                                         0.75 per pint

Variable manufacturing overhead cost per pint   0.25 per pint

Fixed manufacturing overhead costs                    6,000 per month

Total fixed selling and administrative costs          5,000 per month

Sales price per pint                                                  8.00 per pint

Pints of gelato produced                                         12,000 pints

Pints of gelato sold                                                   11,500 pints

There were no beginning inventories, so Tiger Mountain Gelato has 500 pints in ending Finished Goods Inventory (12,000 pints produced less 11,500 pints sold).

Requirements

1. Calculate Tiger Mountain Gelato’s product cost per pint under absorption costing and variable costing.

2. Calculate the balance in Finished Goods Inventory on May 31, 2018, using absorption costing and variable costing.

3. Prepare income statements in good form for Tiger Mountain Gelato for May 2018 using absorption costing and variable costing.

4. Reconcile the differences between operating incomes and Finished Goods Inventory balances between the two-costing method

Preparing variable and absorption costing income statements 

This problem continues the Piedmont Computer Problem situation from Chapter 20. Piedmont Computer Company manufactures personal computers and tablets. Based on the latest information from the cost accountant, using the current sales mix, the weighted-average sales price per unit is \(750 and the weighed-average variable cost per unit is \)450. The company does not expect the sales mix to vary for the next year. Assume the beginning balance in Finished Goods Inventory is \(0. Additional data for the first month of 2020: 

January 2020 

Unitsproduced and sold: Sales 945 units Production 1,000 units Variable manufacturing cost per unit \) 450 Sales commission cost per unit 25 Total fixed manufacturing overhead 93,600 Total fixed selling and administrative costs 62,400

Requirements 

1. Compute the product cost per unit produced under absorption costing and under variable costing. 

2. Prepare income statements for January 2020 using: a. absorption costing. b. variable costing. 

3. Is operating income higher under absorption costing or variable costing in January? What causes the difference?

: Before you begin this assignment, review the Tying It All Together feature in the chapter. CF Industries Holdings, Inc. is one of the largest manufacturers and distributors of nitrogen fertilizer and other nitrogen products in the world. The corporation often produces and stores large amounts of inventory during periods of low demand to ensure that there is enough product to meet the demand of peak seasons. Assume that one line of fertilizer (with no beginning Finished Goods Inventory) had the following data during a time period of low demand: 

Sales price $ 20.00 per case Variable manufacturing costs 4.00 per case Fixed manufacturing costs 100,000 per quarter Variable selling and administrative costs 2.00 per case Fixed selling and administrative costs 45,000 per quarter Given that the time period has low demand, assume the company produced 1,000,000 cases but only sold 250,000 cases. 

Requirement 

1. Prepare the income statement for the quarter using variable costing.

2. Prepare the income statement for the quarter using absorption costing. 

3. Why, if at all, is there a difference between operating income under the two methods?

Question: The Hurley Hat Company manufactures baseball hats. Hurley’s primary customers are sporting goods stores that supply uniforms to youth baseball teams. Following is Hurley’s income statement for 2018:

In 2018, Hurley produced and sold 200,000 baseball hats. Of the Cost of Goods Sold, \(150,000 is fixed; 80% of the Selling and Administrative Expenses are fixed. There were no beginning inventories on January 1, 2018. The company is considering two options to increase sales. 

Option 1: The company is operating at 100,000 hats below full production capacity and is considering increasing advertising to increase sales to the production capacity level in 2019. The marketing director predicts that an additional \)100,000 expenditure for advertising would increase sales to 300,000 hats per year. 

Option 2: The sales manager has been negotiating with buyers for several national sporting goods retailers and recommends the company expand production capacity to 400,000 hats in order to secure long-term contracts beginning in 2019. The expansion is expected to increase fixed manufacturing costs by \(200,000 per year. Additionally, the retailers are requesting a higher-quality hat, and the changes to the hat materials and manufacturing process would increase variable manufacturing costs by \)1 per hat for the additional 200,000 hats. (The original 200,000 hats manufactured and sold would not be affected by this change.) 

Requirements 

1. Use the data from the 2018 income statement to prepare an income statement using variable costing. Assume no beginning or ending inventories. Calculate the contribution margin ratio. Round to two decimal places. 

2. Prepare an absorption costing income statement assuming the company pursues Option 1 and increases advertising and production and sales increase to 300,000 hats. 

3. Refer to the original data. Prepare an absorption costing income statement assuming the company pursues Option 2 and increases capacity and sales and production increases to 400,000 total hats. 

4. Which option should the company pursue? Explain your reasoning.

Sampson Company operates a manufacturing facility where several products are made. Each product is considered a business segment, and the product managers have the opportunity to receive a bonus based on the profit of the segment. Franco Hopper is the manager for the scissors product line. Production and sales data for the scissors product line for the past three years are shown below:

                                                                                                                                                                                 Year 1                                Year 2                          Year 3                                                                                                                                        Units produced                                                                                                                                           100,000 units                    125,000 units               160,000 units                                                                                                                                  Units sold                                                                                                                                                    100,000 units                    100,000 units               100,000 units                                                                                                                                   Sales price per unit                                                                                                                                \( 12.00 per unit                 \) 12.00 per unit           $ 12.00 per unit                                                                                                                          Variable manufacturing cost per unit                                                                                                        5.00 per unit                      5.00 per unit                5.00 per unit                                                                                                                                      Total fixed manufacturing costs                                                                                                             200,000 per year                200,000 per year         200,000 per year 

Hopper’s bonus is 0.5% of the gross profit of the scissors product line, based on absorption costing. Upper management is discussing changing the bonus system so that bonuses are based on operating income using variable costing. Hopper is opposed to this change and has been trying to convince the other product managers to join him in voicing their opposition. There are no beginning inventories in Year 1.

Requirements:

1. Calculate the fixed cost per unit produced for each year. 
2. Prepare income statements for the three years using absorption costing. 
3. Calculate Hopper’s bonus based on the current plan. 
4. Prepare income statements for the three years using variable costing. 
5. Calculate Hopper’s bonus based on the proposed plan. 
6. Give possible reasons why Hopper is opposed to the proposed bonus plan. Do you think Hopper’s actions have been ethical the past three years? Why or why not?

Question: Communication Activity 21-1 

In 100 words or fewer, explain the main differences and similarities between variable costing and absorption costing.