Principles of Accounting: Chapter Twenty-Three

Home

Chapter 23 compares variable (direct) costing to absorption costing. Absorption costing is required under generally accepted accounting principles, but may not be as useful. Under absorption costing, product costs include all costs of production. Under variable costing, product costs include only the variable manufacturing components. Income reporting under variable costing helps identify the variable manufacturing margin and overall contribution margin.

Segment reporting results in various measures for each business unit, such as the contribution margin, controllable contribution margin, and segment margin. Selected segment data may also be presented on an external basis, and facilitate evaluations of residual income. Residual income adjusts operating income for the cost of capital associated with deployed assets.

Some business units, like janitorial services, are not direct producers of output, but instead exist only to support other units. Allocation methods like the direct and step approaches can be used to assign the costs of such units to productive business units. The chapter concludes by examining how an information system can be used to sort, classify, and present data in ways that may prove beneficial to management.

Exercises

To aid in your understanding of this chapter, exercises with solutions are available for free download at Bookboon.com. You will find these exercises very helpful in providing models and guidelines for solving all of the problems at principlesofaccounting.com.

Click here to go to Bookboon.

Problems
Goals Achievement
Fill in the Blanks
Multiple Choice
Objectives
Key Terms

Multiple Choice: Chapter Twenty-Three

1. Which of the following statements is incorrect?

a. Absorption costing is also known as product costing.

b. Variable costing is not GAAP.

c. Only variable manufacturing costs are assigned to products under the variable costing approach.

d. When using a variable costing system, the contribution margin discloses the excess of revenues over variable costs.

Answera. Absorption costing is also known as full costing. Product costing can be conducted by either absorption or variable costing methods. The other statements are all correct.

2. Income computed by the absorption costing method will tend to exceed income computed by the variable costing method if:

a. Fixed manufacturing costs decrease.

b. Units sold exceed units produced.

c. Variable manufacturing costs decrease.

d. Units produced exceed units sold.

Answerd. When the units produced exceed the units sold, absorption costing income tends to be higher than variable costing income. This results because some of the fixed manufacturing costs are allocated to unsold inventory at the end of the period; whereas, with variable costing all such costs would be expensed in the period incurred.

3. Wang Company provides the following information for their first year of operation:

Sales	5,000 units @ $10
Selling and administrative costs:
Fixed	$1,000
Variable	$1 per unit
Variable production costs per unit:
Direct materials	$2
Direct labor	$2
Variable overhead	$1
Fixed factory overhead	$7,500
Production	7,500 units

If Wang uses absorption costing, cost of goods sold would be:

a. $20,000

b. $25,000

c. $30,000

d. $36,000

Answer

4. Wang Company provides the following information for their first year of operation:

Sales	5,000 units @ $10
Selling and administrative costs:
Fixed	$1,000
Variable	$1 per unit
Variable production costs per unit:
Direct materials	$2
Direct labor	$2
Variable overhead	$1
Fixed factory overhead	$7,500
Production	7,500 units

If Wang uses variable costing, operating income would be:

a. $11,500

b. $14,000

c. $16,500

d. $20,000

Answer

5. Nina Company has two production departments -- fabrication and assembly. These departments are supported by janitorial and engineering service units. Janitorial costs are allocated to the production departments based on square footage while engineering is allocated based on machines in use within each department. The following table reveals relevant facts about the various departments.

Relevant Facts

Assuming Nina uses the direct method of allocating service department costs, how much is the total cost attributable to the fabrication department?

a. $5,000,000

b. $5,700,000

c. $5,837,500

d. $6,200,000

Answer

6. Nina Company has two production departments -- fabrication and assembly. These departments are supported by janitorial and engineering service units. Janitorial costs are allocated to the engineering, fabrication, and assembly departments based on square footage. Engineering is allocated to productive departments based on machines in use within each department. The following table reveals relevant facts about the various departments.

Relevant Facts

Assuming Nina uses the step method of allocating service department costs, how much is the total cost attributable to the assembly department?

a. $3,000,000

b. $3,350,000

c. $3,362,000

d. $4,200,000

Answer

7. Manson Company produces fishing boats. From the production supervisor's perspective, depreciation on the factory is:

a. Uncontrollable and fixed.

b. Uncontrollable and variable.

c. Controllable and fixed.

d. Controllable and variable.

Answer a. Factory depreciation is an uncontrollable cost which is fixed in amount.

8. Strickland Company prepared segment information relative to its office furniture manufacturing division. The controllable contribution margin differed from the segment margin by $100,000. This amount corresponds to the:

a. Total variable costs.

b. Controllable fixed costs.

c. Uncontrollable fixed costs.

d. Non-traceable costs.

Answerc. Uncontrollable fixed costs are subtracted from the controllable contribution margin to arrive at the segment margin. Total variable costs are subtracted from sales to achieve the contribution margin. Controllable fixed costs are subtracted from the contribution margin to calculate the controllable contribution margin. Nontraceable costs are not considered in calculating the individual business unit's segment margin.

9. Maverick Corporation had four operating segments. Information for each segment is included in the following table. Maverick has a threshold rate of return of 7%. Which segment has the largest residual income?

	Segment A	Segment B	Segment C	Segment D

Operating Income	$100,000	$200,000	$300,000	$400,000

Operating Assets	$200,000	$300,000	$300,000	$5,000,000

a. Segment A

b. Segment B

c. Segment C

d. Segment D

Answer

10. The management of Ahad Engineering Services has been approached about purchasing a new management information system. The perceived advantages of the system include each of the following, except:

a. The new system will reduce confusion by doing away with dual presentations of information by line item and object of expenditure.

b. The new system will enable customized business dashboards, with each executive having real-time reports of critical business information.

c. The new system will enable automatic preparation of both internal variable costing information and external absorption costing information.

d. The new system will facilitate disaggregation of overall results into business segment information.

Answer a. The ability to prepare dual presentations of information by line item and object of expenditure is an advantage (not disadvantage) of modern information systems.