Assignment Material

Questions

1. 9-1. Differences in operating income between variable costing and absorption costing are due solely to accounting for fixed costs. Do you agree? Explain.
2. 9-2. Why is the term direct costing a misnomer?
3. 9-3. Do companies in either the service sector or the merchandising sector make choices about absorption costing versus variable costing?
4. 9-4. Explain the main conceptual issue under variable costing and absorption costing regarding the timing for the release of fixed manufacturing overhead as expense.
5. 9-5. “Companies that make no variable-cost/ fixed-cost distinctions must use absorption costing, and those that do make variable-cost/ fixed-cost distinctions must use variable costing.” Do you agree? Explain.
6. 9-6. The main trouble with variable costing is that it ignores the increasing importance of fixed costs in manufacturing companies. Do you agree? Why?
7. 9-7. Give an example of how, under absorption costing, operating income could fall even though the unit sales level rises.
8. 9-8. What are the factors that affect the breakeven point under (1) variable costing and (2) absorption costing?
9. 9-9. Critics of absorption costing have increasingly emphasized its potential for leading to undesirable incentives for managers. Give an example.
10. 9-10. What are two ways of reducing the negative aspects associated with using absorption costing to evaluate the performance of a plant manager?
11. 9-11. What denominator-level capacity concepts emphasize the output a plant can supply? What denominator-level capacity concepts emphasize the output customers demand for products produced by a plant?
12. 9-12. Describe the downward demand spiral and its implications for pricing decisions.
13. 9-13. Will the financial statements of a company always differ when different choices at the start of the accounting period are made regarding the denominator-level capacity concept?
14. 9-14. What is the IRS’s requirement for tax reporting regarding the choice of a denominator-level capacity concept?
15. 9-15. “The difference between practical capacity and master-budget capacity utilization is the best measure of management’s ability to balance the costs of having too much capacity and having too little capacity.” Do you agree? Explain.

Multiple-Choice Questions

1. 9-16. In comparing the absorption and variable cost methods, each of the following statements is true except
   1. a. Selling, general, and administrative (SG&A) fixed expenses are not included in inventory in either method.
   2. b. Only the absorption costing method may be used for external financial reporting.
   3. c. Variable costing charges fixed overhead costs to the period they are incurred.
   4. d. When inventory increases over the period, variable net income will exceed absorption net income.
2. 9-17. Queen Sales, Inc. has just completed its first year of operations. The company has not had any sales to date. Queen has incurred the following costs associated with its production as of December 31, Year 1:

1. Under absorption costing, what is the inventory amount shown on the balance sheet at December 31, Year 1?
   1. a. $155,600
   2. b. $115,600
   3. c. $98,500
   4. d. $80,000
2. 9-18. King Tooling has produced and sold the following number of units of their only product during their first 2 years in business:

1. Production costs per unit have not changed over the 2-year period. Under variable costing, what is the amount of cost of sales relative to the cost of sales shown on the GAAP income statement of the company?

1. 9-19. The following information relates to Drexler Inc.’s Year 3 financials:

1. Year 3 period costs for Drexler, under both the absorption and variable cost methods, will be

1. 9-20. Which of the following statements is not true regarding the use of variable and absorption costing for performance measurement?
   1. a. The net income reported under the absorption method is less reliable for use in performance evaluations because the cost of the product includes fixed costs, which means the level of inventory affects net income.
   2. b. The net income reported under the contribution income statement is more reliable for use in performance evaluations because the product cost does not include fixed costs.
   3. c. Variable costing isolates contribution margins to aid in decision making.
   4. d. The IRS allows either absorption or variable costing as long as the method is not changed from year to year, while U.S. GAAP only allows absorption costing.

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Exercises

1. 9-21. VARIABLE AND ABSORPTION COSTING, EXPLAINING OPERATING-INCOME DIFFERENCES. Nascar Motors assembles and sells motor vehicles and uses standard costing. Actual data relating to April and May 2020 are as follows:

1. The selling price per vehicle is $24,000. The budgeted level of production used to calculate the budgeted fixed manufacturing cost per unit is 500 units. There are no price, efficiency, or spending variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs.
   1. Required
   2. 1. Prepare April and May 2020 income statements for Nascar Motors under (a) variable costing and (b) absorption costing.
   3. 2. Prepare a numerical reconciliation and explanation of the difference between operating income for each month under variable costing and absorption costing.
2. 9-22. THROUGHPUT COSTING (CONTINUATION OF 9-21). The variable manufacturing costs per unit of Nascar Motors are as follows:

1. 1. Required
   2. 1. Prepare income statements for Nascar Motors in April and May 2020 under throughput costing.
   3. 2. Contrast the results in requirement 1 with those in requirement 1 of Exercise 9-21.
   4. 3. Give one motivation for Nascar Motors to adopt throughput costing.
2. 9-23. VARIABLE AND ABSORPTION COSTING, EXPLAINING OPERATING-INCOME DIFFERENCES. EntertainMe Corporation manufactures and sells 50-inch television sets and uses standard costing. Actual data relating to January, February, and March 2020 are as follows:

1. The selling price per unit is $3,300. The budgeted level of production used to calculate the budgeted fixed manufacturing cost per unit is 1,500 units. There are no price, efficiency, or spending variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs.
   1. 1. Prepare income statements for EntertainMe in January, February, and March 2020 under (a) variable costing and (b) absorption costing.
   2. 2. Explain the difference in operating income for January, February, and March under variable costing and absorption costing.
2. 9-24. THROUGHPUT COSTING (CONTINUATION OF 9-23). The variable manufacturing costs per unit of EntertainMe Corporation are as follows:

1. 1. Required
   2. 1. Prepare income statements for EntertainMe in January, February, and March 2020 under throughput costing.
   3. 2. Contrast the results in requirement 1 of this exercise with those in requirement 1 of Exercise 9-23.
   4. 3. Give one motivation for EntertainMe to adopt throughput costing.
2. 9-25. VARIABLE VERSUS ABSORPTION COSTING. The Tomlinson Company manufactures trendy, high-quality, moderately priced watches. As Tomlinson’s senior financial analyst, you are asked to recommend a method of inventory costing. The chief financial officer (CFO) will use your recommendation to prepare Tomlinson’s 2020 income statement. The following data are for the year ended December 31, 2020:

1. Assume standard costs per unit are the same for units in beginning inventory and units produced during the year. Also, assume no price, spending, or efficiency variances. Any production-volume variance is written off to cost of goods sold.
   1. Required
   2. 1. Prepare income statements under variable and absorption costing for the year ended December 31, 2020.
   3. 2. What is Tomlinson’s operating income as percentage of revenues under each costing method?
   4. 3. Explain the difference in operating income between the two methods.
   5. 4. Which costing method would you recommend to the CFO? Why?
2. 9-26. ABSORPTION AND VARIABLE COSTING. (CMA) Houston, Inc. planned and actually manufactured 220,000 units of its single product in 2020, its first year of operation. Variable manufacturing cost was $22 per unit produced. Variable operating (nonmanufacturing) cost was $9 per unit sold. Planned and actual fixed manufacturing costs were $660,000. Planned and actual fixed operating (nonmanufacturing) costs totaled $440,000. Houston sold 160,000 units of product at $44 per unit.
   1. Required
   2. 1. Houston’s 2020 operating income using absorption costing is (a) $1,160,000, (b) $980,000, (c) $1,420,000, (d) $1,600,000, or (e) none of these. Show supporting calculations.
   3. 2. Houston’s 2020 operating income using variable costing is (a) $1,640,000, (b) $1,160,000, (c) $980,000, (d) $1,420,000, or (e) none of these. Show supporting calculations.
3. 9-27. ABSORPTION VERSUS VARIABLE COSTING. Horace Company manufactures a professional-grade vacuum cleaner and began operations in 2020. For 2020, Horace budgeted to produce and sell 25,000 units. The company had no price, spending, or efficiency variances and writes off production-volume variance to cost of goods sold. Actual data for 2020 are as follows:

1. 1. Required
   2. 1. Prepare a 2020 income statement for Horace Company using variable costing.
   3. 2. Prepare a 2020 income statement for Horace Company using absorption costing.
   4. 3. Explain the differences in operating incomes obtained in requirements 1 and 2.
   5. 4. Horace’s management is considering implementing a bonus for its supervisors based on gross margin under absorption costing. What incentives will this bonus plan create for the supervisors? What modifications could Horace management make to improve such a plan? Explain briefly.
2. 9-28. VARIABLE AND ABSORPTION COSTING, SALES, AND OPERATING-INCOME CHANGES. Honeyland uses standard costing to produce a particularly popular type of candy. Honeyland’s president, Tim Thorne, was unhappy after reviewing the income statements for the first 3 years of business. He said, “I was told by our accountants—and in fact, I have memorized—that our breakeven volume is 29,000 units. I was happy that we reached that sales goal in each of our first 2 years. But here’s the strange thing: In our first year, we sold 29,000 units and indeed we broke even. Then in our second year we sold the same volume and had a significant, positive operating income. I didn’t complain, of course . . . but here’s the bad part. In our third year, we sold 20% more candy, but our operating income dropped by nearly 90% from what it was in the second year! We didn’t change our selling price or cost structure over the past 3 years and have no price, efficiency, or spending variances . . . so what’s going on?!”

1. 1. Required
   2. 1. What denominator level is Honeyland using to allocate fixed manufacturing costs to the candy? How is Honeyland treating any favorable or unfavorable production-volume variance at the end of the year? Explain your answer briefly.
   3. 2. How did Honeyland’s accountants arrive at the breakeven volume of 29,000 units?
   4. 3. Prepare a variable costing-based income statement for each year. Explain the variation in variable costing operating income for each year based on contribution margin per unit and sales volume.
   5. 4. Reconcile the operating incomes under variable costing and absorption costing for each year, and use this information to explain to Tim Thorne the positive operating income in 2020 and the drop in operating income in 2021.
2. 9-29. CAPACITY MANAGEMENT, DENOMINATOR-LEVEL CAPACITY CONCEPTS. Match each of the following numbered descriptions with one or more of the denominator-level capacity concepts by putting the appropriate letter(s) by each item:
   1. a. Theoretical capacity
   2. b. Practical capacity
   3. c. Normal capacity utilization
   4. d. Master-budget capacity utilization
   5. 1. Measures the denominator level in terms of what a plant can supply
   6. 2. Is based on producing at full efficiency all the time
   7. 3. Represents the expected level of capacity utilization for the next budget period
   8. 4. Measures the denominator level in terms of demand for the output of the plant
   9. 5. Takes into account seasonal, cyclical, and trend factors
   10. 6. Should be used for performance evaluation in the current year
   11. 7. Represents an ideal benchmark
   12. 8. Highlights the cost of capacity acquired but not used
   13. 9. Should be used for long-term pricing purposes
   14. 10. Hides the cost of capacity acquired but not used
   15. 11. If used as the denominator-level concept, would avoid the restatement of unit costs when expected demand levels change
3. 9-30. DENOMINATOR-LEVEL PROBLEM. Thunder Bolt, Inc., is a manufacturer of the very popular G36 motorcycles. The management at Thunder Bolt has recently adopted absorption costing and is debating which denominator-level concept to use. The G36 motorcycles sell for an average price of $8,200. Budgeted fixed manufacturing overhead costs for 2020 are estimated at $6,480,000. Thunder Bolt, Inc., uses subassembly operators that provide component parts. The following are the denominator-level options that management has been considering:
   1. a. Theoretical capacity—based on three shifts, completion of five motorcycles per shift, and a 360-day year— $3\times 5\times 360=5\text{,}400\text{.}$
   2. b. Practical capacity—theoretical capacity adjusted for unavoidable interruptions, breakdowns, and so forth— $3\times 4\times 320=3\text{,}840\text{.}$
   3. c. Normal capacity utilization—estimated at 3,240 units.
   4. d. Master-budget capacity utilization—the strengthening stock market and the growing popularity of motorcycles have prompted the marketing department to issue an estimate for 2020 of 3,600 units.
   5. Required
   6. 1. Calculate the budgeted fixed manufacturing overhead cost rates under the four denominator-level concepts.
   7. 2. What are the benefits to Thunder Bolt, Inc., of using either theoretical capacity or practical capacity?
   8. 3. Under a cost-based pricing system, what are the negative aspects of a master-budget denominator level? What are the positive aspects?
4. 9-31. VARIABLE AND ABSORPTION COSTING AND BREAKEVEN POINTS. Ardella, a leading firm in the sports industry, produces basketballs for the consumer market. For the year ended December 31, 2020, Ardella sold 177,700 basketballs at an average selling price of $37 per unit. The following information also relates to 2020 (assume constant unit costs and no variances of any kind):

1. 1. Required
   2. 1. Calculate the breakeven point (in basketballs sold) in 2020 under:
      1. a. Variable costing
      2. b. Absorption costing
   3. 2. Suppose direct materials costs were $11 per basketball instead. Assuming all other data are the same, calculate the minimum number of basketballs Ardella must have sold in 2020 to attain a target operating income of $110,000 under

1. 1. 1. a. Variable costing
      2. b. Absorption costing

1. 9-32. VARIABLE COSTING VERSUS ABSORPTION COSTING. The Stenback Company uses an absorption-costing system based on standard costs. Variable manufacturing cost consists of direct material cost of $4 per unit and other variable manufacturing costs of $1.20 per unit. The standard production rate is 20 units per machine-hour. Total budgeted and actual fixed manufacturing overhead costs are $520,000. Fixed manufacturing overhead is allocated at $16 per machine-hour based on fixed manufacturing costs of $\$\text{520,000}÷\text{32,500}$ machine-hours, which is the level Stenback uses as its denominator level.
2. The selling price is $13 per unit. Variable operating (nonmanufacturing) cost, which is driven by units sold, is $2 per unit. Fixed operating (nonmanufacturing) costs are $55,000. Beginning inventory in 2020 is 35,000 units; ending inventory is 45,000 units. Sales in 2020 are 575,000 units.
3. The same standard unit costs persisted throughout 2019 and 2020. For simplicity, assume that there are no price, spending, or efficiency variances.
   1. Required
   2. 1. Prepare an income statement for 2020 assuming that the production-volume variance is written off at year-end as an adjustment to cost of goods sold.
   3. 2. The president has heard about variable costing. She asks you to recast the 2020 statement as it would appear under variable costing.
   4. 3. Explain the difference in operating income as calculated in requirements 1 and 2.
   5. 4. Graph how fixed manufacturing overhead is accounted for under absorption costing. That is, there will be two lines: one for the budgeted fixed manufacturing overhead (which is equal to the actual fixed manufacturing overhead in this case) and one for the fixed manufacturing overhead allocated. Show the production-volume variance in the graph.
   6. 5. Critics have claimed that a widely used accounting system has led to undesirable buildups of inventory levels. (a) Is variable costing or absorption costing more likely to lead to such buildups? Why? (b) What can managers do to counteract undesirable inventory buildups?
4. 9-33.  THROUGHPUT COSTING (CONTINUATION OF 9-32)
   1. Required
   2. 1. Prepare an income statement under throughput costing for the year ended December 31, 2020 for Stenback Company.
   3. 2. Reconcile the difference between the contribution margin and the throughput margin for Stenback in 2020. Then reconcile the operating income between variable costing and throughput costing for Stenback in 2020.
   4. 3. Advocates of throughput costing say it provides managers less incentive to produce for inventory than either variable costing or, especially, absorption costing. Do you agree? Why or why not? Under what circumstances might you recommend that Stenback use throughput costing?

Problems

1. 9-34. VARIABLE COSTING AND ABSORPTION COSTING, THE EVERGREEN ALL-FIXED CORPORATION. (R. Marple, adapted) It is the end of 2020. Evergreen All-Fixed Corporation began operations in January 2019. The company is so named because it has no variable costs. All its costs are fixed; they do not vary with output.
2. Evergreen All-Fixed Corp. is located on the bank of a river and has its own hydroelectric plant to supply power, light, and heat. The company manufactures a synthetic fertilizer from air and river water and sells its product at a price that is not expected to change. It has a small staff of employees, all paid fixed annual salaries. The output of the plant can be increased or decreased by pressing a few buttons on a keyboard.
3. The following budgeted and actual data are for the operations of Evergreen All-Fixed. The company uses budgeted production as the denominator level and writes off any production-volume variance to cost of goods sold.

1. 1. Required
   2. 1. Prepare income statements with one column for 2019, one column for 2020, and one column for the 2 years together using (a) variable costing and (b) absorption costing.
   3. 2. What is the breakeven point under (a) variable costing and (b) absorption costing?
   4. 3. What inventory costs would be carried in the balance sheet on December 31, 2019 and 2020 under each method?
   5. 4. Assume that the performance of the top manager of Evergreen All-Fixed is evaluated and rewarded largely on the basis of reported operating income. Which costing method would the manager prefer? Why?
2. 9-35.  COMPARISON OF VARIABLE COSTING AND ABSORPTION COSTING. Gammaro Company uses standard costing. Tim St. Germaine, the new president of Gammaro Company, is presented with the following data for 2020:

1. 1. Required
   2. 1. At what percentage of denominator level was the plant operating during 2020?
   3. 2. How much fixed manufacturing overhead was included in the 2019 and the 2020 ending inventory under absorption costing?
   4. 3. Reconcile and explain the difference in 2020 operating incomes under variable and absorption costing.
   5. 4. Tim St. Germaine is concerned: He notes that despite an increase in sales over 2019, 2020 operating income has actually declined under absorption costing. Explain how this occurred.
2. 9-36.  EFFECTS OF DIFFERING PRODUCTION LEVELS ON ABSORPTION COSTING INCOME: METRICS TO MINIMIZE INVENTORY BUILDUPS. Northern Press produces textbooks for high school accounting courses. The company recently hired a new editor, Leslie Green, to handle production and sales of books for an introductory accounting course. Leslie’s compensation depends on the gross margin associated with sales of this book. Leslie needs to decide how many copies of the book to produce. The following information is available for the fall semester of 2020:

1. Leslie has decided to produce either 24,000, 30,000, or 36,000 books.
   1. Required
   2. 1. Calculate expected gross margin if Leslie produces 24,000, 30,000, or 36,000 books. (Make sure you include the production-volume variance as part of cost of goods sold.)
   3. 2. Calculate ending inventory in units and in dollars for each production level.
   4. 3. Managers who are paid a bonus that is a function of gross margin may be inspired to produce a product in excess of demand to maximize their own bonus. The chapter suggested metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this objective? Show your work.
      1. a. Incorporate a charge of 10% of the cost of the ending inventory as an expense for evaluating the manager.
      2. b. Include nonfinancial measures (such as the ones recommended on page 334) when evaluating management and rewarding performance.
2. 9-37. ALTERNATIVE DENOMINATOR-LEVEL CAPACITY CONCEPTS, EFFECT ON OPERATING INCOME. Zing Lager has just purchased the Chicago Brewery. The brewery is 2 years old and uses absorption costing. It will “sell” its product to Zing Lager at $44 per barrel. Peter Bryant, Zing Lager’s controller, obtains the following information about Chicago Brewery’s capacity and budgeted fixed manufacturing costs for 2020:

1. 1. Required
   2. 1. Compute the budgeted fixed manufacturing overhead rate per barrel for each of the denominator-level capacity concepts. Explain why they are different.
   3. 2. In 2020, the Chicago Brewery reported these production results:

1. There are no variable cost variances. Fixed manufacturing overhead cost variances are written off to cost of goods sold in the period in which they occur. Compute the Chicago Brewery’s operating income when the denominator-level capacity is (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization.
2. 9-38. MOTIVATIONAL CONSIDERATIONS IN DENOMINATOR-LEVEL CAPACITY SELECTION (CONTINUATION OF 9-37).
   1. Required
   2. 1. If the plant manager of the Chicago Brewery gets a bonus based on operating income, which denominator-level capacity concept would he or she prefer to use? Explain.
   3. 2. What denominator-level capacity concept would Zing Lager prefer to use for U.S. income-tax reporting? Explain.
   4. 3. How might the IRS limit the flexibility of an absorption-costing company like Zing Lager attempting to minimize its taxable income?
3. 9-39. VARIABLE AND ABSORPTION COSTING AND BREAKEVEN POINTS. Let It Snow, LLC (LIS) manufactures snowboards. LIS began 2020 with an inventory of 250 boards. During the year, it produced 1,200 boards and sold 1,400 for $300 each. Fixed production costs were $169,020, and variable production costs were $112 per unit. Fixed advertising, marketing, and other general and administrative expenses were $75,000, and variable shipping costs were $20 per board. Assume that the cost of each unit in beginning inventory is equal to 2020 inventory cost. LIS uses a denominator level of 1,200 units.
   1. Required
   2. 1. Prepare an income statement assuming LIS uses variable costing.
   3. 2. Prepare an income statement assuming LIS uses absorption costing. Production-volume variances are written off to cost of goods sold.
   4. 3. Compute the breakeven point in units sold assuming LIS uses the following methods. Provide proof of your breakeven calculations.
      1. a. Variable costing
      2. b. Absorption costing
4. 9-40. DOWNWARD DEMAND SPIRAL. No More Litter, Inc. (NML) recently patented its new electronic and remote-controlled litter box. Research indicates that the scooping of the litter is the task most abhorred by cat owners. NML’s new product automatically “scoops” and fills the pan with fresh litter from the reservoir.
5. NML has budgeted 40,000 units for production and sales in the first year of operation. Practical capacity is 60,000 units.
6. Variable manufacturing costs per unit are as follows:

1. Fixed manufacturing overhead is $450,000 annually.
   1. Required
   2. 1. Assume that NML uses absorption costing and uses master-budget utilization as the denominator level for calculating its fixed manufacturing overhead rate. Selling price is set at 150% of total manufacturing cost. Compute NML’s selling price.
   3. 2. Due to a lagging economy, sales are not as robust as NML anticipated. Adding to the pressure on sales, Mr. Charles Buttons, President of NML, believes the stream of newcomers to the market are (1) using his patent-protected technology and (2) pricing their products at a loss. No change is made to the pricing model and budgeted sales and production for 2021 is 30,000 units. You are the CFO at NML. Explain to Mr. Buttons what effect this revised forecast will have in 2021.
   4. 3. Recompute the selling price using practical capacity as the denominator level of activity. How would this choice have affected NML’s position in the marketplace? Generally, how would this choice affect the production-volume variance?
2. 9-41. ABSORPTION COSTING AND PRODUCTION-VOLUME VARIANCE—ALTERNATIVE CAPACITY BASES. Energy Glow Light (EGL), a producer of energy-efficient light bulbs, expects that demand will increase markedly over the next decade. Due to the high fixed costs involved in the business, EGL has decided to evaluate its financial performance using absorption costing income. The production-volume variance is written off to cost of goods sold. The variable cost of production is $2.70 per bulb. Fixed manufacturing costs are $1,020,000 per year. Variable and fixed selling and administrative expenses are $0.20 per bulb sold and $290,000, respectively. Because its light bulbs are currently popular with environmentally conscious customers, EGL can sell the bulbs for $9.60 each.
3. EGL is deciding among various concepts of capacity for calculating the cost of each unit produced. Its choices are as follows:

1. 1. Required
   2. 1. Calculate the inventoriable cost per unit using each level of capacity to compute fixed manufacturing cost per unit.
   3. 2. Suppose EGL actually produces 250,000 bulbs. Calculate the production-volume variance using each level of capacity to compute the fixed manufacturing overhead allocation rate.
   4. 3. Assume EGL has no beginning inventory. If this year’s actual sales are 212,500 bulbs (and production is 250,000 bulbs), calculate operating income for EGL using each type of capacity to compute fixed manufacturing cost per unit.
2. 9-42. OPERATING INCOME EFFECTS OF DENOMINATOR-LEVEL CHOICE AND ADJUSTMENT FOR PRODUCTION-VOLUME VARIANCE (CONTINUATION OF 9-41).
   1. Required
   2. 1. If EGL sells all 250,000 bulbs produced, what would be the effect on operating income of using each type of capacity as a basis for calculating manufacturing cost per unit?
   3. 2. Compare the results of operating income at different capacity levels when 212,500 bulbs are sold and when 250,000 bulbs are sold. What conclusion can you draw from the comparison?
   4. 3. Using the original data (that is, 250,000 units produced and 212,500 units sold) if EGL had used the proration approach to allocate the production-volume variance, what would operating income have been under each level of capacity? (Assume that there is no ending work in process.)
3. 9-43. VARIABLE AND ABSORPTION COSTING, ACTUAL COSTING. The Iron City Company started business on January 1, 2020. Iron City manufactures a specialty honey beer, which it sells directly to state-owned distributors in Pennsylvania. Honey beer is produced and sold in six-packs, and in 2020, Iron City produced more six-packs than it was able to sell. In addition to variable and fixed manufacturing overhead, Iron City incurred direct materials costs of $880,000, direct manufacturing labor costs of $400,000, and fixed marketing and administrative costs of $295,000. For the year, Iron City sold a total of 180,000 six-packs for a sales revenue of $2,250,000.
4. Iron City’s CFO is convinced that the firm should use an actual costing system but is debating whether to follow variable or absorption costing. The controller notes that Iron City’s operating income for the year would be $438,000 under variable costing and $461,000 under absorption costing. Moreover, the ending finished-goods inventory would be valued at $7.15 under variable costing and $8.30 under absorption costing.
5. Iron City incurs no variable nonmanufacturing expenses.
   1. Required
   2. 1. What is Iron City’s total contribution margin for 2020?
   3. 2. Iron City incurs fixed manufacturing costs in addition to its fixed marketing and administrative costs. How much did Iron City incur in fixed manufacturing costs in 2020?
   4. 3. How many six-packs did Iron City produce in 2020?
   5. 4. How much in variable manufacturing overhead did Iron City incur in 2020?
   6. 5. For 2020, how much in total manufacturing overhead is expensed under variable costing, either through cost of goods sold or as a period expense?
6. 9-44. COST ALLOCATION, DOWNWARD DEMAND SPIRAL. Cafe One operates a chain of 10 hospitals in the Los Angeles area. Its central food-catering facility, Cafeman, prepares and delivers meals to the hospitals. It has the capacity to deliver up to 1,025,000 meals a year. In 2020, based on estimates from each hospital controller, Cafeman budgeted for 925,000 meals that year. Budgeted fixed costs in 2020 were $1,517,000. Each hospital was charged $6.04 per meal—$4.40 variable costs plus $1.64 allocated budgeted fixed cost.
7. Recently, the hospitals have been complaining about the quality of Cafeman’s meals and their rising costs. In mid-2020, Cafe One’s president announces that all Cafe One hospitals and support facilities will be run as profit centers. Hospitals will be free to purchase quality-certified services from outside the system. Luke Hayward, Cafeman’s controller, is preparing the 2021 budget. He hears that three hospitals have decided to use outside suppliers for their meals, which will reduce the 2021 estimated demand to 820,000 meals. No change in variable cost per meal or total fixed costs is expected in 2021.
   1. Required
   2. 1. How did Hayward calculate the budgeted fixed cost per meal of $1.64 in 2020?
   3. 2. Using the same approach to calculating budgeted fixed cost per meal and pricing as in 2020, how much would hospitals be charged for each Cafeman meal in 2021? What would the reaction of the hospital controllers be to the price?
   4. 3. Suggest an alternative cost-based price per meal that Hayward might propose and that might be more acceptable to the hospitals. What can Cafeman and Hayward do to make this price profitable in the long run?
8. 9-45. COST ALLOCATION, RESPONSIBILITY ACCOUNTING, ETHICS (CONTINUATION OF 9-44). In 2021, only 740,000 Cafeman meals were produced and sold to the hospitals. Hayward suspects that hospital controllers had systematically inflated their 2021 meal estimates.
   1. Required
   2. 1. Recall that Cafeman uses the master-budget capacity utilization to allocate fixed costs and to price meals. What was the effect of production-volume variance on Cafeman’s operating income in 2021?
   3. 2. Why might hospital controllers deliberately overestimate their future meal counts?
   4. 3. What other evidence should Cafe One’s president seek to investigate Hayward’s concerns?
   5. 4. Suggest two specific steps that Hayward might take to reduce hospital controllers’ incentives to inflate their estimated meal counts.
9. 9-46. COSTING METHODS AND VARIANCES, COMPREHENSIVE. Rob Kapito, the controller of Blackstar Paint Supply Company, has been exploring a variety of internal accounting systems. Rob hopes to get the input of Blackstar’s board of directors in choosing one. To prepare for his presentation to the board, Rob applies four different cost accounting methods to the firm’s operating data for 2020. The four methods are actual absorption costing, normal absorption costing, standard absorption costing, and standard variable costing.
10. With the help of a junior accountant, Rob prepares the following alternative income statements:

1. Where applicable, Rob allocates both fixed and variable manufacturing overhead using direct labor hours as the driver. Blackstar carries no work-in-process inventory. Standard costs have been stable over time, and Rob writes off all variances to cost of goods sold. For 2020, there was no flexible budget variance for fixed overhead. In addition, the direct labor variance represents a price variance.
   1. Required
   2. 1. Match each method below with the appropriate income statement (A, B, C, or D):

1. 1. 2. During 2020, how did Blackstar’s level of finished-goods inventory change? In other words, is it possible to know whether Blackstar’s finished-goods inventory increased, decreased, or stayed constant during the year?
   2. 3. From the four income statements, can you determine how the actual volume of production during the year compared to the denominator (expected) volume level?
   3. 4. Did Blackstar have a favorable or unfavorable variable overhead spending variance during 2020?
2. 9-47. ABSORPTION, VARIABLE, AND THROUGHPUT COSTING. JetStar produces jet bridges for many domestic and international airports. Cost information for JetStar’s jet bridges is as follows:

1. Additional information for the first three quarters of 2020 for Jetstar are shown below:

1. JetStar’s controller, Max, wishes to analyze the difference in the income statements between throughput costing, absorption costing, and variable costing for the first 3 quarters of 2020.
2. Assume no beginning inventory.
   1. Required
   2. 1. Prepare an absorption costing income statement
   3. 2. Prepare a variable costing income statement
   4. 3. Prepare a throughput costing income statement
   5. 4. Explain the difference in the net income under each costing method.
   6. 5. Based on the information provided, which costing method do you believe JetStar is currently using to calculate the bonus for the production manager? Why?
   7. 6. If Q4 sales were 65 and Q4 actual and budgeted production was 50, what difference would you expect in Q4 income between absorption costing and variable costing? Why?
3. 9-48. ABSORPTION COSTING, UNDESIRABLE INCENTIVES FOR MANAGERS TO BUILD UP INVENTORY. Rollalong Inc. produces wheelchairs that are sold primarily to hospitals. Rollalong’s three plant managers’ bonuses are based on operating income that is produced using absorption costing. The company suspects that the current buildup of inventory is a result of the managers’ desire for higher bonuses. Senior management wishes to institute an inventory limit to eliminate this inventory buildup without changing or eliminating the bonus structure. The variable cost per wheelchair is $5,500 and the fixed costs for 2020 were $11,019,840. Fixed costs are allocated based on master-budget capacity utilization. Budgeted production was 12,480 chairs and actual sales were 12,000 units. Actual production in 2020 was 13,320. In 2019, inventory increased by 3,000 units and that was also the ending inventory in units.
   1. Required
   2. 1. How much did inventory increase in 2020?
   3. 2. What amount of fixed costs was absorbed into inventory in 2020?
   4. 3. Why may it not be a good idea for senior management to institute an inventory limit?
   5. 4. Aside from instituting an inventory limit, how could senior management control the incentive of the plant managers to build up inventory in order to increase their bonuses?