HOW CAN VARIABLE COSTING BE USED FOR DECISION MAKING IN A SERVICE COMPANY?
4. How can variable costing be used for decision making in a service company?
■
■ In most short-term decisions, it is usually appropriate to use variable costing, whereas absorption costing is usually appropriate in most long-term decisions.
■
■ Variable costing can be used in the following types of decisions:
• Setting sales prices
• Controlling costs
• Planning production
• Analyzing profitability
• Analyzing contribution margin
4. How can variable costing be used for decision making in a service company?
■
■ Variable costing can also be used in service companies, especially in making short- term decisions.
■
■ In service companies, variable costing can be used for:
• Profitability analysis
• Contribution margin analysis
> Things You Should Know
> Check Your Understanding
Check your understanding of the chapter by completing this problem and then looking at the solution. Use this practice to help identify which sections of the chapter you need to study more.
Limonade incurs the following costs for its powdered sports beverage mix in March 2018:
Direct materials cost per case $ 8.00 per case
Direct labor cost per case 3.00 per case
Variable manufacturing overhead cost per case 2.00 per case Variable selling and administrative costs 0.50 per case Total fixed manufacturing overhead costs 50,000.00 per month Total fixed selling and administrative costs 25,000.00 per month
Sales price per case 25.00 per case
Cases of powdered mix produced 10,000 cases
Cases of powdered mix sold 8,000 cases
There were no beginning inventories, so Limonade has 2,000 cases of powdered mix in ending Finished Goods Inventory (10,000 cases produced - 8,000 cases sold).
Requirements
1. What is Limonade’s product cost per case under absorption costing and variable costing? (See Learning Objective 1)
2. Prepare income statements for Limonade for March 2018 using absorption costing and variable costing. (See Learning Objective 2)
3. Calculate the balance in Finished Goods Inventory on March 31, 2018, using absorption costing and variable costing. (See Learning Objective 2)
4. Reconcile the differences between the operating incomes and Finished Goods Inventory balances between the two costing methods. (See Learning Objective 2)
> Solution
Requirement 1
Absorption Costing
Variable Costing
Direct materials $ 8.00 $ 8.00
Direct labor 3.00 3.00
Variable manufacturing overhead 2.00 2.00
Fixed manufacturing overhead ($50,000 / 10,000 cases) 5.00
Total unit product cost $ 18.00 $ 13.00
Requirement 2
Absorption Costing
Net Sales Revenue (8,000 cases* $25.00 per case) $ 200,000 Cost of Goods Sold (8,000 cases* $18.00 per case) 144,000
Gross Profit 56,000
Selling and Administrative Costs:
Variable S&A Costs (8,000 cases* $0.50 per case) $ 4,000
Fixed S&A Costs 25,000 29,000
Operating Income $ 27,000
Variable Costing
Net Sales Revenue (8,000 cases* $25.00 per case) $ 200,000 Variable Manufacturing Costs (8,000 cases* $13.00 per case) $ 104,000
Variable S&A Costs (8,000 cases* $0.50 per case) 4,000 108,000
Contribution Margin 92,000
Fixed Costs:
Fixed Manufacturing Costs 50,000
Fixed S&A Costs 25,000 75,000
Operating Income $ 17,000
Requirement 3
Finished Goods Inventory balance, March 31, 2018:
Absorption Costing: 2,000 cases * $18.00 per case = $36,000 Variable Costing: 2,000 cases * $13.00 per case = $26,000 Requirement 4
Absorption
Costing Variable
Costing Difference Operating Income $ 27,000 $ 17,000 $ 10,000 Finished Goods Inventory 36,000 26,000 10,000
The $10,000 difference is the $5 per unit of fixed manufacturing cost assigned to the unsold units and not expensed by absorption costing. $5 per unit * 2,000 unsold units = $10,000.
> Key Terms
Absorption Costing (p. 1143) Business Segment (p. 1154)
Contribution Margin (p. 1143) Contribution Margin Ratio (p. 1154)
Variable Costing (p. 1143)
> Quick Check
1. The primary difference between variable costing and absorption costing is a. in variable costing, fixed manufacturing overhead is a product cost.
b. in absorption costing, fixed manufacturing overhead is a product cost.
c. in variable costing, variable selling and administrative costs are product costs.
d. in absorption costing, fixed selling and administrative costs are product costs.
2. Winters, Inc. is preparing financial statements to be distributed to investors and creditors. The company should prepare the income statement using
a. variable costing because it is better for planning purposes.
b. variable costing because it follows GAAP.
c. absorption costing because it is better for controlling purposes.
d. absorption costing because it follows GAAP.
Use the following data for questions 3–7:
Donovan Company incurred the following costs while producing 500 units: direct materials, $10 per unit; direct labor, $25 per unit; variable manufacturing overhead,
$15 per unit; total fixed manufacturing overhead costs, $10,000; variable selling and administrative costs, $5 per unit; total fixed selling and administrative costs, $7,500.
There are no beginning inventories.
3. What is the unit product cost using variable costing?
a. $50 per unit b. $55 per unit
c. $70 per unit d. $90 per unit 4. What is the unit product cost using absorption costing?
a. $50 per unit b. $55 per unit
c. $70 per unit d. $90 per unit
5. What is the operating income using absorption costing if 500 units are sold for $100 each?
a. $500 b. $2,500
c. $2,750 d. $5,000
6. What is the operating income using variable costing if 450 units are sold for $100 each?
a. $2,750 b. $5,000
c. $500 d. $2,500
7. What is the ending balance in Finished Goods Inventory using variable costing if 450 units are sold?
a. $2,000 c. $2,750
Learning Objective 1
Learning Objective 1
Learning Objective 1
Learning Objective 1
Learning Objective 2
Learning Objective 2
Learning Objective 2
8. The contribution margin per unit and total contribution margin for Singles and Supremes are:
Singles Supremes
Contribution
Margin per Unit Total Contribution
Margin Contribution
Margin per Unit Total Contribution Margin
a. $6 $720 $6 $180
b. $6 $180 $6 $720
c. $6 $240 $6 $360
d. $6 $180 $6 $180
9. Which pizza should Sammie’s Pizza promote to maximize profits?
a. Singles because they contribute the highest total contribution margin.
b. Supremes because they have the highest contribution margin ratio.
c. Singles because they have the highest contribution margin ratio.
d. Both should be promoted equally because they have the same contribution margin per unit.
10. During a recent month, Cleveland Company planned to provide cleaning services to 30 customers for $25 per hour. Each job was expected to take 3 hours. The company actually served 10 more customers than expected, but the average time spent on each job was only 2.5 hours each. Cleveland’s revenues for the month were
a. $250 more than expected.
b. $250 less than expected.
c. $750 more than expected.
d. Cannot be determined from data given Check your answers at the end of the chapter.
Learning Objective 3
Learning Objective 3
Learning Objective 4
ASSESS YOUR PROGRESS
> Review Questions
1. What is absorption costing?
2. What is variable costing?
3. How are absorption costing and variable costing the same? How are they different?
4. When units produced equal units sold, how does operating income differ between variable costing and absorption costing?
5. When units produced exceed units sold, how does operating income differ between variable costing and absorption costing? Why?
6. When units produced are less than units sold, how does operating income differ between variable costing and absorption costing? Why?
7. Explain why the fixed manufacturing overhead cost per unit changes when there is a change in the number of units produced.
8. Explain how increasing production can increase gross profit when using
absorption costing.
9. When should a company use absorption costing when setting sales prices? When should it use variable costing?
10. In the long run, all costs are controllable. Is this statement true? Why or why not?
11. Why is it appropriate to use variable costing when planning production in the short term?
12. What is a business segment? Give some examples.
13. Explain how sales mix can affect the profitability of a company.
14. What are the two components that can affect contribution margin? Why is it important to investigate both?
15. How do service companies differ from manufacturing companies?
16. How can variable costing be used in service companies?
> Short Exercises
S21-1 Classifying costs
Classify each cost by placing an X in the appropriate columns. The first cost is completed as an example.
Absorption Costing Variable Costing Product Cost Period Cost Product Cost Period Cost
a. Direct materials X X
b. Direct labor
c. Variable manufacturing overhead d. Fixed manufacturing overhead
e. Variable selling and administrative costs f. Fixed selling and administrative costs
Use the following information for Short Exercises S21-2 and S21-3.
Martin Company had the following costs:
Units produced 320 units
Direct materials $ 71 per unit
Direct labor 40 per unit
Variable manufacturing overhead 13 per unit Fixed manufacturing overhead 7,360 per year Variable selling and administrative costs 22 per unit
Learning Objective 1
S21-3 Computing unit product cost, variable costing
Calculate the unit product cost using variable costing. Round your answer to the nearest cent.
Use the following information for Short Exercises S21-4 and S21-5.
Dracut Company reports the following information for June:
Net Sales Revenue $ 755,000
Variable Cost of Goods Sold 240,000
Fixed Cost of Goods Sold 198,000
Variable Selling and Administrative Costs 168,000 Fixed Selling and Administrative Costs 79,000
S21-4 Calculating contribution margin and operating income, variable costing Calculate the contribution margin and operating income for June using variable costing.
S21-5 Calculating gross profit and operating income, absorption costing Calculate the gross profit and operating income for June using absorption costing.
S21-6 Computing absorption cost per unit and variable cost per unit Adamson, Inc. has the following cost data for Product X:
Direct materials $ 41 per unit
Direct labor 57 per unit
Variable manufacturing overhead 7 per unit Fixed manufacturing overhead 20,000 per year
Calculate the unit product cost using absorption costing and variable costing when production is 2,000 units, 2,500 units, and 5,000 units.
Note: Short Exercise S21-6 must be completed before attempting Short Exercise S21-7.
S21-7 Computing absorption costing gross profit
Refer to your answers to Short Exercise S21-6. Product X sells for $175 per unit.
Assume no beginning inventories. Calculate the gross profit using absorption costing when Adamson:
a. Produces and sells 2,000 units.
b. Produces 2,500 units and sells 2,000 units c. Produces 5,000 units and sells 2,000 units.
Note: Short Exercise S21-6 must be completed before attempting Short Exercise S21-8.
S21-8 Computing variable costing contributon margin
Refer to your answers to Short Exercise S21-6. Product X sells for $175 per unit.
Assume no beginning inventories. Calculate the contribution margin using variable costing when Adamson:
a. Produces and sells 2,000 units.
b. Produces 2,500 units and sells 2,000 units c. Produces 5,000 units and sells 2,000 units.
Learning Objective 1
Learning Objective 2
Learning Objective 2
Learning Objective 2
Learning Objective 2
Learning Objective 2
S21-9 Computing inventory balances
Zeng Company reports the following data:
Finished Goods Inventory:
Beginning balance, in units 300
Units produced 2,900
Units sold (1,600)
Ending balance, in units 1,600 Production Costs:
Variable manufacturing costs per unit $ 57 Total fixed manufacturing costs 26,100
Calculate the product cost per unit and the total cost of the 1,600 units in ending inventory using absorption costing and variable costing.
S21-10 Analyzing profitability
Camden Company has divided its business into segments based on sales territories:
East Coast, Midland, and West Coast. Following are financial data for 2018:
East Coast Midland West Coast
Units sold 71 69 53
Sales price per unit $ 10,300 $ 13,600 $ 12,000 Variable cost per unit 6,283 7,072 7,080
Prepare an income statement for Camden Company for 2018 using the contribution margin format assuming total fixed costs for the company were $435,000. Include columns for each business segment and a column for the total company.
Note: Short Exercise S21-10 must be completed before attempting Short Exercise S21-11.
S21-11 Analyzing profitability
Refer to Short Exercise S21-10. Which business segment provided the greatest total contribution margin? Which business segment had the highest contribution margin ratio?
S21-12 Analyzing profitability analysis, service company
Burlington Internet Services is an Internet service provider for commercial and resi- dential customers. The company provided the following data for its two types of cus- tomers for the month of August:
Learning Objective 2
Learning Objective 3
Learning Objective 3
Learning Objective 4
Total Commercial
800 Number of Customers
Residential 600 200
For each type of customer, determine both the contribution margin per customer and the contribution margin ratio. Round to two decimal places. Which type of service is more profitable?
> Exercises
E21-13 Using absorption and variable costing
Meyer Company reports the following information for March:
Net Sales Revenue $ 45,300
Variable Cost of Goods Sold 12,500
Fixed Cost of Goods Sold 11,800
Variable Selling and Administrative Costs 14,000 Fixed Selling and Administrative Costs 5,400
Requirements
1. Calculate the gross profit and operating income for March using absorption costing.
2. Calculate the contribution margin and operating income for March using variable costing.
Use the following information for Exercises E21-14 and E21-15.
Concord, Inc. has collected the following data for November (there are no beginning inventories):
Units produced and sold 500 units
Sales price $ 450 per unit
Direct materials 64 per unit
Direct labor 68 per unit
Variable manufacturing overhead 26 per unit Fixed manufacturing overhead 7,500 per month Variable selling and administrative costs 15 per unit Fixed selling and administrative costs 4,400 per month
E21-14 Computing absorption costing operating income Refer to the information for Concord, Inc.
Requirements
1. Using absorption costing, calculate the unit product cost.
2. Prepare an income statement using the traditional format.
E21-15 Computing variable costing operating income Refer to the information for Concord, Inc.
Requirements
1. Using variable costing, calculate the unit product cost.
2. Prepare an income statement using the contribution margin format.
Learning Objectives 1, 2 2. CM $18,800
Learning Objectives 1, 2 1. $173.00
Learning Objectives 1, 2 2. CM $138,500
E21-16 Preparing variable costing income statements, production exceeds sales
ReVitalAde produced 13,000 cases of powdered drink mix and sold 12,000 cases in April 2018. The sales price was $29, variable costs were $12 per case ($9 manufactur- ing and $3 selling and administrative), and total fixed costs were $100,000 ($91,000 manufacturing overhead and $9,000 selling and administrative). The company had no beginning Finished Goods Inventory.
Requirements
1. Prepare the April income statement using variable costing.
2. Determine the product cost per unit and the total cost of the 1,000 cases in Finished Goods Inventory as of April 30.
Note: Exercise E21-16 must be completed before attempting Exercise E21-17.
E21-17 Preparing absorption costing income statements, production exceeds sales
Refer to Exercise E21-16.
Requirements
1. Prepare the April income statement using absorption costing.
2. Determine the product cost per unit and the total cost of the 1,000 cases in Finished Goods Inventory as of April 30.
3. Is the April 30 balance in Finished Goods Inventory higher or lower than variable costing? Explain why.
Note: Exercises E21-16 and E21-17 must be completed before attempting Exercise E21-18.
E21-18 Comparing variable and absorption costing Refer to Exercises E21-16 and E21-17.
Requirements
1. Which costing method produces the highest operating income?
Explain why.
2. Which costing method produces the highest April 30 balance in Finished Goods Inventory? Explain why.
Note: Exercise E21-16 must be completed before attempting Exercise E21-19.
E21-19 Preparing variable costing income statements, production less than sales
Refer to your answers to Exercise E21-16. In May 2018, ReVitalAde produced 22,000 cases of powdered drink mix and sold 23,000 cases, of which 1,000 were produced in April. The sales price was $29, variable costs were $12 per case ($9 manufacturing and $3 selling and administrative), and total fixed costs were $100,000 ($91,000
Learning Objectives 1, 2 2. FG $9,000
Learning Objectives 1, 2 1. OI $111,000
Learning Objectives 1, 2
Learning Objectives 1, 2 1. CM $391,000
Note: Exercise E21-19 must be completed before attempting Exercise E21-20.
E21-20 Preparing absorption costing income statements, production less than sales Refer to Exercise E21-19.
Requirements
1. Prepare the May income statement using absorption costing.
2. Is operating income using absorption costing higher or lower than variable costing income? Explain why.
3. Determine the balance in Finished Goods Inventory as of May 31.
E21-21 Setting sales prices
The Sweet Treats Company manufactures candy that is sold to food distributors. The company produces at full capacity for six months each year to meet peak demand dur- ing the “candy season” from Halloween through Valentine’s Day. During the other six months of the year, the manufacturing facility operates at 75% of capacity. The Sweet Treats Company provides the following data for the year:
Cases of candy produced and sold 1,800,000 cases
Sales price $ 37.00 per case
Variable manufacturing costs 20.00 per case Fixed manufacturing costs 6,400,000 per year Variable selling and administrative costs 2.00 per case Fixed selling and administrative costs 3,500,000 per year
The Sweet Treats Company receives an offer to produce 13,000 cases of candy for a special event. This is a one-time opportunity during a period when the company has excess capacity. What is the minimum sales price The Sweet Treats Company should accept for the order? Explain why.
E21-22 Analyzing profitability
Sampler Company sells two products, Sigma and Zeta, with a sales mix of 70% and 30%, respectively. Sigma has a contribution margin per unit of $26, and Zeta has a contribution margin per unit of $21. The company sold 700 total units in September.
Calculate the total amount each product contributed to the coverage of fixed costs and the total contribution margin for the company.
Note: Exercise E21-22 must be completed before attempting Exercise E21-23.
E21-23 Analyzing profitability
Refer to Exercise E21-22. Assume the sales mix shifted to 50% for each product.
Calculate the total amount each product contributed to the coverage of fixed costs and the total contribution margin for the company.
E21-24 Using variable costing, service company
Henry’s Helpers provides locksmith services. One type of service call is to evaluate private residences for security concerns and make recommendations for a safety plan.
Use the data below to determine the company’s total contribution margin, contribu- tion margin per service call, and contribution margin ratio when 220 service calls are made in the month of June.
Service Revenue $ 170 per service call Variable Costs 68 per service call Fixed Costs 21,040 per month Learning Objectives 1, 2
1. OI $284,000
Learning Objective 3
Learning Objective 3 Total CM $17,150
Learning Objective 3
Total CM $16,450
Learning Objective 4 VC at 220 Svc Calls $14,960
E21-25 Using variable costing, service company
Sherman Company provides carpet cleaning services to commercial and residential customers. Using the data below, determine the contribution margin ratio for each business segment, rounded to two decimal places:
Learning Objective 4 CMR for Residential 76%
Total Commercial
$ 380,000 259,400 120,600 Service Revenue
Variable Costs Contribution Margin Fixed Costs
Operating Income
15,000
$ 244,400 Residential
182,400 57,600
$ 240,000 77,000
63,000
$ 140,000
Note: Exercise E21-25 must be completed before attempting Exercise E21-26.
E21-26 Using variable costing, service company
Refer to Exercise E21-25. The commercial business segment provided services to 200 customers. The residential business segment provided services to 400 customers.
Determine the average amount Sherman Company charged each type of customer for services, the average variable cost per customer, and the average contribution margin per customer, rounded to two decimal places. What caused the difference in contribu- tion margin in the two segments?
Learning Objective 4 VC per Customer for Commercial $315
> Problems Group A
P21-27A Preparing variable and absorption costing income statements
Linda’s Foods produces frozen meals that it sells for $7 each. The company computes a new monthly fixed manufacturing overhead allocation rate based on the planned num- ber 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 1,000 meals
Production 1,200 meals
Variable manufacturing cost per meal $ 3
Sales commission cost per meal 1
Total fixed manufacturing overhead 660 Total fixed selling and administrative costs 500
Requirements
Learning Objectives 1, 2 2b. VC $4,000
P21-28A Preparing variable and absorption costing income statements Game Store manufactures video games that it sells for $38 each. The company uses a fixed manufacturing overhead allocation rate of $3 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 2,800 units 2,800 units
Variable manufacturing cost per game $ 16 $ 16
Sales commission cost per game 8 8
Total fixed manufacturing overhead 8,400 8,400 Total fixed selling and administrative costs 8,000 8,000
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 col- umns 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 Octo- ber? 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 Novem- ber 30 under absorption costing and variable costing. Compare the differences in inventory balances and the differences in operating income. Explain the differ- ences in inventory balances based on absorption costing versus variable costing.
P21-29A Analyzing profitability
Relative Furniture Company manufactures and sells oak tables and chairs. Price and cost data for the furniture follow:
Tables Chairs
Sales Price $ 1,400 $ 50
Variable manufacturing costs 1,148 21
Sales commission (8%) 112 4
Relative Furniture has three sales representatives: Abe, Brett, and Corrin. Abe sold 50 tables with 4 chairs each. Brett sold 110 tables with 6 chairs each. Corrin sold 90 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.
Learning Objectives 1, 2 1. Absorption costing $19.00
Learning Objective 3 1. CMR for Abe 15.00%