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Absorption and Variable Costing Assignment

Question 1 What is the basic difference between absorption costing and variable costing?

Solution 1: The basic difference between absorption and variable costing is the inventory valuation. Under absorption costing, all product costs irrespective of fixed or variable are considered for inventory valuation whereas under variable costing, only variable product costs are considered for inventory valuation.

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Question 2 Refined Elegance Corp. makes a desk specially designed for personal computers. The desk sells for $200.

Solution 2:

Units in beginning inventory 0
Units produced 10,000
Units sold 9,000
Units in ending inventory 1,000
Variable costs per unit  
Direct materials  $40
Direct labour 35
Variable manufacturing overhead  10
Variable selling and administrative 25
Total variable cost per unit  $110
Fixed costs  
Fixed manufacturing overhead   $300,000
Fixed selling and administrative 450,000
Total fixed costs   $750,000

i. Compute the unit product cost for one computer desk.

Unit product cost for one computer desk
Formula= (DM+DL+Variable manufacturing Overheads)
Direct materials  $40
Direct labour 35
Variable manufacturing overhead  10
Unit product cost for one computer desk $85

ii. Prepare a contribution format income statement for the year.

Contribution format Income statement


Total Sales   1800000
Less: Variable cost    
    Beginning Inventory 0  
    Manufacturing cost 850000  
    Cost of Goods Available for Sale 850000  
Less: Ending inventory 85000  
Cost of Goods Sold   765000
Gross Margin   1035000
Less: variable selling & admin expenses   225000
Contribution margin   810000
Fixed manufacturing expense  300000  
Fixed selling & admin expenses 450000  
Total fixed cost   750000
Net Income   60000

iii. What is the company's break-even point in terms of units sold?

Break-even point in terms of units sold
Formula= Fixed costs/ per unit contribution
Total fixed costs $750,000
Contribution per unit $90
Break-even point in terms of units sold 8333.333333

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Question 3 Refer to the data in the previous question for Refined Elegance Corp. Assume in this exercise that the company uses absorption costing.

Solution:

i. Compute the unit product cost for one computer desk.

Unit product cost for one computer desk
Formula= (DM+DL+Variable manufacturing Overheads+ Fixed manufacturingoverhead(absorbed))
Direct materials  $40
Direct labour $35
Variable manufacturing overhead  $10
Fixed Manufacturing overheads (Absorbed) $30
Unit product cost for one computer desk $115

ii. Prepare an income statement for the year.

Contribution format Income statement

Total Sales   1800000
Less: Variable cost    
    Beginning Inventory 0  
    Manufacturing cost 1150000  
    Cost of Goods Available for Sale 1150000  
Less: Ending inventory 115000  
Cost of Goods Sold   1035000
Gross Margin   765000
Less: variable selling & admin expenses 225000
Fixed selling & admin expenses 450000  
Total selling and administration cost   675000
Net Income   90000

Question 4 What was the total standard cost of the ending inventory under absorption costing?

Solution:

Selling price per unit $41
Standard fixed manufacturing costs per unit $20
Variable selling and administrative costs per unit $4
Fixed selling and administrative cost per unit $16,000
Beginning inventories:  
          Units ?
          Standard fixed manufacturing cost $40,000
          Standard variable manufacturing cost $20,000
          Units produced 10,000
          Units sold 9,600

Total standard cost of the ending inventory under absorption costing
Ending inventory 400
Standard variable manufacturing cost (20000/10000*400) $800
Standard fixed manufacturing cost  $8,000
Total standard cost of the ending inventory  $8,800

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Question 5 The company produces the same number of units every month, although the sales in units vary from month to month. The company's variable costs per unit and total fixed costs have been constant from month to month.

Solution:

Selling price $111
   
Units in beginning inventory 400
Units produced 8,800
Units sold 8,900
   
Variable costs per unit  
          Direct materials $34
          Direct labour $37
          Variable manufacturing overhead $3
          Variable selling and administrative $9
   
Fixed costs  
          Fixed manufacturing overhead $61,600
          Fixed selling and administrative $169,100

i. Compute the total Contribution Margin.

Compute the total Contribution Margin

Total Sales   $987,900
Less: Variable cost    
 Beginning Inventory  29600  
Manufacturing cost 651200  
Cost of Goods Available for Sale 680800  
Less: Ending inventory (400+8800-8900)= 300 22200  
variable Cost of Goods Sold 658600  
Less: variable selling & admin expenses $80,100  
Total variable cost   $738,700
Contribution margin   $249,200

400* Total variable cost = (34+37+3) 74

ii. Compute the Operating Income under Variable Costing.

Total Sales   $987,900
Less: Variable cost    
 Beginning Inventory  $29,600  
Manufacturing cost $651,200  
Cost of Goods Available for Sale $680,800  
Less: Ending inventory (400+8800-8900)= 300 $22,200  
variable Cost of Goods Sold $658,600  
Less: variable selling & admin expenses $80,100  
Total variable cost   $738,700
Contribution margin   $249,200
Fixed manufacturing expense  $61,600  
Fixed selling & admin expenses $169,100  
Total fixed cost   $230,700
Net Income   $18,500

400* Total variable cost = (34+37+3) 74

iii. Prepare a reconciliation from your Variable Costing Operating Income to compute Operating Income under absorption costing.

Total Sales   $987,900
Less: Variable cost    
 Beginning Inventory  (assuming absorption rate to be same as current year) $32,400  
Manufacturing cost $712,800  
Cost of Goods Available for Sale $745,200  
Less: Ending inventory (400+8800-8900)= 300 $24,300  
Cost of Goods Sold
$720,900
Gross margin   $267,000
Less: Variable selling & admin expenses $80,100  
           Fixed selling & admin expenses $169,100  
Total selling & admin expenses   $249,200
Net Income   $17,800



Reconcillation

Net Income under variable costing $18,500
Add: fixed manufacturing overhead costs deferred in inventory under absorption costing 2100
Less: fixed manufacturing overhead costs released from inventory under absorption costing  2800
Net income under absorption costing  $17,800

400* Total variable cost = (34+37+3+7) 81

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