ChalkTalk Ltd manufactures blackboard chalk for educational uses. The company's product is sold by the bog at 550 per unit. ChalkTalk uses an actual costing system, which means that the actual costs of direct material, direct labour and manufacturing overhead are entered into work in process inventory. The actual application rate for manufacturing overhead is calculated each year: actual manufacturing overhead is divided by actual production (in units) to calculate the actual manufacturing overhead rate.

Information for ChalkTalk's first two years of operation is as follows:

ChalkTalk had no beginning or ending work in process inventories for either year.
Required:
1. Prepare income statements for both years based on absorption costing.
2. Prepare income statements for both years based on variable costing.
3. Reconcile reported profit under absorption and variable costing, during each year, by comparing the following two amounts on each income statement:
(a) Cost of goods sold.
(b) Fixed Lust (expensed as a period expense).
4. What was ChalkTalk's total profit across both years under
(a) Absorption costing.
(b) Variable costing.
5. Subtract the total costs expensed across both years from the total sales revenue across both years under
(a) Absorption costing.
(b) Variable costing.
6. Comment on the results obtained in requirements 3, 4 and 5 above in light of the following assertion: Timing is the key in distinguishing between absorption and variable costing.
7. Selected information from ChalkTalk's year-end balance sheets for its first two years of operation is as follows:

(a) Explain why the year 1 ending balance in finished goods inventory is greater if absorption costing is used rather than variable costing.
(b) Explain why the year 2 ending balance in finished goods inventory is the same under absorption and variable costing.
(c) Notice that the ending balance of finished goods inventory under absorption costing is greater than or equal to the ending finished goods inventory balance under variable costing for both years 1 and 2. Will this relationship always hold true at any balance sheet date? Explain.
(d) Calculate the amount by which the year-end balance in finished goods inventory declined during year 2 (i.e. between December 31 of year i and December 31 of year 2):
• Using the data from the balance sheet prepared under absorption costing.
• Using the data from the balance sheet prepared under variable costing.
(e) Refer to your calculations from requirement 7(d). Calculate the difference in the amount by which the year-end balances in finished goods inventory declined under absorption versus variable costing. Then compare the amount of this difference with the difference in the company's reported profit for year 2 under absorption versus variable costing. (Refer to the income statements prepared in Parts t and 2.)
(f) Notice that the retained earnings balance at the end of both years 1 and 2 on the balance sheet prepared under absorption costing is greater than or equal to the corresponding retained earnings balance on the statement prepared under variable costing. Will this relationship hold true at any balance sheet date? Explain.

Transcribed Image Text:

Year 1 Year 2 Sales (in units) 2 500 2 500 Production (in units) 3 000 2 000 Production costs: $21 000 Variable manufacturing costs $14000 Fixed manufacturing overhead 42 000 42 000 Selling and administrative costs: Variable 25 000 25 000 Fixed 20 000 20 000 Based on absorption costing Finished goods inventory Retained earnings Based on variable costing Finished goods inventory Retained earnings End of year 1 End of year 2 $10 500 16 500 End of year 2 $ 3 500 $0 24 600 End of year 2 $0 24 600 9 500