QUESTION A: Variable costing versus absorption costing

9-27VARIABLE COSTING VERSUS ABSORPTION COSTING.The Garvis Company uses an absorption- costing system based on standard costs. Variable manufacturing cost consists of direct material cost of $4.50 per unit and other variable manufacturing costs of $1.50 per unit. The standard production rate is 20 units per machine-hour. Total budgeted and actual fixed manufacturing overhead costs are $840,000. Fixed manufacturing overhead is allocated at $14 per machine-hour based on fixed manufacturing costs of$840,00060,000

$840,00060,000machine-hours, which is the level Garvis uses as its denominator level.

The selling price is $10 per unit. Variable operating (nonmanufacturing) cost, which is driven by units sold, is $2 per unit. Fixed operating (nonmanufacturing) costs are $240,000. Beginning inventory in 2017 is 60,000 units; ending inventory is 80,000 units. Sales in 2017 are 1,080,000 units.

The same standard unit costs persisted throughout 2016 and 2017. For simplicity, assume that there are no price, spending, or efficiency variances.

1.calculate an operating statement for 2017 using absorption costing. Assume the production-volume variance is written off at year-end as an adjustment to cost of goods sold.

Reveune

10800000

COGS

Beginning Inventory

402000

Variable manufacturing cost

6600000

Allocated fixed manufacturing cost

770000

Cost of goods available

7772000

Less ending inventory

536000

Add adjustment pvv

70000

Cost of goods sold

7306000

Gross Margin

3494000

Operating costs

Variable operating costs

2160000

Fixed operating costs

240000

Total operating costs

2400000

Operating income

1094000

Question A (continued)

2.Prepare an operating statement for 2017 using variable costing.

Question A (continued)

3.Prepare a reconciliation of the differences in net income between the absorption and variable costing approaches.

4.Explain 2 methods that could be used to discourage overproduction with the purpose of maximizing operating income.

5.Let's go back to the end of 2016...to the time budgets were being determined for the 2017 year.. The production manager is rewarded a bonus based on a minimum return on investment of 10% on an investment of $11 million. The controller, who is friends with the production manager tells the production manager that he will advise the management accountant to reduce the planned production to 42,000 machine hours.

a.What effect will reducing the production hours have on the production volume variance?

b.

c.What effect will this have on operating income using absorption costing? Will the production manager receive his bonus?

d.If the production volume variance is written off directly to cost of goods sold, what will be the cost per unit sold? What will be the cost per units in ending inventory? What concerns might you have with this arrangement and how should this be controlled?