Principles of Accounting Chapter 19

Environmental profit and loss (EP&L) account

A report in monetary terms of the impact on human welfare from an entity's activities.

When production is less than sales, the use of absorption costing:

Answer: produces a lower net income than the use of variable costing How: When production is less than sales, absorption costing net income is less than variable costing net income.

The fixed overhead cost in ending inventory is ___________ the variable costing income when reconciling income under variable costing to income under absorption costing.

Answer: added to How: Income under absorption costing = Income under variable costing + Fixed overhead cost in ending inventory − Fixed overhead cost in beginning inventory = Income under absorption costing.

Absorption costing

Costing method that assigns both variable and fixed manufacturing costs to products; this method is required under U.S. GAAP; also called full costing.

Over the long run, the starting point for setting selling prices should be established by adding the target markup to the _________ cost per unit.

Answer: absorption How: Over the long run, price must be high enough to cover all costs, including variable costs and fixed costs, and still provide an acceptable return to owners. For this purpose, absorption cost information is useful because it reflects the full costs that sales must exceed for the company to be profitable. The absorption cost per unit plus the target markup per unit is the starting point in setting prices.

Freshmart, Inc., began operations last year when it produced and sold the same number of units. This year, the company produced 1,000 units and sold 750 units at a selling price of $100 per unit. Fixed overhead costs totaled $30,000 and fixed selling and administrative expenses were $15,000. Variable production costs were $25.00 per unit while variable selling and administrative expenses were $10.00 per unit. Using absorption costing, net income was:

Answer: $11,250 How: Sales 750 x $100 = $75,000 Variable production 750 x $25 = $18,750 Fixed overhead ($30,000 / 1,000) = $30 x 750 = $22,500 Variable selling and administrative expenses 750 x $10 = $7,500 Fixed selling and administrative expenses $15,000 Net income: $11,250

Freshmart, Inc., began operations this year. The company produced 1,000 units and sold 1,000 units at a selling price of $100 per unit. Fixed overhead costs totaled $30,000 and fixed selling and administrative expenses were $15,000. Variable production costs were $25.00 per unit while variable selling and administrative expenses were $10.00 per unit. Using absorption costing, net income was:

Answer: $20,000. How: Per unit production costs = variable costs of $25 + fixed overhead cost of $30 (or $30,000 ÷ 1,000 units) = $55. Net income = Sales of $100,000 (or 1,000 units × $100 per unit) − Cost of goods sold of $55,000 (or 1,000 units × $55 per unit) − Selling and administrative expenses of $25,000 (or (1,000 units × $10 per unit) + $15,000) = $20,000.

Units produced: 1,000 Direct materials: $6 Direct labor: $10 Fixed overhead: $6,000 Variable overhead: $6 Fixed selling and administrative: $2,000 Variable selling and administrative: $2 The cost per unit under variable costing is:

Answer: $22. How: Using variable costing, the unit cost is determined as follows:Direct materials of $6 + Direct labor of $10 + Variable overhead of $6 = Unit cost of $22 per unit.

Units produced: 1,000 Direct materials: $6 Direct labor: $10 Fixed overhead: $6,000 Variable overhead: $6 Fixed selling and administrative: $2,000 Variable selling and administrative: $2 The total product cost per unit under absorption costing is:

Answer: $28. How: Using absorption costing, the total product cost per unit is determined as follows:Direct materials of $6 + Direct labor of $10 + Variable overhead of $6 + Fixed overhead of $6 (or $6,000 ÷ 1,000) = Total product cost of $28 per unit.

Stewart Corporation manufactures solar-powered calculators. The company can manufacture 1,200,000 calculators a year at a variable cost of $3,000,000 and a fixed cost of $1,800,000. Based on management's projections for next year, 960,000 calculators will be sold at the regular price of $20.00 each. A special order has been received for 240,000 calculators at $6 per calculator. Total fixed costs would be unaffected by this order. The company's net operating income will be increased as a result of the special order by:

Answer: $840,000 How: First, compute the variable cost per unit as follows. Total variable costs of $3,000,000 ÷ 1,200,000 units = $2.50 per unit. Then, determine the impact on net operating income as follows. Incremental sales of $1,440,000 (or 240,000 × $6) − Incremental variable costs of $600,000 (or 240,000 × $2.50) = Incremental income of $840,000.

An income statement under variable costing includes all of the following:

Answer: Direct materials, direct labor, and variable overhead. How: (An income statement under variable costing includes only variable production costs including direct materials, direct labor, and variable overhead.)

An income statement under absorption costing includes all of the following:

Answer: Direct materials, direct labor, variable overhead, and fixed overhead. How: (An income statement under absorption costing includes all production costs including direct materials, direct labor, variable overhead, and fixed overhead.)

To properly evaluate special orders, a company should use _____ cost information.

Answer: absorption How: Absorption cost information is useful in deciding if a company should accept a special order because it reflects the full costs that sales must exceed for the company to be profitable. The contribution margin (or excess of selling price over variable cost) that results will help to cover the fixed costs and result in additional income.

An income statement prepared using the ___________ highlights the impact of each cost element for income and is also useful in aiding managers in pricing.

Answer: contribution format How: An income statement prepared using the contribution format highlights the impact of each cost element for income and is also useful in aiding managers in setting prices.

Higher-level managers usually make decisions to change a company's ___________ costs.

Answer: fixed How: Decisions to change a company's fixed costs are usually assigned to higher-level managers. This is different from most variable costs that are assigned to lower-level managers and supervisors. An effective cost control practice is to hold managers responsible only for their controllable costs. A cost is controllable if a manager has the power to determine or at least markedly affect the amount incurred. Uncontrollable costs are not within the manager's control or influence.

Variable costing

Costing method that includes only variable manufacturing costs (direct materials, direct lobar, and variable manufacturing overhead) in unit product costs; also called direct or marginal costing.

Uncontrollable costs

Costs that a manager does not have the power to determine or strongly influence.

Controllable costs

Costs that a manager has the power to control or at least strongly influence.

Contribution format

Income statement that separately reports variable costs and fixed costs.

Contribution margin income statement

Income statement that separates variable and fixed costs; highlights the contribution margin, which is sales less variable expenses.

Fixed overhead cost deferred in (ending) inventory

The portion of the fixed manufacturing overhead cost of a period that goes into inventory under the absorption costing method as a result of production exceeding sales.

Fixed overhead cost recognized from (beginning) inventory

The portion of the fixed manufacturing overhead cost of a prior period that becomes an expense of the current period under the absorption costing method as a result of sales exceeding production.