Ch. 9 -- Inventory Costing and Capacity Analysis (Adv Mnmt Acct)

Majesty ​Sales, Inc. has just completed its first year of operations. The company has not had any sales to date. Majesty has incurred the following costs associated with its production as of December​ 31, Year​ 1: Under absorption​ costing, what is the inventory amount shown on the balance sheet at December​ 31, Year​ 1? Direct materials - $42,000 Production labor - 33,000 Bookkeeper salary - 30,000 Factory utilities - 19,500 Office rent - 16,000 Factory supervisor salary - 9,800 Machine maintenance contract - 7,600

$111,900 (Direct materials $42,000 + Production labor 33,000 + Factory utilities 19,500 + Factory supervisor salary 9,800 + Machine maintenance contract 7,600) *raw materials, labor, and any other direct expenses that are incurred in the production process

What are the 4 different capacity levels used to compute the budgeted fixed manufacturing cost rate?

1) Theoretical capacity 2) Practical capacity 3) Normal capacity utilization 4) Master-budget capacity utilization

What​ denominator-level capacity concepts emphasize the output a plant can​ supply? What​ denominator-level capacity concepts emphasize the output customers demand for products produced by a​ plant? A. The theoretical capacity and the practical capacity concepts emphasize the output a plant can supply. The normal capacity utilization and the​ master-budget capacity utilization concepts emphasize the demand for a​ plant's output. B. The normal capacity utilization and the practical capacity concepts emphasize the output a plant can supply. The theoretical capacity and the​ master-budget capacity utilization concepts emphasize the demand for a​ plant's output. C. The theoretical capacity and the​ master-budget capacity utilization concepts emphasize the output a plant can supply. The normal capacity utilization and the practical capacity concepts emphasize the demand for a​ plant's output. D. The normal capacity utilization and the​ master-budget capacity utilization concepts emphasize the output a plant can supply. The theoretical capacity and the practical capacity concepts emphasize the demand for a​ plant's output.

A. The theoretical capacity and the practical capacity concepts emphasize the output a plant can supply. The normal capacity utilization and the​ master-budget capacity utilization concepts emphasize the demand for a​ plant's output.

The following information relates to Kenyon ​Inc.'s Year 3​ financials: Direct labor - $410,000 Direct materials - 260,000 Variable overhead - 201,000 Fixed overhead - 348,000 Variable SG&A expenses - 200,000 Fixed SG&A expenses - 197,000 Year 3 period costs for Kenyon​, under both the absorption and variable cost​ methods, will be:

Absorption = 200,000 Variable SGA Exp. + 197,0000 Fixed SGA Exp. = $397,000 Variable = 200,000 Variable SGA Exp. + 197,000 Fixed SGA Exp. + 348,000 FOH = 745,000

​"Companies that make no​ variable-cost/fixed-cost distinctions must use absorption​ costing, and those that do make​ variable-cost/fixed-cost distinctions must use variable​ costing." Do you​ agree? Explain. A. No. A company that does not make a​ variable-cost/fixed-cost distinction is not forced to use absorption costing for internal reporting purposes. It can use variable​ costing, absorption​ costing, or throughput costing. B. No. A company that makes a​ variable-cost/fixed-cost distinction is not forced to use variable costing for internal reporting purposes. It can use variable​ costing, absorption​ costing, or throughput costing. C. Yes. A company that does not make a​ variable-cost/fixed-cost distinction must adopt absorption costing for internal reporting purposes. D. Yes. A company that makes a​ variable-cost/fixed-cost distinction must use variable costing for internal reporting purposes.

B. No. A company that makes a​ variable-cost/fixed-cost distinction is not forced to use variable costing for internal reporting purposes. It can use variable​ costing, absorption​ costing, or throughput costing.

Will the financial statements of a company always differ when different choices at the start of the accounting period are made regarding the​ denominator-level capacity​ concept? A. Yes. If different choices at the start of the accounting period are made regarding the​ denominator-level capacity​ concept, this will always result in different financial statement numbers at​ year-end. B. No. It depends on how a company handles the​ production-volume variance in the​ end-of-period financial statements. For​ example, if the adjusted​ allocation-rate approach is​ used, each​ denominator-level capacity concept will give the same financial statement numbers at​ year-end. C. No. It depends on how a company handles the​ production-volume variance in the​ end-of-period financial statements. For​ example, if the​ write-off approach is​ used, each​ denominator-level capacity concept will give the same financial statement numbers at​ year-end. D. Yes. The four different​ capacity-level concepts result in four different budgeted fixed manufacturing overhead cost rates per​ unit, which in turn leads to different results being reported on the financial statements.

B. No. It depends on how a company handles the​ production-volume variance in the​ end-of-period financial statements. For​ example, if the adjusted​ allocation-rate approach is​ used, each​ denominator-level capacity concept will give the same financial statement numbers at​ year-end.

Which of the following statements is not true regarding the use of variable and absorption costing for performance​ measurement? A. Variable costing isolates contribution margins to aid in decision making. B. The net income reported under the absorption method is less reliable for use in performance evaluations because the cost of the product includes fixed​ costs, which means the level of inventory affects net income. C. The IRS allows either absorption or variable costing as long as the method is not changed from year to​ year, while U.S. GAAP only allows absorption costing. D. The net income reported under the contribution income statement is more reliable for use in performance evaluations because the product cost does not include fixed costs.

C. The IRS allows either absorption or variable costing as long as the method is not changed from year to​ year, while U.S. GAAP only allows absorption costing.

Describe the downward demand spiral and its implications for pricing decisions. A. The downward demand spiral is a reduction in the production of a​ company's products. It is less likely to occur when Managers use reported unit costs in a mechanical way to set prices. They are more likely to promote a downward demand spiral when they use practical capacity than when they use normal capacity utilization or​ master-budget capacity utilization. B. The downward demand spiral is the continuing inability for a company to meet the demand for its products that occurs when competitors offer the same​ products; as demand drops​ further, higher and higher unit costs result from spreading budgeted fixed manufacturing costs to less volume of units. C. The downward demand spiral is the continuing reduction in demand for a​ company's product that occurs when the prices of​ competitors' products are not​ met; as demand drops​ further, higher and higher unit costs result in more and more reluctance to meet​ competitors' prices. D. The downward demand spiral for a company is the continuing increase in the demand for its products that occurs when competitor prices are​ lowered; as demand​ increases, lo

C. The downward demand spiral is the continuing reduction in demand for a​ company's product that occurs when the prices of​ competitors' products are not​ met; as demand drops​ further, higher and higher unit costs result in more and more reluctance to meet​ competitors' prices.

Give an example of​ how, under absorption​ costing, operating income could fall even though the unit sales level rises. A. Under absorption​ costing, operating income could never fall if the unit sales level rises. B. Under absorption​ costing, large purchases of inventory during the accounting period might combine with increased production and a small production volume variance. This combination could result in lower operating income even if the unit sales level rises. C. Under absorption​ costing, heavy reductions of inventory during the accounting period might combine with low production and a large production volume variance. This combination could result in lower operating income even if the unit sales level rises. D. Under absorption​ costing, the build up of older inventories combined with low production can result in lower operating income regardless of the unit sales level rising.

C. Under absorption​ costing, heavy reductions of inventory during the accounting period might combine with low production and a large production volume variance. This combination could result in lower operating income even if the unit sales level rises.

In comparing the absorption and variable cost​ methods, each of the following statements is true​ except: A. Only the absorption method may be used for external financial reporting. B. Variable costing charges fixed overhead costs to the period they are incurred. C. When inventory increases over the​ period, variable net income will exceed absorption net income. D. Selling, general, and administrative​ (SG&A) fixed expenses are not included in inventory in either method.

C. When inventory increases over the​ period, variable net income will exceed absorption net income.

Differences in operating income between variable costing and absorption costing are due solely to accounting for fixed costs. Do you​ agree? A. Yes, that is the only difference. B. No, differences in operating income between variable costing and absorption costing are due to accounting for variable manufacturing costs. C. ​No, differences in operating income between variable costing and absorption costing are due to accounting for fixed manufacturing costs. D. No, there is no difference in operating income between variable costing and absorption costing.

C. ​No, differences in operating income between variable costing and absorption costing are due to accounting for fixed manufacturing costs.

What are two ways of reducing the negative aspects associated with using absorption costing to evaluate the performance of a plant​ manager? A. 1. Adopt either variable or throughput​ costing, both of which reduce the incentives of managers to produce for inventory. 2. Focus the bonus plan for management based on absorption costing operating income. B. 1. Focus on careful budgeting and inventory planning to reduce​ management's freedom to build up excess inventory. 2. Increase incentives for managers who increase operating income over a specific period of time. C. 1. Reduce the time period used to evaluate performance. By evaluating performance over a shorter time​ period, the incentive to maximize quarterly or annual income at the potential expense of​ long-run income in lessened. 2. Adopt an inventory holding charge for managers who tie up funds in inventory. D. 1. Include nonfinancial as well as financial variables in the measures used to evaluate performance. 2. Extend the time period used to evaluate performance. By evaluating performance over a longer time period​ (say, 3 to 5​ years), the incentive to take​ short-run actions that reduce​ long-term income is lessened.

D. 1. Include nonfinancial as well as financial variables in the measures used to evaluate performance. 2. Extend the time period used to evaluate performance. By evaluating performance over a longer time period​ (say, 3 to 5​ years), the incentive to take​ short-run actions that reduce​ long-term income is lessened.

Why is the term direct costing a​ misnomer? A. Variable​ (direct) costing does not include all direct costs as inventoriable costs. Only variable direct manufacturing costs are included. Any fixed direct manufacturing​ costs, and any direct nonmanufacturing costs​ (either variable or​ fixed), are excluded from inventoriable costs. B. Variable​ (direct) costing includes as inventoriable costs not only direct manufacturing costs but also some indirect costs​ (variable indirect manufacturing​ costs). C. Variable​ (direct) costing considers both variable manufacturing and variable nonmanufacturing costs as period​ costs, which are expensed. D. Both a and b are correct.

D. Both a and b are correct. Variable​ (direct) costing does not include all direct costs as inventoriable costs. Only variable direct manufacturing costs are included. Any fixed direct manufacturing​ costs, and any direct nonmanufacturing costs​ (either variable or​ fixed), are excluded from inventoriable costs. Variable​ (direct) costing includes as inventoriable costs not only direct manufacturing costs but also some indirect costs​ (variable indirect manufacturing​ costs).

True or False: Absorption costing is also referred to as super-variable costing

False

True or False: Under variable costing, lease charges paid on the factory bldg. is an inventoriable cost.

False

True or False: The contribution-margin format of the income statement is used with absorption costing

False -- contribution-margin format is used with variable costing

True or False: The only real challenge in planning and controlling capacity costs is with the denominator as the numerator of a budgeted fixed manufacturing cost allocation rate is rarely the issue.

False; unexpected costs is usually where issues arise

Why is theoretical capacity rarely used to calculate budgeted fixed manufacturing cost per unit?

It is significantly different from the "real" capacity (practical capacity is used instead)

Represents the expected level of capacity utilization for the next budget period

Master-budget capacity utilization

Should be used for performance evaluation in the current year

Master-budget capacity utilization

Is variable costing acceptable under GAAP?

No; however, many believe that variable costing is necessary for external reporting purposes because fixed costs are more related to the capacity to produce rather than the actual production of specific units.

Takes into account seasonal, cyclical, and trend factors

Normal capacity utilization

Hides the cost of capacity acquired but not used

Normal capacity utilization and Master-budget capacity utilization

Measures the denominator level in terms of demand for the output of the plant

Normal capacity utilization and Master-budget capacity utilization

Should be used for long-term pricing purposes

Practical capacity

Is based on producing at full efficiency all the time

Theoretical capacity

Represents an ideal benchmark

Theoretical capacity

If used as the denominator-level concept, would avoid the restatement of unit costs when expected demand levels change

Theoretical capacity and Practical capacity

Measures the denominator level in terms of what a plant can supply

Theoretical capacity and Practical capacity

Highlights the cost of capacity acquired but not used

Theoretical capacity or Practical capacity

True or False: Absorption costing is the required inventory method for external financial reporting in most countries

True

True or False: Engineering and HR factors are both important when estimating theoretical or practical capacity

True

True or False: Practical capacity rather than master-budget volume is a better way to price product and avoid downward demand spiral

True

Throughput/Super-variable costing

When managers take the view that only direct materials are truly variable and are the only costs that should be inventoried. All other costs are labeled as period costs

absorption costing

a method of inventory costing in which all variable manufacturing costs and all fixed manufacturing costs are included as inventoriable costs (measures costs based on character)

________ costing is the required inventory method for external reporting in the US and most other countries

absorption

Variable, absorption and throughput costing may be combined with...

actual, normal or standard costing

variable costing

aka direct costing; is a method of inventory costing in which all variable manufacturing costs are included in the inventoriable costs (measures costs based on behavior)

Those supporting absorption costing maintain that inventories should contain fixed cost components because...

both fixed and variable manufacturing costs are necessary to produce goods

The capacity level chosen will affect the...

budgeted fixed overhead cost rate

Normal capacity and master-budget utilization measure capacity in terms of...

demand

What is the most strategic and difficult decisions managers face?

determining the appropriate level of capacity

If capacity isn't attained in the manufacturing process, there may be...

excess capacity later in the value chain (such as with distribution)

As the company _______ prices to cover fixed costs, demand ______ due to the higher price, resulting in another price ________ to cover still higher per-unit costs

increases; drops; increase

Throughput margin formula

revenues - direct material COGS

What is the key issue in absorption costing?

the capacity level used to compute fixed costs per unit produced

Downward demand spiral

the continuing reduction in demand that occurs when competitor prices are not met

Normal capacity

the level capacity utilization that satisfies average customer demand over a period of time

Theoretical capacity

the level of capacity based on producing at full efficiency all the time (achieved for a short period but not sustainable)

Master-budget capacity

the level of capacity that managers expect for the current time period, typically one year

Practical capacity

the level of capacity that reduces theoretical capacity by considering unavoidable operating interruptions

What is the main difference b/t variable and absorption costing?

the treatment of fixed manufacturing costs

Theoretical and practical capacity measure capacity in terms of...

what a plant can supply