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
