CHAPTER 10

Exercises

Exercise 1

Requirement 1

a. The unit product cost under absorption costing would be:

Direct materials ....................................................................... P18

Direct labor.............................................................................. 7

Variable manufacturing overhead ........................................... 2

Total variable manufacturing costs .......................................... 27

Fixed manufacturing overhead (P160,000 ÷ 20,000 units) ....... 8

Unit product cost ..................................................................... P35

b. The absorption costing income statement:

Sales (16,000 units × P50 per unit) ....................... P800,000

Less cost of goods sold:

Beginning inventory ........................................ P 0
Add cost of goods manufactured
(20,000 units × P35 per unit) ......................... 700,000
Goods available for sale ................................... 700,000

Less ending inventory

(4,000 units × P35 per unit)........................... 140,000 560,000

Gross margin ....................................................... 240,000

Less selling and administrative expenses............. 190,000 *

Net operating income.......................................... P 50,000

*(16,000 units × P5 per unit) + P110,000 = P190,000.

Requirement 2

a. The unit product cost under variable costing would be:

Direct materials ............................................................................ P18

Direct labor................................................................................... 7
Variable manufacturing overhead ................................................ 2

Unit product cost .......................................................................... P27

b. The variable costing income statement:

Sales (16,000 units × P50 per unit) ..................... P800,000

Less variable expenses:

Variable cost of goods sold:

Beginning inventory ................................... P 0

Add variable manufacturing costs
(20,000 units × P27 per unit) ................... 540,000
Goods available for sale ............................. 540,000

Less ending inventory

(4,000 units × P27 per unit) ..................... 108,000
Variable cost of goods sold ............................ 432,000 *
Variable selling expense
(16,000 units × P5 per unit)......................... 80,000 512,000

Contribution margin .......................................... 288,000

Less fixed expenses:

Fixed manufacturing overhead ...................... 160,000

Fixed selling and administrative ..................... 110,000 270,000

Net operating income........................................ P 18,000

* The variable cost of goods sold could be computed more simply as: 16,000 units × P27 per
unit = P432,000.
Exercise 2

Requirement 1

Sales (40,000 units × P33.75 per unit).................................... P1,350,000

Less variable expenses:

Variable cost of goods sold

(40,000 units × P16 per unit*) ....................................... P640,000

Variable selling and administrative expenses

(40,000 units × P3 per unit) ........................................... 120,000 760,000

Contribution margin ............................................................. 590,000

Less fixed expenses:

Fixed manufacturing overhead ......................................... 250,000

Fixed selling and administrative expenses ........................ 300,000 550,000

Net operating income .......................................................... P 40,000

* Direct materials......................................................... P10

Direct labor ............................................................... 4

Variable manufacturing overhead ............................. 2

Total variable manufacturing cost ............................. P16

Requirement 2

The difference in net operating income can be explained by the P50,000 in fixed manufacturing
overhead deferred in inventory under the absorption costing method:

Variable costing net operating income ...................................... P40,000

Add: Fixed manufacturing overhead

cost deferred in inventory under
absorption costing: 10,000 units × P5
per unit in fixed manufacturing
overhead cost......................................................................... 50,000
Absorption costing net operating
income ...................................................................................... P90,000

Exercise 3

Requirement 1

Under variable costing, only the variable manufacturing costs are included in product costs.

Direct materials ........................................................................ P 600

Direct labor............................................................................... 300

Variable manufacturing overhead ............................................ 100

Unit product cost ...................................................................... P1,000

Note that selling and administrative expenses are not treated as product costs; that is, they are not
included in the costs that are inventoried. These expenses are always treated as period costs and are
charged against the current period’s revenue.

Requirement 2

The variable costing income statement appears below:

Sales..................................................................... P18,000,000
Less variable expenses:

Variable cost of goods sold:

Beginning inventory .................................... P 0

Add variable manufacturing costs
(10,000 units × P1,000 per unit) ................ 10,000,000
Goods available for sale .............................. 10,000,000

Less ending inventory (1,000 units × P1,000

per unit) ................................................ 1,000,000
Variable cost of goods sold* ............................. 9,000,000

Variable selling and administrative (9,000 units

× P200 per unit)................................................ 1,800,000 10,800,000
Contribution margin ............................................. 7,200,000

Less fixed expenses:

Fixed manufacturing overhead ............................. 3,000,000

Fixed selling and administrative ........................... 4,500,000 7,500,000

Net operating loss ................................................ P (300,000)

* The variable cost of goods sold could be computed more simply as: 9,000 units sold × P1,000 per unit =
P9,000,000.

Requirement 3

The break-even point in units sold can be computed using the contribution margin per unit as follows:
Selling price per unit ........................................................................ P2,000

Variable cost per unit ....................................................................... 1,200

Contribution margin per unit ........................................................... P 800

Fixed expenses
Break-even unit sales =
Unit contribution margin
P7,500,000
=
P800 per unit
= 9,375 units

Exercise 4

Requirement 1

Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs.

Direct materials .............................................................. P 600

Direct labor..................................................................... 300

Variable manufacturing overhead .................................. 100

Fixed manufacturing overhead (P3,000,000 ÷ 10,000
units) .......................................................................... 300

Unit product cost ............................................................ P1,300

Requirement 2

The absorption costing income statement appears below:

Sales (9,000 units × P2,000 per unit) .................................. P18,000,000

Cost of goods sold:

Beginning inventory ...................................................... P 0

Add cost of goods manufactured (10,000 units × P1,300 per

unit) ........................................................................... 13,000,000

Goods available for sale ................................................. 13,000,000

Less ending inventory (1,000 units × P1,300 per unit) ..... 1,300,000 11,700,000

Gross margin ..................................................................... 6,300,000

Selling and administrative expenses:

Variable selling and administrative (9,000 units × P200 per

unit) ........................................................................... 1,800,000

Fixed selling and administrative ..................................... 4,500,000 6,300,000

Net operating income........................................................ P 0

Note: The company apparently has exactly zero net operating income even though its sales are below
the break-even point computed in Exercise 3. This occurs because P300,000 of fixed manufacturing
overhead has been deferred in inventory and does not appear on the income statement prepared
using absorption costing.

Exercise 5

Requirement 1

2,000 units × P60 per unit fixed manufacturing overhead = P120,000

Requirement 2

The variable costing income statement appears below:

Sales ........................................................................... P4,000,000

 Variable expenses:

Variable cost of goods sold:

Beginning inventory ............................................ P 0

Add variable manufacturing costs (10,000 units × P310 per
unit) ................................................................. 3,100,000

Goods available for sale ....................................... 3,100,000

Less ending inventory (2,000 units × P310 per unit) 620,000

Variable cost of goods sold* .................................... 2,480,000

Variable selling and administrative (8,000 units × P20 per unit)

............................................................................ 160,000 2,640,000

Contribution margin .................................................... 1,360,000

Fixed expenses:
Fixed manufacturing overhead ................................ 600,000

Fixed selling and administrative .............................. 400,000 1,000,000

Net operating income ................................................. P 360,000

* The variable cost of goods sold could be computed more simply as: 8,000 units sold × P310 per
unit = P2,480,000.

The difference in net operating income between variable and absorption costing can be explained by
the deferral of fixed manufacturing overhead cost in inventory that has taken place under the
absorption costing approach. Note from part (1) that P120,000 of fixed manufacturing overhead cost
has been deferred in inventory to the next period. Thus, net operating income under the absorption
costing approach is P120,000 higher than it is under variable costing.
Problem 1

Requirement 1: Variable Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing

For the Year Ended December 31, 20X3

Sales P20,700,000

Less: Variable Cost of Sales

Inventory, Jan. 1 P1,155,000

Current Production 7,700,000

Total Available for Sale P8,855,000

Inventory, Dec. 31 805,000 8,050,000

Contribution Margin P12,650,000

Less Fixed Costs and Expenses 6,000,000

Net Income P 6,650,000

Requirement 2: Absorption Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing

For the Year Ending December 31, 20X4

Sales P26,100,000

Less Cost of goods sold:

Inventory, Jan. 1 P 1,380,000

Current Production 16,100,000

Total Available for Sale P17,480,000

 Inventory, Dec. 31 747,500

Cost of Sales - Standard P16,732,500

Favorable Capacity Variance 900,000 15,832,500

Income from Manufacturing P10,267,500

Requirement 3: Variable Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing

For the Year Ending December 31, 20X4

Sales P26,100,000

Less Variable Cost of Sales:

Inventory, Jan. 1 P 805,000

Production 9,800,000

Total Available for Sale P10,605,000

Inventory, Dec. 31 455,000 10,150,000

Contribution Margin - Manufacturing P15,950,000

Less Fixed Cost 5,400,000

Income from Manufacturing P10,550,000

Reconciliation

Net Income, absorption costing P10,267,500

Add Fixed Factory Overhead Inventory, 1/1 575,000

Total P10,842,500

Less Fixed Factory Overhead Inventory, 12/31 292,500

 Net Income, direct costing P10,550,000

Problem 2

Requirement 1

Honey Company

Income Statement - Direct Costing

For the Year Ended December 31, 20X3

Sales P280,000

Less Variable Cost of Sales:

Finished Goods Inventory, 1/1 P 4,000

Current Production 120,000

Total Available for Sale P124,000

Finished Goods Inventory, 12/31 12,000

Variable Cost of Sale - Standard P112,000

Unfavorable Variance 5,000 117,000

Contribution Margin - Manufacturing P163,000

Less Variable Marketing Expenses 28,000

Contribution Margin - Final P135,000

Less Fixed Costs and Expenses:

Fixed Factory Overhead P 54,000

Fixed Marketing and

Administrative Expenses 20,000 74,000

Net Income P 61,000

Requirement 2

Honey Company

Income Statement - Absorption Costing

 For the Year Ended December 31, 20X3

Sales P280,000

Less: Cost of Sales

Finished goods inventory, Jan. 1 (1,000 x P5.50) P 5,500

Current production costs

Variable (30,000 x P4.00) P120,000

Fixed (30,000 x P1.50) 45,000 165,000

P170,500

Less: Finished goods inventory, Dec. 31

(3,000 x P5.50) 16,500

Cost of Sales - at Standard P154,000

Add (Deduct) Variance

Unfavorable variable manufacturing

costs variances 5,000

Underapplied fixed factory overhead

(6,000 x P1.50) 9,000

Cost of Sales - Actual P168,000

Gross Profit P112,000

Less: Selling and administrative expenses

Variable 28,000

Fixed 20,000

P 48,000

Net Income P 64,000

Problem 3

Requirement 1

The unit product cost under the variable costing approach would be computed as follows:
Direct materials ................................................................. P 8
 Direct labor ....................................................................... 10

Variable manufacturing overhead ..................................... 2

Unit product cost............................................................... P20

With this figure, the variable costing income statements can be prepared:

Year 1 Year 2

Sales.................................................................... P1,000,000 P1,500,000

Less variable expenses:

Variable cost of goods sold @ P20 per unit...... 400,000 600,000

Variable selling and administrative @ P3 per
unit 60,000 90,000

Total variable expenses ....................................... 460,000 690,000

Contribution margin ............................................ 540,000 810,000

Less fixed expenses:

Fixed manufacturing overhead ........................ 350,000 350,000

Fixed selling and administrative....................... 250,000 250,000

Total fixed expenses ............................................ 600,000 600,000

Net operating income (loss) ................................ P (60,000) P 210,000

Requirement 2

Variable costing net operating income (loss) ...... P (60,000) P 210,000

Add: Fixed manufacturing overhead cost
deferred in inventory under absorption
costing (5,000 units × P14 per unit) ................ 70,000

Deduct: Fixed manufacturing overhead cost

released from inventory under absorption
costing (5,000 units × P14 per unit) ................ (70,000)
Absorption costing net operating income .......... P 10,000 P 140,000
Problem 4

Requirement 1

Year 1 Year 2 Year 3

P1,000,00
Sales.............................................................. 0 P 800,000 P1,000,000

Less variable expenses:

Variable cost of goods sold @ P4 per unit .. 200,000 160,000 200,000

Variable selling and administrative @ P2 per

unit ........................................................... 100,000 80,000 100,000

Total variable expenses.................................. 300,000 240,000 300,000

Contribution margin ...................................... 700,000 560,000 700,000

Less fixed expenses:

Fixed manufacturing overhead ............... 600,000 600,000 600,000

Fixed selling and administrative .............. 70,000 70,000 70,000

Total fixed expenses ...................................... 670,000 670,000 670,000

Net operating income (loss) ........................... P 30,000 P(110,000) P 30,000

Requirement 2
a.
Year 1 Year 2 Year 3

Variable manufacturing cost .............. P 4 P 4 P 4

Fixed manufacturing cost:

P600,000 ÷ 50,000 units ................. 12

P600,000 ÷ 60,000 units ................. 10

P600,000 ÷ 40,000 units ................. 15

Unit product cost ............................... P16 P14 P19

b.

Variable costing net operating income

(loss) .................................................. P30,000 P(110,000) P 30,000

Add (Deduct): Fixed manufacturing 200,000 (200,000)

overhead cost deferred in inventory
 from Year 2 to Year 3 under absorption
costing (20,000 units × P10 per unit) .....

Add: Fixed manufacturing overhead cost

deferred in inventory from Year 3 to the
future under absorption costing
(10,000 units × P15 per unit) ................. 150,000

Absorption costing net operating income

(loss) .................................................. P30,000 P 90,000 P(20,000)

Requirement 3

Production went up sharply in Year 2 thereby reducing the unit product cost, as shown in (2a). This
reduction in cost, combined with the large amount of fixed manufacturing overhead cost deferred in
inventory for the year, more than offset the loss of revenue. The net result is that the company’s net
operating income rose even though sales were down.

Requirement 4

The fixed manufacturing overhead cost deferred in inventory from Year 2 was charged against Year 3
operations, as shown in the reconciliation in (2b). This added charge against Year 3 operations was
offset somewhat by the fact that part of Year 3’s fixed manufacturing overhead costs was deferred in
inventory to future years [again see (2b)]. Overall, the added costs charged against Year 3 were
greater than the costs deferred to future years, so the company reported less income for the year
even though the same number of units was sold as in Year 1.

Requirement 5

a. Several things would have been different if the company had been using JIT inventory methods.
First, in each year production would have been geared to sales so that little or no inventory of
finished goods would have been built up in either Year 2 or Year 3. Second, unit product costs
probably would have been the same in all three years, since these costs would have been
established on the basis of expected sales (50,000 units) for each year. Third, since only 40,000
units were sold in Year 2, the company would have produced only that number of units and
therefore would have had some underapplied overhead cost for the year. (See the discussion on
underapplied overhead in the following paragraph.)

b. If JIT had been in use, the net operating income under absorption costing would have been the
same as under variable costing in all three years. The reason is that with production geared to
sales, there would have been no ending inventory on hand, and therefore there would have been
no fixed manufacturing overhead costs deferred in inventory to other years. Assuming that the
 company expected to sell 50,000 units in each year and that unit product costs were set on the
basis of that level of expected activity, the income statements under absorption costing would
have appeared as follows:
Year 1 Year 2 Year 3

Sales
P1,000,000 P 800,000 P1,000,000

Less cost of goods sold:

Cost of goods manufactured @ P16 per unit ... 800,000 640,000 * 800,000

Add underapplied overhead ............................ 120,000 **

Cost of goods sold ........................................... 800,000 760,000 800,000

Gross margin ................................................... 200,000 40,000 200,000

Selling and administrative expenses ................ 170,000 150,000 170,000

Net operating income (loss) ............................ P 30,000 P(110,000) P 30,000

* 40,000 units × P16 per unit = P640,000.

** 10,000 units not produced × P12 per unit fixed manufacturing overhead cost = P120,000 fixed
manufacturing overhead cost not applied to products.

Problem 5

Requirement 1 (a)

Under absorption costing, all manufacturing costs, variable and fixed, are included in unit product
costs:

Year 1 Year 2

Direct materials P11 P11

Direct labor 6 6

Variable manufacturing overhead 3 3

Fixed manufacturing overhead

(P120,000  10,000 units) 12

(P120,000  6,000 units) 20

 Unit product cost P32 P40

Requirement 1 (b)

The absorption costing income statements follow:

Year 1 Year 2

Sales (8,000 units x P50 per unit) P400,000 P400,000

Cost of goods sold:

Beginning inventory P 0 P 64,000

Add cost of goods manufactured (10,000

units x P32 per unit; 6,000 units x P40 per
unit) 320,000 240,000

Goods available for sale 320,000 304,000

Less ending inventory

(2,000 units x P32 per unit; 0 units x P40 per

unit) 64,000 256,000 0 304,000

Gross margin 144,000 96,000

Selling and administrative expenses (8,000

units x P4 per unit + P70,000) 102,000 102,000

Net operating income P 42,000 P (6,000)

Requirement 2 (a)

Under variable costing, only the variable manufacturing costs are included in unit product costs:

Year 1 Year 2

Direct materials P11 P11

Direct labor 6 6
 Variable manufacturing overhead 3 3

Unit product cost P20 P20

Requirement 2 (b)

The variable costing income statements follow. Notice that the variable cost of goods sold is
computed in a simpler, more direct manner than in the examples provided earlier. On a variable
costing income statement, this simple approach or the more complex approach illustrated earlier is
acceptable for computing the cost of goods sold.

Year 1 Year 2

Sales (8,000 units x P50 per unit) P400,00

P400,000 0

Variable expenses:

Variable cost of goods sold (8,000 units x P20 per unit) P160,00 P160,00
0 0

Variable selling and administrative (8,000 units x P4 per

unit) 32,000 192,000 32,000 192,000

Contribution margin 208,000 208,000

Fixed expenses:

Fixed manufacturing overhead 120,000 120,000

Fixed selling and administrative expenses

70,000 190,000 70,000 190,000

Net operating income P

P 18,000 18,000

Requirement 3

The reconciliation of the variable and absorption costing net operating incomes follows:
Year 1 Year 2

Variable costing net operating income P18,000 P18,000

 Add fixed manufacturing overhead costs deferred in
inventory under absorption costing (2,000 units x P12 per
unit) 24,000

Deduct fixed manufacturing overhead costs released from

inventory under absorption costing (2,000 units x P12 per
unit) (24,000)

Absorption costing net operating income P42,000 P(6,000)

Problem 6

Requirement 1

Sales (40,000 units × P33.75 per unit).......................................... P1,350,000

Variable expenses:
Variable cost of goods sold (40,000 units × P16 per unit*) ...... P640,000

Variable selling and administrative expenses (40,000 units × P3 per

unit) .................................................................................... 120,000 760,000

Contribution margin ................................................................... 590,000

Fixed expenses:
Fixed manufacturing overhead ............................................... 250,000

Fixed selling and administrative expenses .............................. 300,000 550,000

Net operating income ................................................................ P 40,000

* Direct materials...................................................... P10

Direct labor ............................................................ 4

Variable manufacturing overhead .......................... 2

Total variable manufacturing cost .......................... P16

Requirement 2

The difference in net operating income can be explained by the P50,000 in fixed manufacturing
 overhead deferred in inventory under the absorption costing method:

Variable costing net operating income ............................................................. P40,000

Add: Fixed manufacturing overhead cost deferred in inventory under

absorption costing: 10,000 units × P5 per unit in fixed manufacturing
overhead cost ............................................................................................... 50,000
Absorption costing net operating income ........................................................ P90,000

Answer to Multiple Choice Questions

1. D 11. B

2. B 12. A

3. B 13. C

4. B 14. D

5. B 15. B

6. C 16. A

7. A 17. C

8. B 18. C

9. A 19. B

10. A 20. C