MODULE 7

C.VARIABLE COSTING AND SEGMENTED REPORTING

THEORIES:

1. A basic tenet of direct costing is that period costs should be currently expensed.
What is the rationale behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific
product.
b. Period costs are generally immaterial in amount and the cost of assigning the
amounts to specific products would outweigh the benefits.
c. Allocation of period costs is arbitrary at best and could lead to erroneous
decisions by management.
d. Because period costs will occur whether or not production occurs, it is
improper to allocate these costs to production and defer a current costs of
doing business.

2. Which of the following must be known about production process in order to institute
a direct costing system?
a. The variable and fixed components of all costs related to production.
b. The controllable and non controllable components of all costs related to
production
c. Standard production rates and times for all elements of production.
d. Contribution margin and breakeven point for all goods in production.

3. Under the direct costing concept, unit product cost would most likely be increased by
a. A decrease in the remaining useful life of factory machinery depreciated on the
units-of-production method.
b. A decrease in the number of units produced.
c. An increase in the remaining useful life of factory machinery depreciated on
the sum-of-the-years'-digits method.
d. An increase in the commission paid to salesmen for each unit sold.

4. Which of the following statements is true for a firm that uses variable (direct)
costing?
a. The cost of a unit of product changes because in the number of units
manufactured.
b. Profits fluctuate with sales
c. An idle facility variation is calculated
d. Product costs include "direct" (variable) administrative costs.

5. Which of the following is an argument against the use of direct (variable) costing?
a. Absorption costing overstates the balance sheet value of inventories.
b. Variable factory overhead is a period cost.
c. Fixed factory overhead is difficult to allocate properly.
d. Fixed factory overhead is necessary for the production of a product.

6. What is the primary difference between variable and absorption costing?

a. inclusion of fixed selling expenses in product costs
b. inclusion of variable factory overhead in period costs
c. inclusion of variable selling expenses in product costs
d. inclusion of fixed factory overhead in product costs
7. Which of the following statements is true?
a. Absorption costing net income exceeds variable costing net income when units
produced and sold are equal.
b. Variable costing net income exceeds variable absorption costing net income
when units produced exceeds units sold.
c. Variable costing net income exceeds absorption costing net income when units
produced equal units sold.
d. Absorption costing net income exceeds variable costing net income when units
produced are greater than units sold.

8. Absorption costing of inventories, as required by GAAP, has been criticized for

encouraging managers to increase year-end inventories in order to boost reported
profits. Which of the following techniques is the most effective at resolving this
problem?
a. Senior management control of inventory levels
b. Adoption of just-in-time (JIT) production system
c. Reward managers based upon the residual income approach
d. Use variable costing to determine income for bonus purposes

9. A Manufacturing company prepares income statements using both absorption and

variable costing methods. At the end of a period actual sales revenues, total gross
profit, and total contribution margin approximated budgeted figures, whereas net
income was substantially greater than the budgeted amount. There were no
beginning or ending inventories. There most likely explanation of the net income
increase is that, compared to budget, actual
a. Manufacturing fixed costs had increased.
b. Selling and administrative fixed expenses had decreased.
c. Sales prices and variable costs had increased proportionately.
d. Sales prices had declined proportionately less than variable costs.

10. Advocates of variable costing for internal reporting purposes do not rely on which of
the following points?
a. The matching concept
b. Price-volume relationships
c. Absorption costing does not include selling and administrative expenses as a
part of inventoriable cost
d. Production influences income under absorption costing

11. When absorption costing is used, all of the following costs are considered product
costs except
a. direct labor
b. variable overhead
c. variable selling and administrative costs
d. fixed overhead

12. Which of the following is not true of variable costing?

a. Profits may increase though sales decrease.
b. Profits fluctuate with sales.
c. The cost of the product consists of all variable production costs.
d. The income statement under variable costing does not include overhead
volume variance.

13. Which costing method is not acceptable to the SFAS external reporting?
a. absorption costing
b. variable costing
c. full costing
 d. all of these are acceptable

14. When variable costing is used, fixed manufacturing overhead is recognized as an

expense when
a. the cost is incurred
b. the product is completed
c. The product is sold
d. the product is inventoried

15. When variable costing is used, the income statement is usually prepared using
a. a contribution margin format
b. an operational format
c. a functional format
d. all of these

16. Variable costing can be used for

a. external reporting
b. internal reporting
c. either external reporting or internal reporting
d. neither external reporting or internal reporting

17. In a variable costing system, product cost includes

a. direct materials, direct labor, variable overhead
b. direct materials, direct labor, fixed overhead
c. direct labor, variable overhead, fixed overhead
d. direct materials, variable overhead, fixed overhead

18. Variable-costing income will usually exceed absorption costing income when
a. sales exceed production
b. production and sales are equal
c. production exceeds sales
d. none of these

19. Variable costing net income is

a. higher than absorption net income when more units are sold than produced
b. lower than absorption net income when more units are produced than sold
c. the same as absorption net income when all units produced are sold
d. all of the above

20. The level of production affects income under which of the following methods?
a. absorption costing
b. both absorption and variable costing
c. variable costing
d. neither absorption nor variable costing

21. Unabsorbed fixed overhead costs in an absorption costing system are

a. Fixed factory costs not allocated to units produced.
b. Variable overhead costs not allocated to units produced.
c. Excess variable overhead costs.
d. Costs that should be controlled.

22. Net earnings determined using full absorption costing can be reconciled to net
earnings determined using direct costing by computing the difference between
a. Inventoried fixed costs in the beginning and ending inventories and any
deferred over- or under applied fixed factory overhead.
 b. Inventoried discretionary costs in the beginning and ending inventories.
c. Gross margin (absorption costing method) and contribution margin (direct
costing method).
d. Sales as recorded under the direct costing method and sales as recorded under
the absorption costing method.

23. Net profit under absorption costing may differ from net profit determined under
direct costing. How is this difference calculated?
a. Change in the quantity of all units in inventory times the relevant fixed costs
per unit.
b. Change in the quantity of all units produced times the relevant fixed costs per
unit.
c. Change in the quantity of all units in inventory times the relevant variable cost
per unit.
d. Change in the quantity of all units produced times the relevant variable cost
per unit.

24. A segment is any part of an organization about which a manager seeks

a. cost data
b. revenue data
c. quantitative data
d. any of the above

25. The guideline(s) used in assigning costs to a segment include(s) whether

a. costs are fixed
b. costs are variable
c. costs are directly traceable
d. all of the above

26. Which of the following could be considered a segment?

a. division
b. sales territory
c. product line
d. all of these

27. Segment margin is equal to

a. sales less variable costs
b. sales less variable costs and direct fixed costs
c. sales less variable cots and indirect fixed costs
d. sales less cost of goods sold

28. Which of the following costs would continue to be incurred even if a segment is
eliminated?
a. direct fixed expenses
b. common fixed costs
c. variable cost of goods sold
d. variable selling and administrative expenses

29. Revenue less variable costs and direct fixed costs equals
a. contribution margin
b. segment margin
c. income before taxes
d. income after taxes

30. Indicate which of the following costs would be avoided if a segment is eliminated.
1. variable manufacturing costs
 2. direct fixed costs
3. common fixed costs
4. variable selling costs
5. direct fixed selling costs
common fixed selling costs
a. 2, 3, 5, 6
b. 1, 2, 4, 5
c. 2, 3, 4, 5
d. 1, 4, 5, 6

31. Which of the following is a good reason for allocating indirect costs to operating
departments?
a. The company could lose money if the operating departments do not pay for
the services they use.
b. To remind managers of the need to cover indirect costs.
c. To encourage managers to use more services.
d. To determine the true costs of operating departments.

32. The term "dual rates" refers to

a. allocating costs to several operating departments
b. allocating fixed costs based on capacity requirements and variable costs based
on use
c. allocating both actual costs and budgeted costs
d. using the budgeted rate to allocate some costs, the actual rate to allocate
others

33. The cost allocation policy most likely to encourage use if service is based on
a. budgeted total costs of the service department
b. actual total costs of the service department
c. budgeted variable costs for the service department
d. actual variable costs for the service department

34. The WORST method of allocating service costs is

a. to allocate total actual costs based on actual use of the service
b. to allocate total budgeted costs based on long-term expected use of the
service
c. to allocate total budgeted cost based on actual use of the service
d. none of the above, because all the above are equally undesirable

PROBLEMS:

1. During May, Roy Co. produced 10,000 units of Product X. Costs incurred by Roy
during May were as follows

Direct materials P10,000

Direct labor 20,000
Variable manufacturing overhead 5,000
Variable selling and general 3,000
Fixed manufacturing overhead 9,000
Fixed selling and general 4,000
Total P51,000
What are the unit costs under absorption and variable costing methods, respectively?
A. P5.10; P3.80
B. P3.80; P5.10
C. P4.40; P3.50
D. P3.50; P4.40
2. The following information pertains to Sharapova Corporation:

Beginning inventory 0 units

Ending inventory 5,000 units
Direct labor per unit P10
Direct materials per unit 8
Variable overhead per unit 2
Fixed overhead per unit 5
Variable selling costs per unit 6
Fixed selling costs per unit 8
What is the value of ending inventory using the variable costing method?
A. P155,000
B. P125,000
C. P100,000
D. P195,000

3. Consider the following :

Sales price, per unit P18, per unit

Standard absorption cost rate P12 per unit
Standard variable cost rate P8 per unit
Variable selling expense rate P2 per unit
Fixed selling and administrative expenses P40,000
Fixed manufacturing overhead P60,000

Last period, 13,000 units were produced. In the current period, 15,000 units were
produced. In each period, 13,000 units were sold. What is the difference in reported
income under absorption and variable costing for the current period?
A. The variable-costing income exceeded absorption-costing income by P4,000.
B. The absorption-costing income exceeded variable-costing income by P8,000.
C. The variable-costing income exceeded absorption-costing income by P6,000.
D. Net income will not be different between the two methods.

4. The Blue Company has failed to reach its planned activity level during its first two
years of operation. The following table shows the relationship between units
produced, sales, and normal activity for these years and the projected relationship
for Year 3. All prices and costs have remained the same for the last two years and
are expected to do so in Year 3. Income has been positive in both Year 1 and Year 2.

Units Planned
Produced Sales Activity
Year 1 90,000 90,000 100,000
Year 2 95,000 95,000 100,000
Year 3 90,000 90,000 100,000

Because Blue Company uses an absorption costing system, one would predict gross
margin for Year 3 to be
A. Greater than Year 1.
B. Greater than Year 2.
C. Equal to Year 1.
D. Equal to Year 2.

5. A company manufactures a single product for its customers by contracting in

advance of production. Therefore, the company only produces units that will be sold
by the end of each period. During the last period, the following sales were made and
costs incurred:
 Sales P40,000
Direct materials 9,050
Direct labor 6,000
Rent (9/ 10 factory, 1 / 10 office) 3,000
Depreciation on factory equipment 2,000
Supervision (2 / 3 factory, 1 / 3 office) 1,500
Salespeople's salaries 1,300
Insurance (2 / 3 factory, 1 / 3 office) 1,200
Office supplies 750
Advertising 700
Depreciation on office equipment 500
Interest on loan 300
Based on the above data, the gross margin percentage for the last period (rounded
to nearest percent) was
A. 41%
B. 44%
C. 46%
D. 49%

6. A company had income of P50,000 using costing for a given period. Beginning and
selling inventories for that period were 13,000 units and 18,000 units, respectively.
Ignoring income taxes, if the fixed overhead application rate were P2.00 per unit,
what would the income have been using absorption costing?
A. P40,000
B. P50,000
C. P60,000
D. Cannot be determined from the information given.

7. The following information was extracted from the first year of absorption-based
accounting records of Soulmate Co.

Total fixed costs incurred P100,000

Total variable costs incurred 50,000
Total period costs incurred 70,000
Total variable period costs incurred 30,000
Units produced 20,000
Units sold 12,000
Units sales Price P 12

Based on variable costing, if Soulmate Co. had sold 12,001 units instead of 12,000,
its income before taxes would have been
A. P 9.50 higher
B. P 8.50 higher
C. P11.00 higher
D. P 8.33 higher

8. At its present level of operations, a small manufacturing firm has total variable costs
equal to 75% of sales and total fixed costs equal to 15% of sales. Based on variable
costing, if sales change by P1.00, income will change by
A P 0.25
B P 0.12
C P 0.75
D P 0.10
9. Luna Company had income of P65,000 using absorption costing for a given period .
Beginning and ending inventories for that period were 13,000 units and 18,000
respectively.
Ignoring income taxes, if the fixed overhead application rate were P2.50 per unit,
what would the income have been using variable costing?
A P 77,500
B P 60,000
C P 52,500
D P 20,000

10. Questions 10 through 13 are based on the following annual flexible budget which
has been prepared for use in making decisions relating to Product X.
Budgeted units 100,000 150,000 200,000
Sales Volume P800,000 P1,200,000 P1,600,000
Manufacturing costs:
Variable P300,000 P 450,000 P 600,000
Fixed 200,000 200,000 200,000
P500,000 P 650,000 P 800,000
Selling expenses:
Variable P200,000 P 300,000 P 400,000
Fixed 160,000 160,000 160,000
P360,000 P 460,000 P 560,000
Income (or loss) (P60,000) P 90,000 P 240,000

The 200,000-unit budget has been adopted and will be used for allocating fixed
manufacturing costs to units of Product X. At the end of the first six months the
following information is available:
Units
Production completed 120,000
Sales 60,000
All fixed costs are budgeted and incurred uniformly throughout the year and all costs
incurred coincide with the budget.

Over- and under applied fixed manufacturing costs are deferred until year-end.
Annual sales have the following seasonal pattern:
Portion of Annual Sales
First quarter 10%
Second quarter 20%
Third quarter 30%
Fourth quarter 40%
100%

The amount of fixed factory costs applied to product during the first six months
under absorption costing would be
A. Overhead by P20,000.
B. Equal to the fixed costs incurred.
C. Under applied by P40,000.
D Under applied by P80,000.

11. Reported net income (or loss) for the first six months under absorption costing would
be
A. P160,000
B. P 40,000
C. P 80,000
D. P(40,000)
12. Reported net income (or loss) for the first six months under direct costing would be
A. P144,000
B. P0
C. P 72,000
D. P(36,000)

13. Assuming than 90,000 units of Product X were sold during the first six months and
that is to used as a basis, the revised budget estimate we for the total number of
units to be sold during this year would be
A. 360,000
B. 200,000
C. 240,000
D. 300,000

14. Zambales Mining Co. mines three products. Gold Ore sells for P1,000,000 per ton,
variable costs are P600,000 per ton, and fixed mining costs are P5,000,000. The
segment margin for 2005 was P(1,000,000). The management of Zambales Mining
was considering dropping the mining of Gold Ore. Only one-half of the fixed
expenses are direct and would be eliminated if the segment was dropped. If Gold
Ore were dropped, net income for Zambales Mining would
A. Increase by P1,000,000
B. Increase by P1,500,000
C. Decrease by P1,000,000
D. Decrease by P1,500,000

15. Aging Company plans to discontinue a segment with a P32,000 segment margin.
Common expenses allocated to the segment amounted to P45,000, of which P20,000
cannot be eliminated if the segment were closed. The effect of closing down the
segment on Aging Company's before tax profit would be
A. P12,000 decrease
B. P12,000 increase
C. P 7,000 decrease
D. P 7,000 increase

Use this data to respond to questions 16 through 17.

Omid Publishing Company has three divisions: A,B, and C. The revenues of these
divisions are P29,000, 48,000, and 63,000 respectively. Variable costs of these divisions
amount to 57%, 59%, and 64% of the given revenues. The divisions' short-term
controllable fixed costs are P4,200, 5,200, and 6,200 respectively. The divisions' long
term controllable fixed costs amount to P3,800,4,900, and 5,700 in the order given. The
company's uncontrollable costs amount to P7,150, and income tax is at 20% of operating
income.

16. Long -term controllable margin for division A amounts to

A. P4,470
B. P8,270
C. P12,470
D. P16,470

17. Short-term controllable margin for division B amounts to

A. P9,580
B. P14,480
C. P19,680
D. P23,580