UNIVERSITY OF THE SOUTH

PACIFIC
AF201 MANAGERIAL
ACCOUNTING
SEMESTER 2, 2021
TUTORIAL 2
WEEK 5
SOLUTIONS

NAME: SHIRANI SIMRAN PRASAD

ID: S11186702
CHAPTER 7
A CLOSER LOOK AT OVERHEAD COSTS
REVIEW QUESTIONS
7.1 Both absorption and variable costing systems assign direct material, direct labor and variable
manufacturing overhead costs to products in exactly the same way, but they differ over their
treatment of fixed manufacturing overhead. Absorption costing includes fixed manufacturing
overhead as a part of product cost. Variable costing excludes fixed manufacturing overhead from
product cost and expenses it in the period in which it is incurred.
The key distinction between variable and absorption costing is the timing of fixed manufacturing
overhead becoming an expense. Eventually, fixed overhead is expensed under both product
costing systems. Under variable costing, fixed overhead is expensed immediately, when it is
incurred. Under absorption costing, fixed overhead is inventoried and not expensed until the
accounting period during which the manufactured goods are sold.
EXERCISES
7.31 1.

PORTER LTD
INCOME STATEMENT UNDER ABSORPTION COSTING
FOR THE YEAR ENDED 31ST DECEMBER
Sales Revenue (36,000 * $45) $1,620,000
Less: Cost of Goods Sold (36,000 * $35) $1,260,000
Gross Margin $360,000
Less: Selling and Administrative Expense
Variable $108,000
Fixed $30,000
$138,000
Net Profit $222,000

2.

PORTER LTD
CONTRIBUTION MARGIN STATEMENT UNDER VARIABLE COSTING
FOR THE YEAR ENDED 31ST DECEMBER
Sales Revenue (36,000 * $45) $1,620,000
Less: Variable Expense
Variable Manufacturing Cost $972,000
(36,000 * $27)
Variable Selling & Administrative Expense $108,000
$1,080,000
Contribution Margin $540,000
Less: Fixed Expenses
Fixed Manufacturing Overhead $300,000
Fixed Selling & Administrative Expense $30,000
$330,000
Net Profit $210,000

3. (a) The absorption costing profit is higher because 1500 units produced are carried
forward as finished goods inventory. Each unit carries forward a cost of $8 for
manufacturing overhead that is expensed under variable costing. Therefore using
the absorption costing method the costs in the income statement are $12 000 lower
than when using the contribution margin approach, where total fixed costs are
expensed as period costs.
(b) The short cut method is based on the change in closing inventory, which represents
costs incurred in the current period which will be released against future revenue.
Where production is greater than sales (as in this case) the higher value of closing
 inventory deducted from the cost of goods available for sale shows a lower cost of
goods sold— and, therefore, a higher gross profit. The calculation for this is shown
below:

Increase (decrease) in × Fixed Manufacturing = Difference in Profit

units in Inventory Cost per unit
1500 Units × $8 = $12,000 more under
absorption costing
PROBLEMS
7.42 Absorption versus Variable Costing: Manufacturer
1.

Cost per unit Variable Absorption

Direct material $6.00 $6.00

Direct labour 3.00 3.00

Variable overhead 4.00 4.00

Fixed overhead * 2.00

$13.00 $15.00

budgeted fixed overhead

* Fixed overhead =
budgeted level of production
$ 400 000
=
200 000
= $2 per unit

2.
(a) Net Profit under Absorption Costing

YoYum LTD
INCOME STATEMENT UNDER ABSORPTION COSTING
FOR THE YEAR ENDED 31ST DECEMBER
Sales Revenue (190,000 * $19) $3,610,000
Less: Cost of Goods Sold (190,000 * $15) $2,850,000
Gross Margin $760,000
Less: Selling and Administrative Expense
Variable (190,000 * $2) $380,000
Fixed $70,000
$450,000
Net Profit $310,000
(b) Net Profit under Variable Costing

YoYum LTD
CONTRIBUTION MARGIN STATEMENT UNDER VARIABLE COSTING
FOR THE YEAR ENDED 31ST DECEMBER
Sales Revenue (190,000 * $19) $3,610,000
Less: Variable Expense
Variable Manufacturing Cost $2,470,000
(190,000 * $13)
Variable Selling & Administrative Expense $380,000
(190,000 * $2)
$2,850,000
Contribution Margin $760,000
Less: Fixed Expenses
Fixed Manufacturing Overhead $400,000
Fixed Selling & Administrative Expense $70,000
$470,000
Net Profit $290,000

3.

Cost of Goods Sold under Absorption Costing $2,850,000

Variable Cost of Goods Sold $2,470,000
Difference in Cost of Goods Sold $380,000
Fixed Manufacturing Overhead Under Variable Costing (Period Exp) $400,000
Total Difference between the two methods $(20,000)
Net Profit under Variable Costing $290,000
Net Profit under Absorption Costing $310,000
Difference in Net Profit $(20,000)

4. The short cut method is based on the change in closing inventory, which represents costs
incurred in the current period which will be released against future revenue. Where
production is greater than sales (as in this case) the higher value of closing inventory
deducted from the cost of goods available for sale shows a lower cost of goods sold— and,
therefore, a higher gross profit. The calculation for this is shown below:

Increase (decrease) in × Fixed Manufacturing = Difference in Profit

units in Inventory Cost per unit
10,000 Units × $2 = $20,000 more under
absorption costing
5.
Units sold 190 000
Sales price $ 20.00
Direct material $ 6.50
Direct labour $ 3.00
Variable overhead $ 4.00
Fixed overhead $ 2.00

(a) Absorption costing

Units Cost Total
Sales revenue 190 000 $ 20.00 $ 3 800 000.00
Less: Cost of goods sold 190 000 $ 15.50 $ 2 945 000.00
Gross margin $ 855 000.00
Less: Selling and admin. exp. 190 000 $ 2.00 $ 380 000.00
Fixed expense $ 70 000.00
Net profit $ 405 000.00

(b) Variable costing

Units Cost Total
Sales revenue 190 000 $ 20.00 $ 3 800 000.00
Less: Variable expense 190 000 $ 13.50 $ 2 565 000.00
Variable selling and admin. exp. 190 000 $ 2.00 $ 380 000.00
Contribution margin $ 855 000.00
Less: Manufacturing overhead $ 400 000.00
Fixed expense $ 70 000.00
Net profit $ 385 000.00
CASES
7.46 Absorption and Variable Costing: Manufacturer
1. Absorption Costing Income Statement

Year 1 Year 2
Sales revenue $125 000 a
$125 000 d

Less: Cost of goods sold:

Beginning finished goods inventory $ 0 $ 10 500 e

Cost of goods manufactured 63 000 b

56 000 f

Cost of goods available for sale $ 63 000 $ 66 500

Ending finished goods inventory 10 500 c
0
Cost of goods sold $ 52 500 $ 66 500
Gross margin $ 72 500 $ 58 500
Selling and administrative expenses 45 000 45 000
Operating profit $ 27 500 $ 13 500
a
2500 units  $50 per unit
b
$21 000 + $42 000 (i.e. both variable and fixed costs)
c
500 units  ($63 000/3 000 units)
d
2500 units  $50 per unit
e
Same as Year 1 ending inventory
f
$14 000 + $42 000 (i.e. both variable and fixed costs)
2. Variable Costing Income Statement

Year 1 Year 2
Sales revenue $125 000 a
$125 000 d

Less: Cost of goods sold:

Beginning finished goods inventory $ 0 $ 3 500 e

Cost of goods manufactured 21 000 b

14 000 f

Cost of goods available for sale $ 21 000 $ 17 500

Ending finished goods inventory 3 500 c
0
Cost of goods sold $ 17 500 $ 17 500
Variable selling and administrative costs $ 25 000 $ 25 000

Total variable costs: $ 42 500 $ 42 500

Contribution margin $ 82 500 $ 82 500
Less: Fixed costs:
Manufacturing $ 42 000 $ 42 000
Selling and administrative 20 000 20 000
Total fixed costs $ 62 000 $ 62 000
Operating profit $ 20 500 $ 20 500
a
2500 units  $50 per unit
b
The variable manufacturing cost only, $21 000
c
500 units  ($21 000/3 000 units)
d
2500 units  $50 per unit
e
Same as Year 1 ending inventory
f
The variable manufacturing cost only, $14 000
3. Reconciliation of reported income under absorption and variable costing:

Year 1 Absorption Costing Variable Costing

Income Statement Income Statement
Cost of goods sold $52 500 $17 500
†
Fixed cost (expensed as period expense) 20 000 * 62 000
Total $72 500 $79 500

Difference (cost greater on variable

costing income statement) $7000

Reported profit $27 500 $20 500

Difference in reported profit (profit

greater on absorption costing profit
statement) $7000
* Fixed selling and administrative cost only
†
Both fixed selling and administrative cost and fixed manufacturing overhead
Year 2 Absorption Costing Variable Costing
Income Statement Income Statement
Cost of goods sold $66 500 $17 500
Fixed cost (expensed as period expense) 20 000 62 000
Total $86 500 $79 500
Difference (cost greater on absorption
costing income statement) $7000

Reported profit $13 500 $20 500

Difference in reported profit (profit

greater on variable costing profit
statement) $7000

NOTE: As additional explanation instructors may wish to cover the following:

Year Change in Actual Difference in Absorption

Inventory Fixed Fixed Costing Profit
(in units) Overhead Overhead Minus Variable
Rate Expensed Costing Profit
1 500 increase  $14 $ 7000 $7000
2 500 decrease  $14* $(7000) (7000)
* The 500 units which were sold in year 2, but which were manufactured in year 1, include an absorption-
costing product cost of $14 per unit for fixed overhead. Since these 500 units were manufactured in year 1,
it is the year 1 fixed-overhead rate that is relevant to this calculation, not the year 2 rate.
Explanation: At the end of Year 1, under absorption costing, $7000 of fixed overhead
remained stored in finished goods inventory as a product cost (Year 1 fixed-overhead rate
of $14 per unit  500 units = $7000). However, in Year 1, under variable costing, that fixed
overhead was expensed as a period cost.
In Year 2, under absorption costing, that same $7000 of fixed overhead was expensed
when the units were sold. However, under variable costing, that $7000 of fixed overhead
cost had already been expensed in Year 1 as a period cost.

4. Total profit across both years:

(a) Absorption costing: $27 500 + $13 500 = $41 000
(b) Variable costing: $20 500 + $20 500 = $41 000
5. Total sales revenue across both years:
(a) Absorption costing: $125 000 + $125 000 = $250 000
(b) Variable costing: $125 000 + $125 000 = $250 000
Total of all costs expensed across both years:
(a) Absorption costing: $97 500 + $111 500 = $209 000
(b) Variable costing: $104 500 + $104 500 = $209 000
Total sales revenue minus total costs expensed across both years:
(a) Absorption costing: $250 000 – $209 000 = $41 000
(b) Variable costing: $250 000 – $209 000 = $41 000
6. The total sales revenue across both of Chalk Talk’s first two years of operation is the
same under absorption and variable costing, $250 000, as shown in requirement 5.
Sales revenue has nothing to do with the costing method used. Chalk Talk sold 5000
units in Years 1 and 2 combined, at a sales price of $50. This results in total sales
revenue for the two years of $250 000.
The total of the costs expensed across Years 1 and 2, is the same under both variable
and absorption costing, $209 000, as shown in requirement 5. The reason for this
result is that Chalk Talk produced the same number of units that the company sold,
across the two-year period. Chalk Talk produced and sold 5000 units during Years 1
and 2 combined. Thus, the same amount of manufacturing cost is expensed, during
the two-year period, under absorption and variable costing.
Chalk Talk’s combined profit across the two-year period is $41 000 under both
absorption and variable costing (requirement 4). This result must occur, of course,
because total sales revenue and total expenses are the same under both costing
methods over the two-year period.
As the analysis in requirement 3 shows, Chalk Talk’s profit is distributed differently
across Years 1 and 2 under absorption and variable costing. Both costing methods
yield the same reported profit across the two-year combined period, but the profit is
not the same within each year under the two costing methods. Absorption costing
yields a $7000 higher profit in Year 1 and a $7000 lower profit in Year 2. This result
occurs because under absorption costing, Chalk Talk’s expenses are $7000 lower in
Year 1 and $7000 greater in Year 2.
Thus, the timing with which expenses are recognised causes the difference between
absorption and variable costing. Under absorption costing, some of Chalk Talk’s Year
1 fixed manufacturing overhead is not expensed until Year 2, when the units are
sold. In contrast, under variable costing all of the Year 1 fixed manufacturing
overhead is expensed in Year 1 as a period cost.
CHAPTER 19
INFORMATION FOR DECISIONS: RELEVANT COSTS AND BENEFITS
REVIEW QUESTIONS
19.16 A by-product has little value in comparison with other joint products and its output is not
the purpose of the joint production process. It is not allocated any of the joint processing
costs. A common way of dealing with its revenue and any separable costs is to deduct the
net realisable value of the by-product from the joint processing costs before they are
allocated to the remaining joint products.
Examples of by-products (and rethinking about their worth) are found in the second ‘Real
life’ in ‘Relevant information for some common decisions’. In the Wallaby Airlines case in
the chapter, of a decision to provide a one-off charter flight, by-products could be the
sale of on-board items such as food or duty free products, or use of in-flight video hire
facilities. Other by-products could be more tailored flights in future.

EXERCISES
19.30 Joint Cost Allocation: Manufacturer
1 Physical units method:

Joint cost Joint products Quantity at Relative Allocation of

split-off point proportion joint cost

Yummies 12 000 kg 0.60 $108 000*

$180 000

Crummies 8 000 kg 0.40 72 000†

Total 20 000 kg $180 000

* $108 000 = $180 000  0.60
† $72 000 = $180 000  0.40
2 Relative sales value method:

Joint cost Joint Quantity Sales Sales value at Relative Allocation

products at split-off price split-off point proportion of joint cost

Yummies 12 000 kg $9.00 $108 000 0.5455* $98 190

$180 000

Crummies 8 000 kg 11.25 90 000 0.4545* 81 810

Total $198 000 $180 000

*Rounded
3 Constant gross margin method:

Joint Joint Gross Sales Required Separable Allocation

cost products margin revenue gross cost of of joint cost
percentage* margin processing

Yummies 9.09 $108 $9 817 – $98 172

000

$180
000

Crummies 9.09 90 000 8 181 81 810

Total $180 000**

* [($108 000 + $90 000) – $180 000]/($108 000 + $90 000) = 9.09% (rounded)
** rounding error of $1