1.
Consider the following information:
Q1
Q2
Q3
Beginning inventory (units)
0
H
100
Budgeted units to be produced
25,000
25,000
25,000
Actual units produced
24,500
25,400
O
Units sold
A
25,600
P
Variable manufacturing costs per unit produced
$10
$10
$10
Variable selling costs per unit sold
$4
$4
$4
Budgeted fixed manufacturing costs
$125,000
$125,000
$125,000
Fixed selling costs
$25,000
$25,000
$25,000
Selling price per unit
$25
$25
$25
Variable costing operating income
$116,200
I
$123,900
Absorption costing operating income
B
$130,600
Q
Variable costing beginning inventory ($)
C
$3,000
R
Absorption costing beginning inventory ($)
D
J
S
Variable costing ending inventory ($)
E
K
$3,000
Absorption costing ending inventory ($)
F
L
$4,500
PVV
G
M
T
Allocated fixed manufacturing costs
$122,500
N
$125,500
There are no price, efficiency, or spending variances, and any production-volume variance is directly written off to cost of goods in the quarter in which it occurs.
Complete the missing figures from the above Table.
A
H
O
B
I
P
C
J
Q
D
K
R
E
L
S
F
M
T
G
N
2. Consider each of these situations independently:
a) If a company reports a favorable PVV, what conclusion can we draw about that company?
b) If operating income under variable costing is higher than operating income under absorption costing, what conclusion can we draw about that company?
c) If inventory increases by $65,000 under absorption costing and $42,000 under variable costing for the same company in the same period, what conclusion can we draw about that company?
d) If a company increases production but not sales during a period under absorption costing, what is the impact on the company’s income statement?
3.
a) What is the goal of the EOQ model?
b) Why does a firm hold “safety stock?”
c) What costs are a firm trying to balance when it decides on how much safety stock to hold?
d) In the absence of safety stock, how does a firm determine its re-order point?
Question #1
A firm expects to sell 50,000 units of its product annually. It estimates that it costs $2,000 to place an order and that each unit costs $8.00 annually to carry in inventory. It takes 4 days to receive an order once it is placed. Assume that the store is open every day of the year.
a) How many units should the firm order at a time if it wants to minimize the sum of ordering and carrying costs?
EOQ = 5,000 units
b) How many orders will it place in a year?
10 orders (50,000 / 5,000)
c) How much will total ordering costs be for the year?
10 x $2,000 = $20,000 in ordering costs
d) What will its average inventory level (in units) be during the year?
Average inventory = EOQ / 2 = 2,500 units
e) How much will total carrying costs be for the year?
2,500 x $8 per unit = $20,000 in carrying costs
f) What is its reorder point?
Daily sales = 137 units (50,000 /365); reorder point = 548 units (137 x 4 days)
g) What would you expect to happen to the reorder point if uncertainty is taken into consideration?
The reorder point would be higher if uncertainty is taken into consideration. The new reorder point would be the desired safety stock units plus 548.
Question #2
If a firm is considering implementing a JIT inventory system, list and describe the
accounting
issues that the firm should consider when making this decision.
It will be necessary to track information (metrics) to help see if JIT is feasible and if it is being successful. Specifically, the firm should track information on internal performance and supplier reliability. Examples include:
Examples to measure internal performance include:
·
On-time delivery %
·
Cycle time
·
Defect rates or % yield
·
Unscheduled downtime
·
Sales increase from JIT implementation
·
Customer satisfaction
·
# of rush shipments required
Examples to measure supplier reliability include:
·
% of supplier shipments without defects / errors
·
Cost of ownership
·
% of supplier shipments on time
There are other possibilities
Question #1
Consider the following information:
|
Q1 |
Q2 |
Q3 |
||||||||
Beginning inventory (units) |
0 |
2,000 |
1,000 |
||||||||
Budgeted units to be produced |
300,000 |
||||||||||
Actual units produced |
296,000 |
301,000 |
302,000 |
||||||||
Units sold |
294,000 |
||||||||||
Variable manufacturing costs per unit produced |
$40 |
||||||||||
Variable selling costs per unit sold |
$10 |
||||||||||
Fixed manufacturing costs |
$3,000,000 |
||||||||||
Fixed selling costs |
$1,000,000 |
||||||||||
Selling price per unit |
$70 |
There are no price, efficiency, or spending variances, and any production-volume variance is directly written off to cost of goods in the quarter in which it occurs.
a) Prepare income statements for Q1, Q2, and Q3 using variable costing and absorption costing.
Variable costing |
Q1 |
Q2 |
Q3 |
|||||||
Revenue |
$20,580,000 |
$21,140,000 |
||||||||
Variable cost of goods sold |
$11,760,000 |
$12,080,000 |
||||||||
Variable selling costs |
$2,940,000 |
$3,020,000 |
||||||||
Contribution margin |
$5,880,000 |
$6,040,000 |
||||||||
Operating Income |
$1,880,000 |
$2,040,000 |
||||||||
Beginning inventory |
$0 |
$80,000 |
$40,000 |
|||||||
Variable manufacturing costs |
$11,840,000 |
$12,040,000 |
||||||||
Variable cost of goods available for sale |
$12,120,000 |
|||||||||
Ending inventory |
||||||||||
Variable cost of goods sold |
$11,760,000 |
$12,080,000 |
Absorption costing |
||||||
Cost of goods sold |
$14,740,000 |
$15,090,000 |
$15,080,000 |
|||
Gross margin |
$5,840,000 |
$6,050,000 |
$6,060,000 |
|||
$1,900,000 |
$2,030,000 |
|||||
$0 |
$100,000 |
$50,000 |
||||
$11,840,000 | $12,040,000 | $12,080,000 | ||||
Allocated fixed manufacturing costs |
$2,960,000 |
$3,010,000 |
$3,020,000 | |||
Cost of goods available for sale |
$14,800,000 |
$15,150,000 |
||||
Initial COGS |
$14,700,000 |
$15,100,000 |
||||
Adjustment for PVV |
$40,000 |
-$10,000 |
-$20,000 |
|||
Final COGS |
$14,740,000 | $15,090,000 | $15,080,000 | |||
$2,960,000 |
$3,010,000 |
|||||
PVV positive (negative) = unfav (fav) |
($10,000) |
($20,000) |
b) Explain the differences in operating income between the two costing systems for each quarter. Be specific!
Absorption operating income |
||||||||||||
Variable operating income |
||||||||||||
Difference |
$20,000 |
($10,000) |
$0 |
|||||||||
Change in Inventory, Absorption |
$100,000 |
($50,000) |
||||||||||
Change in Inventory, Variable |
$80,000 |
($40,000) |
||||||||||
$20,000 |
||||||||||||
Units in ending inventory |
||||||||||||
Units in beginning inventory |
||||||||||||
2,000 |
-1,000 |
0 | ||||||||||
Fixed manufacturing in EI |
$10,000 |
|||||||||||
Fixed manufacturing in BI |
In Q1, absorption income is $20,000 higher. We can explain this in two different ways. First, since inventory increased by $20,000 more under absorption costing, income will be $20,000 higher. Another way is to focus on the change in the amount of fixed manufacturing costs in inventory under absorption costing during a period (it is always $0 under variable costing). This is the same as the change in total inventory, since the variable costs in inventory are the same under both methods. In Q1, it increased by $20,000. We know this because inventory increased by 2,000 units, and fixed manufacturing costs are $10 per unit ($3,000,000 / 300,000). We apply similar logic for Q2, except variable income is higher since inventory decreased. There is no difference in income in Q3 since inventory stayed the same.
Question #2
a) Under which inventory costing method would managers have an incentive to build excess inventory? What is it about that method that provides the incentive? Be sure to justify your answer.
Under full absorption costing, managers have an incentive to build excess inventory as more fixed manufacturing costs are absorbed into the balance sheet when production increases. This means less of these costs are expensed on the income statement. There is no incentive for this under variable costing because all fixed manufacturing costs are expensed under this method.
b) What steps can a manager take to reduce the incentive to build excess inventory? Be specific!
One thing a manager can do is use variable costing for internal purposes. A manager can also use additional performance metrics such as days to sell inventory, inventory turnover, inventory levels, and inventory as a % of sales or as a % of assets to discourage excess inventory. A manager can also impose a “charge back” for inventory levels.
Question #3
a) How does the choice of the denominator level capacity impact income reported under variable costing? Be sure to justify your answer.
It plays no role as the choice of capacity impacts the allocation of fixed manufacturing overhead. Under variable costing, there is no allocation as it is all expensed as incurred.
b) How does the choice of the denominator level capacity impact income reported under full absorption costing? Be sure to justify your answer.
The choice of capacity level impacts the rate used to allocate inventory. The higher the capacity used, the lower the allocation rate. With a lower rate, less fixed manufacturing overhead is allocated to actual output, resulting in a larger unfavorable production volume variance. If this variance is written off to COGS, then results using full absorption costing approach results under variable costing. This may be desirable for tax purposes where the goal is generally to reduce taxable income.