- If Phoenix had used variable costing instead of absorption costing, what would be the difference in reported operating income over the two-year period?
Answer: Absorption costing would show $25,000 higher total operating income over both years combined
Year 1: Inventory increased by 3,000 units (15,000 - 12,000), so absorption costing shows $75,000 higher income (3,000 × $25). Year 2: Inventory decreased by 2,000 units (20,000 - 18,000), so absorption costing shows $50,000 lower income (2,000 × $25). Net effect over two years: $75,000 - $50,000 = $25,000 higher under absorption costing.
- A company uses absorption costing. An increase in the value of its finished goods inventory from the beginning to the end of a period implies which of the following?
Answer: Net operating income for the period would have been lower if variable costing had been used.
An increase in the value of finished goods inventory means that the number of units produced exceeded the number of units sold. Under absorption costing, this leads to the deferral of fixed manufacturing overhead in the ending inventory. Because some of the period's fixed overhead is held on the balance sheet instead of being expensed on the income statement, the cost of goods sold is lower and net operating income is higher than it would have been under variable costing, where all fixed overhead is expensed in the period incurred. Therefore, variable costing net income would have been lower.
- When comparing absorption costing and variable costing, which of the following costs is treated differently between the two methods, leading to different inventory valuations and net operating incomes?
Answer: Fixed manufacturing overhead
The sole difference between absorption costing and variable costing lies in the treatment of fixed manufacturing overhead (FMOH). Under absorption costing, FMOH is treated as a product cost, meaning it is included in the cost of inventory and is expensed through cost of goods sold only when the inventory is sold. Under variable costing, FMOH is treated as a period cost and is expensed in its entirety in the period it is incurred, regardless of how many units are produced or sold. All other costs (direct materials, direct labor, variable manufacturing overhead, and all selling and administrative expenses) are treated identically under both methods.
- Company Z switched from variable costing to absorption costing for external reporting. In the first year after the switch, production exceeded sales by 8,000 units, and fixed manufacturing overhead was $5 per unit. In the second year, sales exceeded production by 12,000 units. Assuming all other factors remain constant, what is the cumulative effect on reported operating income over the two-year period?
Answer: Operating income decreased by $20,000 compared to variable costing over the two-year period
Year 1: Production > Sales by 8,000 units, so inventory increased by 8,000 units × $5 = $40,000 higher income under absorption costing. Year 2: Sales > Production by 12,000 units, so inventory decreased by 12,000 units × $5 = $60,000 lower income under absorption costing. Cumulative effect: $40,000 - $60,000 = -$20,000, meaning absorption costing shows $20,000 lower operating income over the two-year period.
- A manager's annual bonus is based on the division's net operating income calculated using absorption costing. The company applies a predetermined fixed overhead rate based on expected production. In the final month of the year, with sales lagging behind forecasts, which of the following actions would most directly lead to an increase in the manager's bonus, even if it is not in the company's best long-term interest?
Answer: Increasing production to a level substantially higher than current sales demand.
Under absorption costing, fixed manufacturing overhead is treated as a product cost and is inventoried. When production exceeds sales, inventory levels increase, and a portion of the period's fixed manufacturing overhead is deferred in the ending inventory balance rather than being expensed. This deferral reduces the cost of goods sold and increases reported net operating income for the period. Therefore, a manager can temporarily boost absorption costing income by overproducing.
- Delta Manufacturing is considering switching from absorption costing to variable costing for internal reporting. The controller notes that over the past three years, production has consistently exceeded sales by an average of 2,000 units annually, with fixed manufacturing overhead of $15 per unit. However, the company expects that over the next three years, sales will consistently exceed production by an average of 1,800 units annually. What should the controller expect regarding the impact on reported operating income?
Answer: Operating income will increase by $27,000 annually on average under variable costing during the next three years
When sales exceed production (inventory decreases), variable costing shows higher income than absorption costing because fixed overhead is released from inventory under absorption costing. With sales exceeding production by 1,800 units annually and fixed overhead of $15 per unit, variable costing will show $27,000 higher income annually (1,800 × $15) compared to absorption costing.
- For the year just ended, a company's variable costing net income was $300,000. Beginning and ending inventories were 10,000 and 15,000 units, respectively. The fixed manufacturing overhead cost per unit was $12. What was the net income under absorption costing?
Answer: $360,000
The difference between absorption and variable costing net income is the fixed manufacturing overhead (FMOH) deferred in or released from inventory. The change in inventory is an increase of 15,000−10,000=5,000 units. Since inventory increased, production exceeded sales, and FMOH was deferred in inventory. The amount of deferred FMOH is 5,000 units×$12/unit=$60,000. When FMOH is deferred, absorption costing income is higher than variable costing income. Therefore, absorption costing net income is $300,000+$60,000=$360,000. - Over the entire life of an enterprise, if inventory levels at the beginning and end of its life are zero, what will be the relationship between the cumulative net operating income reported under absorption costing and variable costing?
Answer: The cumulative incomes reported under both methods will be identical.
The difference in reported income between the two methods is caused by the deferral and release of fixed manufacturing overhead in inventory. While the timing of the expense recognition differs, the total amount of fixed manufacturing overhead incurred over the company's life must eventually be expensed under both methods. If the company starts with zero inventory and ends with zero inventory, there is no net deferral of fixed costs. Therefore, over the long run, the cumulative net operating income will be the same under both absorption and variable costing.
- Titan Corp. applies fixed manufacturing overhead (FMOH) at a rate of $8 per unit, based on a practical capacity of 50,000 units. In the current year, Titan produced 45,000 units and sold 48,000 units. What is the amount of fixed manufacturing overhead released from inventory during the year?
Answer: $24,000
When sales exceed production, a company sells all of the units it produced in the current period plus some units from beginning inventory. The fixed overhead associated with those beginning inventory units is 'released' and charged to cost of goods sold. The number of units released from inventory is the decrease in inventory: 48,000 sold−45,000 produced=3,000 units. The amount of FMOH released is this unit decrease multiplied by the FMOH rate: 3,000 units×$8/unit=$24,000. This amount represents the difference in income between the two methods for the period, with variable costing income being higher. - Which of the following statements presents a valid criticism of using absorption costing for internal evaluation of a manager's performance?
Answer: It can incentivize managers to overproduce in the short term to defer fixed costs and inflate profits.
A significant criticism of absorption costing for internal performance evaluation is that it creates an incentive for managers to increase production levels beyond what is necessary to meet sales demand. By producing more units than are sold, a portion of the period's fixed manufacturing overhead is allocated to the unsold units in ending inventory. This defers the expense to a future period, which lowers the current period's cost of goods sold and increases reported net operating income. A manager whose bonus is tied to this income figure may be motivated to overproduce, leading to excess inventory and associated holding costs, which is not in the company's best interest.
- A company began operations this year. It produced 40,000 units and sold 36,000 units. Costs for the year were: total fixed manufacturing overhead, $200,000; variable manufacturing cost per unit, $15. What is the value of ending inventory on the year-end balance sheet if the company uses absorption costing?
Answer: $80,000
First, calculate the fixed manufacturing overhead (FMOH) rate per unit produced: $200,000/40,000 units=$5 per unit. Under absorption costing, the full product cost per unit is the sum of variable manufacturing cost and allocated fixed manufacturing overhead: $15+$5=$20 per unit. Next, determine the number of units in ending inventory: 40,000 produced−36,000 sold=4,000 units. Finally, calculate the value of ending inventory: 4,000 units×$20/unit=$80,000. - A company reports the following financial results:
* Absorption costing net income: $75,000
* Variable costing net income: $63,000
* Units produced: 20,000
* Units in ending inventory: 6,000
Assuming the company started the period with no inventory, what was the total fixed manufacturing overhead for the period?
Answer: $40,000
First, find the difference in income: $75,000−$63,000=$12,000. Since absorption income is higher, production must have exceeded sales. The change in inventory is the ending inventory of 6,000 units (since beginning inventory was zero). The income difference is equal to the change in inventory multiplied by the fixed overhead (FMOH) rate: $12,000=6,000 units×FMOH rate. Solving for the rate gives $12,000/6,000=$2 per unit. The FMOH rate is also calculated as Total FMOH divided by units produced. Therefore, $2/unit=Total FMOH/20,000 units. Solving for Total FMOH gives $2×20,000=$40,000. - Marvel Corp uses both absorption and variable costing systems. Fixed manufacturing overhead is $8 per unit. During the year, the company had the following inventory changes: Q1 inventory increased by 2,000 units, Q2 inventory decreased by 1,500 units, Q3 inventory increased by 3,500 units, and Q4 inventory decreased by 2,500 units. What is the difference in annual operating income between the two costing methods?
Answer: Absorption costing shows $12,000 higher operating income than variable costing for the year
The difference is based on the net change in inventory for the year. Net inventory change = +2,000 - 1,500 + 3,500 - 2,500 = +1,500 units. Since inventory increased by 1,500 units net, absorption costing will show higher income by 1,500 units × $8 = $12,000. This is because fixed overhead costs are deferred in ending inventory under absorption costing but expensed immediately under variable costing.
- A company reported the following for the year: beginning inventory, 0 units; production, 15,000 units; sales, 12,000 units. Total variable manufacturing costs were $180,000, and total fixed manufacturing overhead was $90,000. What is the difference between the Cost of Goods Sold (COGS) reported under absorption costing versus variable costing?
Answer: $72,000
First, calculate the fixed manufacturing overhead (FMOH) rate per unit produced: $90,000/15,000 units=$6 per unit. Next, calculate the variable manufacturing cost per unit: $180,000/15,000 units=$12 per unit. Under absorption costing, COGS includes both variable and fixed manufacturing costs for the units sold: 12,000 units×($12+$6)=$216,000. Under variable costing, COGS includes only the variable manufacturing costs: 12,000 units×$12=$144,000. The difference is $216,000−$144,000=$72,000. Alternatively, the difference is simply the amount of fixed overhead included in absorption costing COGS: 12,000 units sold×$6 FMOH/unit=$72,000. - If a company uses absorption costing, which of the following actions will decrease net operating income for the current period, assuming all other factors remain constant?
Answer: Selling units from the prior period's ending inventory.
Under absorption costing, fixed manufacturing overhead is a product cost. When units from a prior period's ending inventory are sold, the fixed overhead costs attached to those units are released from the balance sheet (inventory) and recognized as an expense (cost of goods sold) on the income statement. This release of previously deferred costs increases the expenses for the current period, thereby decreasing net operating income. This is the mechanism that causes absorption income to be lower than variable income when sales exceed production.
- A manufacturing firm is making a strategic shift from a traditional, forecast-driven production model to a just-in-time (JIT) system. Assuming all other factors like sales demand and cost structures remain stable, what is the most likely effect of this operational change on the company's reported financial results?
Answer: The discrepancy between net income calculated under absorption and variable costing will diminish significantly.
A just-in-time (JIT) system aims to minimize inventory levels by producing goods only as they are needed to meet customer demand. This means that the number of units produced will be very close to the number of units sold in any given period. The difference between absorption costing income and variable costing income is determined by the change in inventory levels. As inventory levels and changes in those levels approach zero under JIT, the amount of fixed overhead deferred in or released from inventory also approaches zero. Consequently, the net operating income reported under the two methods will become nearly identical.
- A company's inventory level increased by 2,500 units during the year. Its absorption costing net operating income was $220,000. The fixed manufacturing overhead rate is $6 per unit. What was the company's net operating income under variable costing?
Answer: $205,000
When inventory increases, it means production exceeded sales. Under absorption costing, a portion of the period's fixed manufacturing overhead (FMOH) is attached to the unsold units and remains in inventory, rather than being expensed. This deferral of FMOH makes absorption costing income higher than variable costing income. The amount of the difference is the inventory increase in units multiplied by the FMOH rate: 2,500 units×$6/unit=$15,000. Since absorption costing income is higher, the variable costing income is $220,000−$15,000=$205,000. - What is the difference in operating income between absorption costing and variable costing for the two-year period combined?
Answer: Variable costing shows $36,000 higher operating income than absorption costing
The difference in operating income between absorption and variable costing is due to the fixed overhead in inventory changes. Year 1: 5,000 units remain in inventory × $12 = $60,000 higher income under absorption. Year 2: 8,000 units sold from inventory × $12 = $96,000 lower income under absorption. Net effect over two years: $60,000 - $96,000 = -$36,000, meaning variable costing shows $36,000 higher operating income.
- At the beginning of the year, a company had 4,000 units in inventory, valued under absorption costing at $25 per unit, which included $5 of allocated fixed manufacturing overhead (FMOH). During the year, the company produced 20,000 units and incurred total FMOH of $110,000. If the company sold 22,000 units, what is the total FMOH included in the cost of goods sold for the year?
Answer: $119,000
First, determine the FMOH rate for the current period's production: $110,000 ÷ 20,000 units produced = $5.50 per unit. The 22,000 units sold are assumed to come first from beginning inventory (4,000 units) and then from current production (18,000 units) under a FIFO assumption. The FMOH cost from beginning inventory is 4,000 × $5.00 = $20,000. The FMOH cost from current production sold is 18,000 × $5.50 = $99,000. Total FMOH in COGS is $20,000 + $99,000 = $119,000. Choice C ($121,000) represents a common error of applying the current period rate to all units sold (22,000 × $5.50).
- Over a two-year period, a company reported the following production and sales data:
* Year 1: Produced 20,000 units, Sold 17,000 units.
* Year 2: Produced 18,000 units, Sold 21,000 units.
The fixed manufacturing overhead rate was constant at $10 per unit in both years. Which statement correctly describes the relationship between total absorption costing income (ACI) and total variable costing income (VCI) over the entire two-year period?
Answer: Total ACI and total VCI are identical.
The difference in income between the two methods is driven by the change in inventory. In Year 1, production (20,000) exceeded sales (17,000) by 3,000 units, so ACI was 3,000×$10=$30,000 higher than VCI. In Year 2, sales (21,000) exceeded production (18,000) by 3,000 units, so VCI was 3,000×$10=$30,000 higher than ACI. Over the two-year period, the total number of units produced (38,000) equals the total number of units sold (38,000). Because the cumulative change in inventory is zero, the total fixed overhead expensed is the same under both methods, resulting in identical total net operating income over the two years.
