Tutorial 3
Question 1. Variable and absorption costing, explaining operating profit differences
V8 Motors assemble and sells motor vehicle and uses standard costing. Actual data relating
to April and May 2015 are:
A B C D
1 April May
2 Unit data
3 Beginning inventory 0 150
4 Production 500 400
5 Sales 350 520
6 Variable costs
7 Manufacturing cost per unit produced $ 10 000 $ 10 000
8 Operating (marketing) cost per unit sold 3 000 3 000
9 Fixed cost
10 Manufacturing costs $ 2 000 000 $ 2 000 000
11 Operating (marketing) costs 600 000 600 000
The selling price per vehicle is $24 000. The budgeted level of production used to calculate
the budgeted fixed manufacturing cost per unit is 500 units. There are no price, efficiency or
spending variances. Any production volume variance is written off to cost of goods sold in
the month in which it occurs.
Required
1. Prepare April and May 2015 income statements for V8 Motors under: (a) Variable
costing, and (b) absorption costing.
2. Prepare a numerical reconciliation and explanation of the difference between
operating profit for each month under variable costing and absorption costing.
Question 2. Variable costing versus absorption costing
Mavis Ltd uses an absorption costing system based on standard costs.
Total variable manufacturing cost, including direct materials cost, is $3 per unit;
the standard production rate is 10 units per machine-hour.
Total budgeted and actual fixed manufacturing overhead costs are $420 000.
Fixed manufacturing overhead is allocated at $7 per machine-hour ($420 000/60 000
machine-hours of denominator level).
Selling price is $5 per unit.
Variable operating cost is $1/- and variable operating (non-manufacturing) costs are
$120 000.
Beginning inventory in 2014 is 30 000 units; ending inventory is 40 000 units.
Sales in 2014 are 540 000 units.
The same standard unit costs persisted throughout 2013 and 2014.
For simplicity, assume that there are no price, spending or efficiency variances.
Required
1. Prepare an income statement for 2014 assuming that the production volume
variance is written off at financial year-end as an adjustment to cost of goods sold.
2. The president has heard about variable costing. She asks you to recast the 2014
statement as it would appear under variable costing.
3. Explain the difference in operating profit as calculated in requirements 1 and 2.
4. Critics have claimed that a widely used accounting system has led to undesirable
build-ups of inventory levels. (a) Is variable costing or absorption costing more likely
to lead to such build-ups? Why? (b) What can be done to counteract undesirable
inventory build-ups?