1

Absorption VS Variable Costing

Theory—VARIABLE COSTING A. selling price. C. unit sales.
1. To apply direct costing method it is necessary that you know B. unit production. D. unit variable manufacturing costs.
A. Variable and fixed cost related to production 9. Which of the following statements is true for a firm that uses variable costing?
B. Controllable and uncontrollable cost of production A. Profits fluctuate with sales.
C. Contribution margin and break even point in production B. An idle facility variation is calculated.
D. Standard production rate and times of production elements C. Product costs include variable administrative costs.
2. The following statements about the adoption of variable costing are true, except: D. The cost of a unit of product changes because of changes in number of units
A. A direct cost may not become a product cost. manufactured.
B. An indirect cost may be assigned as part of product cost. 10. The change in period-to-period operating income when using variable costing can be
C. It is an acceptable method for general reporting purposes. explained by the change in the
D. All fixed manufacturing costs are recognized as period costs. A. Unit sales level multiplied by the unit sales price
3. Which of the following is NOT an advantage of using variable costing for internal B. Unit sales level multiplied by a constant unit contribution margin.
reporting purposes? C. Finished goods inventory level multiplied by the unit sales price.
A. The impact of fixed costs on profits is emphasized. D. Finished goods inventory level multiplied by a constant unit contribution
B. Total costs may be overlooked when evaluating profits. margin.
C. Profits are directly influenced by changes in sales volume. Theory—ABSORPTION COSTING
D. Fixed costs are reported at incurred values, not absorbed values, thus 11. All of the following are names for the product costing method in which both fixed and
improving control over those costs. variable costs are included in overhead rates, except:
4. A criticism of variable costing for managerial accounting purposes is that it A. absorption costing C. direct costing
A. overstates inventories. B. conventional costing D. full costing
B. does not reflect cost-volume-profit relationships. 12. Which of the following is not associated with absorption costing?
C. is not acceptable for product line segmented reporting. A. contribution margin C. gross margin
D. might encourage managers to emphasize the short term at the expense of the B. functional format D. Period costs
long term. 13. Under absorption costing, fixed manufacturing overhead could be found in all of the
5. Under variable costing, following except the
A. all product costs are fixed. A. Cost of Goods Sold. C. period costs.
B. all period costs are variable. B. finished goods inventory account. D. work-in-process account.
C. all product costs are variable. 14. Jansen, Inc. pays bonuses to its managers based on operating income. The company
D. product costs are both fixed and variable. uses absorption costing, and overhead is applied on the basis of direct labor hours. To
6. Cay Co.’s 1995 fixed manufacturing overhead costs totaled $100,000, and variable increase bonuses, Jansen’s managers may do all of the following except
selling A. Produce those products requiring the most direct labor.
costs totaled $80,000. Under variable costing, how should those costs be classified? B. Defer expenses such as maintenance to a future period.
A. B. C. D. C. Decrease production of those items requiring the most direct labor.
Period Costs $0 $ 80,000 $100,000 $180,000 D. Increase production schedules independent of customer demands.
Product Costs $180,000 $100,000 $ 80,000 $0 15. Unabsorbed fixed overhead costs in an absorption costing system are
7. Under the variable-costing concept, unit product cost would most likely be increased A. costs that cannot be controlled.
by B. excess variable overhead costs.
A. A decrease in the number of units produced. C. variable overhead costs not allocated to units produced.
B. An increase in the commission paid to salesman for each unit sold. D. fixed manufacturing costs not allocated to units produced.
C. A decrease in the remaining useful life of factory machinery depreciated on the 16. When a firm prepares financial reports by using absorption costing
units-of-production method. A. Profits will always increase with increases in sales.
D. An increase in the remaining useful life of factory machinery depreciated on B. Profits will always decrease with decreases in sales.
the sum-of-the-year’s digits method. C. Decreased output and constant sales result in increased profits.
8. Calculating income under variable costing does NOT require knowing
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Absorption VS Variable Costing
D. Profits may decrease with increased sales even if there is no change in selling A. Co. Z would report a higher net income than Co. Y for the years in which
prices and production equals sales
costs. B. Co. Y would report a higher inventory value than Co. Z for the years in which
17. Under absorption costing, if sales remain constant from period 1 to period 2, the production exceeds sales
company will report a larger income in period 2 when C. Co. Z would report a higher inventory value than Co. Y for the years in which
A. period 1 production exceeds period 2 production. production exceeds sales
B. period 2 production exceeds period 1 production. D. Co. Y would report a higher inventory value than Co. Z for the years in which
C. fixed production costs are larger in period 2 than period 1. production exceeds the normal or practical capacity
D. variable production costs are larger in period 2 than period 1. 23. Absorption costing and variable costing are two different methods of assigning costs
to units produced. Of the following five cost items listed, identify the one that is not
Variable & absorption costing correctly accounted for as a product cost. Part
18. A cost that is included as part of product costs under both absorption costing and of Product Cost under
direct costing is: Absorption Cost Variable Cost
A. insurance D. variable marketing expenses. A. Direct labor cost Yes Yes
B. managerial staff costs E. variable materials handling labor B. Insurance on factory Yes No
C. taxes on factory building C. Manufacturing supplies Yes Yes
19. If unit costs remain unchanged and sales volume and sales price per unit both D. Packaging and shipping costs Yes Yes
increase from the preceding period when operating profits were earned, operating profits 24. A company’s net income recently increased by 30% while its inventory increased to
must equal a full year’s sales requirements. Which of the following accounting methods would
A. Increase under the variable costing method. be most likely to produce the favorable income results?
B. Decrease under the variable costing method. A. Absorption costing. C. Standard direct costing.
C. Increase under the absorption costing method. B. Direct costing. D. Variable costing.
D. Decrease under the absorption costing method. 25. Variable costing and absorption costing will show the same incomes when there are
20. When comparing absorption costing with variable costing, which of the following no
statements is not true? A. beginning and ending inventories.
A. When sales volume is more than production volume, variable costing will result B. beginning inventories.
in higher operating profit. C. ending inventories.
B. Under absorption costing, operating profit is a function of both sales volume D. variable costs.
and production volume. 26. Absorption costing differs from variable costing in that
C. Absorption costing enables managers to increase operating profits in the short A. absorption costing inventories are more correctly valued.
run by increasing inventories. B. companies using absorption costing have lower fixed costs.
D. A manager who is evaluated based on variable costing operating profit would C. standards can be used with absorption costing, but not with variable costing.
be tempted to increase production at the end of a period in order to get a more D. production influences income under absorption costing, but not under variable
favorable review. costing.
21. A firm presently has total sales of $100,000. If its sales rise, its 27. In a recent period, Marvel Co. incurred $20,000 of fixed manufacturing overhead and
A. fixed costs will also rise. deducted $30,000 of fixed manufacturing overhead. Marvel Co. must be using
B. per unit variable costs will rise. A. absorption costing. C. standard costing.
C. net income based on absorption costing will go up more than its net income B. direct costing. D. variable costing.
based on variable costing. 28. Other things being equal, net income computed by direct costing method would
D. net income based on variable costing will go up more than its net income exceed net income computed by absorption costing method if
based on absorption costing. A. Units sold were to exceed units produced.
22. Both Company Y and Company Z produce similar products that need negligible B. Units produced were to exceed units sold.
distribution costs. Their assets operation and accounting are very similar in all respects C. Fixed manufacturing costs were to increase.
except that Company Y uses direct costing and Company Z uses absorption costing. D. Variable manufacturing costs were to increase.
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Absorption VS Variable Costing
29. Net income is lower under variable costing than under absorption costing when 2001 was the same as in 2000. The 2001 variable costing statement reported a profit
A. Production equals sales. whereas the 2001 absorption costing statement reported a loss. The difference in
B. Production exceeds sales. reported income could be explained by units produced in 2001 being
C. Production is less than sales. A. Less than units sold in 2001.
D. Production increases from the previous period. B. In excess of units sold in 2001.
30. President X of WXY Corporation requested you to explain the difference of net C. Less than the activity level used for allocating overhead to the product.
income between the variable costing income statements presentation and the absorption D. In excess of the activity level used for allocating overhead to the product.
costing method. You would say that the difference Problems—VARIABLE COSTING
A. Is attributable to the variable costs in the inventory. 1. MNO Products, Inc. planned and actually manufactured 200,000 units of its single
B. Is attributable to the fixed costs in ending inventory. product in 2000, its first year of operations. Variable manufacturing costs were P30 per
C. Is equal to the fixed costs per unit times the number of units sold. unit of product. Planned and actual fixed manufacturing costs were P600,000, and
D. Is none if there is no change in the fixed costs in the beginning and ending marketing and administrative costs totaled P400,000 in 2000. MNO sold 120,000 units of
inventories. product in 2000 at a selling price of P40 per unit. What is the cost of the ending
31. If inventory quantities increase during a period, inventory assuming variable costing is used?
A. Variable costing profits will equal absorption costing profits. A. P2,250,000 C. P2,640,000
B. Absorption costing profits will exceed variable costing profits B. P2,400,000 D. P2,750,000
C. Variable costing profits will exceed absorption costing profits. 2. LY & Company completed its first year of operations during which time the following
D. Variable costing will show a higher inventory value than absorption costing. information were generated:
32. A manufacturing company prepares income statements using both absorption- and Total units produced 100,000
variable-costing methods. At the end of the period, actual sales revenues, total gross Total units sold @ P100 per unit 80,000
margin, and total contribution margin approximated budgeted figures, whereas net Work in process ending inventory 20,000
income was substantially below the budgeted amount. There were no beginning or Costs Variable Cost per Unit Fixed Costs
ending inventories. The most likely explanation of the net income shortfall is that, Raw materials P20.00
compared to budget, actual Direct labor 12.50
A. Manufacturing fixed costs had increased. Factory overhead 7.50 P1.2 million
B. Selling and administrative fixed expenses had increased. Selling and administrative 10.00 0.7 million
C. Sales price and variable costs had declined proportionately. If the company used variable (direct) costing method, the operating income would be
D. Sales prices had declined proportionately more than variable costs. A. P2,100,000 C. P3,040,000
33. As compared with total absorption costing profit over the entire life of a company, B. P2,480,000 D. P4,000,000c.
total variable 3. Youthful Biscuits manufactures and sells boxed coconut cookies. The biggest market
costing profit will for these cookies are as gifts that college students buy for their business teachers. There
A. Be less. B. Be equal. are 100 cookies per box. The following income statement shows the result of the first
C. Be greater. D. Be substantially greater or less depending upon external year of operations. This statement was the one included in the company’s annual report
factors to the stockholders.
34. How will a favorable volume variance affect net income under each of the following Sales (400 boxes at P12.50 a box) P5,000.00
methods? Less: Cost of goods sold (400 boxes at P8 per box) 3,200.00
A. B. C. Gross margin 1,800.00
D. Less: Selling and administrative expenses 800.00
Absorption Increase Increase Reduce Net income 1,000.00
Reduce Variable selling and administrative expenses are P0.90 per box sold. The company
Variable No effect Reduce Increase No produced 500 boxes during the year. Variable manufacturing costs are P5.25 per box
effect and fixed manufacturing overhead costs total P1,375 for the year.
35. A single-product company prepares income statements using both absorption and What is the company’s direct costing net income?
variable costing methods. Manufacturing overhead cost applied per unit produced in A. P 725 C. P2,265
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Absorption VS Variable Costing
B. P1,000 D. P2,540 Supervision (2/3 factory, 1/3 office) 1,500
Problems—ABSORPTION COSTING Salespeople’s salaries 1,300
4. The total production cost for 20,000 units was P21,000 and the total production cost Insurance (2/3 factory, 1/3 office) 1,200
for making 50,000 units was P34,000. Once production exceeds 25,000 units, additional Office supplies 750
fixed costs of P4,000 were incurred. The full production cost per unit for making 30,000 Advertising 700
units is: Depreciation on office equipment 500
A. P0.30 C. P0.84 Interest on loan 300
B. P0.68 D. P0.93 The gross profit margin percentage (rounded) was
5. West Co.’s 1988 manufacturing costs were as follows: A. 34% C. 44%
Direct materials and direct labor $700,000 B. 41% D. 46%
Other variable manufacturing costs 100,000 9. The Blue Company has failed to reach its planned activity level during its first 2 years
Depreciation of factory building and manufacturing equipment 80,000 of operation. The following table shows the relationship among units produced, sales,
Other fixed manufacturing overhead 18,000 and normal activity for these years and the projected relationship for Year 3. All prices
What amount should be considered product cost for external reporting purposes? and costs have remained the same for the last 2 years and are expected to do so in Year
A. $700,000 C. $880,000 3. Income has been positive in both Year 1 and Year 2.
B. $800,000 D. $898,000
6. Coomber Industries manufactures a single product using standard costing. Variable
production costs are $13 and fixed production costs are $125,000. Coomber uses a
normal activity of 12,500 units to set its standard costs. Coomber began the year with Units Produced Sales Planned Activity
1,000 units in inventory, produced 11,000 units, and sold 11,500 units. The standard cost Year 1 90,000 90,000 100,000
of goods sold under absorption costing would be Year 2 95,000 95,000 100,000
A. $115,000 C. $253,000 Year 3 90,000 90,000 100,000
B. $149,500 D. $264,500 Because Blue Company uses an absorption-costing system, gross margin for year 3
7. Z Corp. incurred the following costs in 2001 (its first year of operations) based on should be
production of A. Equal to Year 1. C. Greater than Year 1.
10,000 units: Direct material $5 per unit B. Equal to Year 2. D. Greater than Year 2.
Direct labor $3 per unit 10. Don Juan Ltd. Manufactures a single product for which the costs and selling prices
Variable product costs $2 per unit are:
Fixed product costs (in total) $100,000 Variable production costs P 50 per unit
When Z Corp. prepared its 2001 financial statements, its Cost of Goods Sold was listed at Selling price¶ P125 per unit
$100,000. Based on this information, which of the following statements must be true: Fixed production overhead P200,000 per quarter
A. Z Corp. sold 5,000 units. Fixed selling and administrative overhead P80,000 per quarter
B. Z Corp. had a very profitable year. Normal capacity 20,000 units per quarter
C. Z Corp. sold all 10,000 units that it produced. Production in first quarter was 19,000 units and sales volume was 16,000 units. No
D. From the information given, one cannot tell whether Z Corp.'s financial opening inventory for the quarter.
statements were prepared based on variable or absorption costing. The absorption costing profit for the quarter was
8. A company manufactures a single product for its customers by contracting in advance A. P920,000 C. P960,000
of production. Thus, the company produces only units that will be sold by the end of each B. P950,000 D. P970,000
period. For the last period, the following data were available: Problems—VARIABLE COSTING & ABSORPTION COSTING
Sales $40,000 11. In the ABC Company, sales are P800,000, cost of goods under absorption costing is
Direct materials 9,050 P600,000, and total operating expenses are P120,000. If cost of goods sold is 70%
Direct labor 6,050 variable and total operating expenses are 60% fixed, what is the contribution margin
Rent (9/10 factory, 1/10 office) 3,000 under variable costing?
Depreciation on factory equipment 2,000 A. P260,000. C. P332,000.
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Absorption VS Variable Costing
B. P308,000. D. P380,000. 18. During its first year of operations, a company produced 275,000 units and sold
12. A company has the following cost data: 250,000 units. The following costs were incurred during the year:
Fixed manufacturing costs $2,000 Variable Cost per Unit Fixed Costs
Fixed selling, general, and administrative costs 1,000 Direct materials $15.00
Variable selling costs per unit sold 1 Direct labor 10.00
Variable manufacturing costs per unit 2 Manufacturing overhead 12.50 $2,200,000
Beginning inventory 0 units Selling and administrative 2.50 1,375,000
Production 100 units The difference between operating income calculated on the absorption-costing basis and
Sales 90 units at $40 per unit on the variable costing basis is that absorption-costing operating income is
Variable and absorption-cost net incomes are: A. $62,500 lesser. C. $220,000 greater.
A. $320 variable, $520 absorption C. $520 variable, $320 absorption B. $200,000 greater. D. $325,000 greater.
B. $330 variable, $530 absorption D. $530 variable, $330 absorption Questions 19 through 21 are based on the following information.
13. A company had an income of P50,000 using direct costing for a given month. The following information is available for X Co. for its first year of operations:
Beginning andending inventories for the month are 13,000 units and 18,000 units, Sales in units 5,000
respectively. Ignoring income tax, if the fixed overhead application rate was P2 per unit, Production in units 8,000
what was the income using absorption costing? Manufacturing costs:
A. P40,000 C. P60,000 Direct labor $3 per unit
B. P50,000 D. P70,000 Direct material 5 per unit
14. GHI Company had P100,000 income using absorption costing. GHI has no variable Variable overhead 1 per unit
manufacturing costs. Beginning inventory was P5,000 and ending inventory was Fixed overhead $100,000
P12,000. What is the income under variable costing? Net income (absorption method) $30,000
A. P88,000 C. P100,000. Sales price per unit $40
B. P93,000 D. P107,000
15. Fleet, Inc. manufactured 700 units of Product A, a new product, during the year. 19. What would X Co. have reported as its income before income taxes if it had used
Product A’svariable and fixed manufacturing costs per unit were $6.00 and $2.00 variable costing?
respectively. The inventory of Product A on December 31, consisted of 100 units. There A. ($30,000) C. $30,000
was no inventory of Product A on January 1. What would be the change in the dollar B. ($7,500) D. $67,500
amount of inventory on December 31 if variable costing were used instead of absorption 20. What was the total amount of SG&A expense incurred by X Co.?
costing? A. $6,000 C. $36,000
A. $0 C. $200 increase. B. $30,000 D. $62,500
B. $200 decrease. D. $800 decrease. 21. Based on variable costing, what would X Co. show as the value of its ending
16. At the end of Killo Co.’s first year of operations, 1,000 units of inventory remained on inventory?
hand. Variable and fixed manufacturing cost per unit were $90 and $20, respectively. If A. $24,000 C. $64,500
Killo uses absorption costing rather than direct (variable) costing, the result would be a B. $27,000 D. $120,000
higher pretax income of Questions 22 through 25 are based on the following information.
A. $0. C. $70,000. The annual flexible budget below was prepared for use in making decisions relations to
B. $20,000. D. $90,000. Product X.
17. A company manufactures 50,000 units of a product and sells 40,000 units. Total 100,000 units 150,000 units 200,000
manufacturing cost per unit is $50 (variable manufacturing cost, $10; fixed units
manufacturing cost, $40). Assuming no beginning inventory, the effect on net income if Sales volume $ 800,000 $1,200,000
absorption costing is used instead of variable costing is that: $1,600,000
A. net income is the same C. net income is $400,000 lower Manufacturing costs:
B. net income is $200,000 higher D. net income is $400,000 higher Variable $300,000 $450,000
$600,000
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Absorption VS Variable Costing
Fixed 200,000 200,000 25. Assuming that 90,000 units of Product X were sold during the first 6 months and that
200,000 this is to be used as a basis, the revised budget estimate for the total number of units to
$500,000 $650,000 be sold during this year is: A. 200,000 C. 360,000
$800,000 B. 240,000 D. None of the above
Selling & other expenses Questions 26 through 31 are based on the following information.
Variable $200,000 $300,000 Valyn Corporation employs an absorption costing system for internal reporting purposes;
$400,000 however, the company is considering using variable costing. Data regarding Valyn’s
Fixed 160,000 160,000 planned and actual operations for the 1995 calendar year are presented below.
160,000 Planned Activity Actual
$360,000 $460,000 Activity
$560,000 Beginning finished goods inventory in units 35,000
Income (or loss) $(60,000) $90000 35,000
$240,000 Sales in units 140,000
The 200,000 unit budget has been adopted and will be used for allocating fixed 125,000
manufacturing Production in units 140,000
costs to units of Product X. At the end of the first 6 months, the following information is 130,000
available: The planned per unit cost figures shown in the next schedule were based on the
Units estimated production and sale of 140,000 units in 1995. Valyn uses a predetermined
Production completed 120,000 manufacturing overhead rate for applying manufacturing overhead to its product. Thus,
Sales 60,000 a combined manufacturing overhead rate of $9.00 per unit was employed for absorption
All fixed costs are budgeted and incurred uniformly throughout the year, and all costs costing purposes in1995. Any over- or under-applied manufacturing overhead is closed
incurred to the cost of goods sold account at the end of the reporting year.
coincide with the budget. Over- and under-applied fixed manufacturing costs are Planned Cost
deferred until Incurred
year-end. Annual sales have the following seasonal pattern. Per Unit Total
Portion of Annual Sales Costs
First quarter 10% Direct materials $12.00 $1,680,000
Second quarter 20% $1,560,000
Third quarter 30% Direct labor 9.00 1,260,000
Fourth quarter 40% 1,170,000
22. The amount of fixed factory costs applied to product during the first 6 months under Variable manufacturing overhead 4.00 560,000
absorption 520,000
costing is Fixed manufacturing overhead 5.00 700,000
A. Over-applied by $20,000. C. Under-applied by $80,000. 715,000
B. Under-applied by $40,000. D. Equal to the fixed costs incurred. Variable selling expenses 8.00 1,120,000
23. Reported net income (or loss) for the first 6 months under absorption costing is 1,000,0
A. $(40,000) C. $40,000 Fixed selling expenses 7.00 980,000
B. $0 D. $160,000 980,000
Variable administrative expenses 2.00 280,000
24. Reported net income (or loss) for the first 6 months under variable costing is 250,000
A. $(180,000) C. $40,000 Fixed administrative expenses 3.00 420,000
B. $0 D. $180,000 425,000
Total $50.00 $7,000,000
$6,620,
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Absorption VS Variable Costing
The 1995 beginning finished goods inventory for absorption costing purposes was valued A. $0 C. $15,000
at the 1994 planned unit manufacturing cost, which was the same as the 1995 planned B. $10,000 D. Some other number.
unit manufacturing cost. There are no work-in-process inventories at either the beginning 36. The standard cost of goods sold under variable costing would be
or the end of the year. The planned and actual unit selling price for 1995 was $70.00 per A. $200,000 C. $367,500
unit. B. $210,000 D. Some other number.
26. The value of Valyn Corporation’s 1995 actual ending finished goods inventory on the 37. The standard cost of goods sold under absorption costing would be
absorption costing bases was A. $200,000 C. $367,500
A. $900,000 C. $1,220,000 B. $210,000 D. Some other number.
B. $1,200,000 D. $1,350,000
27. The value of Valyn Corporation’s 1995 actual ending finished goods inventory on the “When the going gets tough, the tough gets going.”
variable costing basis was
A. $750,000 C. $1,125,000.
B. $1,000,000. D. $1,400,000.
28. Valyn Corporation’s total fixed costs expensed in 1995 on the absorption costing
bases were
A. $2,030,000 C. $2,095,000
B. $2,055,000 D. $2,120,000
29. Valyn Corporation’s actual manufacturing contribution margin for 1995 calculated on
the variable costing basis was
A. $4,375,000 C. $4,910,000
B. $4,935,000 D. $5,625,000.
30. The total variable costs expensed in 1995 by Valyn Corporation on the variable
costing basis was
A. $4,325,000 C. $4,500,000
B. $4,375,000 D. $4,550,000
31. The difference between Valyn Corporation’s 1995 operating income calculated on the
absorption costing basis and calculated on the variable costing basis was
A. $25,000 C. $65,000
B. $40,000 D. $90,000
Questions 32 through 37 are based on the following information.
Louder Industries manufactures a single product. Variable production costs are $20 and
fixed production costs are $150,000. Louder uses a normal activity of 10,000 units to set
its standard costs. Louder began the year with no inventory, produced 11,000 units, and
sold 10,500 units.
32. Ending inventory under variable costing would be
A. $10,000 C. $17,500
B. $15,000 D. $20,000
33. Ending inventory under absorption costing would be
A. $10,000 C. $17,500
D. $20,000 B. $15,000
34. The volume variance under variable costing would be
A. $0 C. $15,000
B. $10,000 D. Some other number.
35. The volume variance under absorption costing would be