Week 3 ABSORPTION COST PROBLEMS 5-17 Nickelson Company Variable and Absorption Costing Unit Product

 

Week 3   ABSORPTION COST

 

PROBLEMS 5-17  Nickelson Company

 

Variable and Absorption Costing Unit Product Costs and Income Statements

 

 

 

Nickleson Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operation:

 

 

 

Variable costs per unit:

 

        Manufacturing:

 

                  Direct materials …………………………………….   $ 25

 

                  Direct labor ……………………………………………    $16

 

                  Variable manufacturing overhead …………       $5

 

         Variable selling and administrative………………..       $2

 

Fixed costs per year:

 

         Fixed manufacturing overhead……………………..   $ 300, 000

 

         Fixed selling and administrative expenses…….   $ 180, 000

 

 

 

During its first year of operations Nickelson produced 60, 000 units and sold 60,000 units.

 

During its second year of operations it produced 75, 000 units and sold 50,000 units.

 

In its third year, Nickelson produced 40, 000 units and sold 65, 000 units. The selling price of the company’s product is $ 56 per unit.

 

 

 

REQUIRED:

 

1.      Compute the company’s break-even-point in units sold.

 

2.       Assume the company uses variable costing:

 

a.      Compute the unit product cost for year 1, year 2, and year 3.

 

b.      Prepare an Income statement for year 1, year,  2, and year 3.

 

3.      Assume the company uses absorption costing:

 

a.      Compute the unit product cost for year 1, year 2, and year 3.

 

b.      Prepare an income statement for year 1, year 2, and year 3.

 

4.      Compare the net operating income figures that you computed in requirements 2 and 3 to the break-even point that you computed in requirement 1 . Which net operating income figure seem counterintuitive? Why?

 

 

 

 

 

 

 

 

 

 

 

 

 

 PROBLEM 5-21 Prepare and Reconcile Variable Costing Statements

 

(LO 5-1, LO 5-2, LO 5-3)

 

 

 

Linden Company manufactures and sells a single product. Cost data for the product follow:

 

 

 

Variable costs per unit:

 

             Direct materials……………………………………………. $  6

 

             Direct labor ………………………………………………….   12

 

             Variable factory overhead…………………………..       4

 

             Variable selling and administrative……………..       3

 

Total variable costs per unit……………………………………. $ 25

 

 

 

Fixed costs per month :

 

            Fixed manufacturing overhead ……………………..  $ 240, 000

 

            Fixed selling and administrative ……………………. $ 180, 000

 

 

 

Total fixed cost per month ………………………………………. $ 420, 000

 

 

 

The product sells for $40 per unit. Production and sales data for May and June, the first two months of operation, are as follows:

 

 

 

                                                Units                     Units

 

                                         Produced                   Sold

 

May………………………      30, 000                     26, 000

 

June……………………..      30, 000                  34, 000

 

 

 

Income statements prepared by the accounting department, using absorption costing, are presented below:

 

 

 

                                                                                           May                            June

 

Sales………………………………………………………. $ 1, 040, 000      $ 1, 360, 000

 

Cost of goods sold…………………………………..           780, 000         1, 020, 000

 

Gross margin………………………………………….         260, 000             340,  000

 

Selling and administrative expense……….          260, 000             282,  000

 

Net operating income……………………………  $          2, 000      $      58,  000

 

 

 

REQUIRED:

 

1.       Determine the unit product cost under:

 

a.       Absorption costing

 

b.      Variable costing

 

2.       Prepare contribution formal variable costing income statements for May and June.

 

3.       Reconcile the variable costing and absorption costing net operating incomes.

 

4.       The company’s Accounting Department has determined the break-even point to be 28,000 units per month, computed as follows:

 

 

 

                             Fixed cost per month   =   $ 420,000        =  28,000 units

 

                         Unit contribution margin       $ 15 per unit

 

Upon receiving this figure, the president commented. “There’s something peculiar here. The controller says that the break-even point is 28,000 units per month.  Yet we sold only 26, 000 units in May, and the income statement we received showed a $ 2, 000 profit. 

 

 

 

Which figure do we believe?”   Prepare a brief explanation of what happened on the May income statement.

 

 

 

 

 

 

 

PROBLEM 5-22 SANDI SCOTT

 

Absorption and Variable Costing: Production Constant, Sales Fluctuate (LO 5-1, LO 5-2, LO 5-3)

 

 

 

Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc. to produce and sell the device. During the first month of operations, the device was very well received on the market, so Ms. Scott looked forward to healthy profit. For this reason, she was surprised to see a loss for the month on her income statement.

 

 

 

This statement was prepared by her accounting service which takes great pride in providing its timely financial data. The statement follows:

 

 

 

                                                                Scott Products, Inc.

 

                                                                Income Statement

 

Sales (40,000 units)…………………………………………………                                    $200, 000

 

Variable expenses

 

      Variable cost of goods sold……………………………….   $ 80,000

 

      Variable selling and administrative expenses …         30,000                    110,  000

 

Contribution margin…………………………………………                                           90,  000

 

Fixed expenses

 

      Fixed  manufacturing overhead ……………………….       75, 000

 

      Fixed selling and administrative expenses……….        20, 000                     95,  000

 

Net operating loss …………………………………………………                                     $   (5, 000)

 

 

 

Ms. Scott is discouraged over the loss for the month because she had planned to use the statement to encourage investors to purchase stock in the new company. A friend who is a CPA, insists that the company should be using absorption costing rather than variable costing.  He argues that if absorption costing had been used, the company would have reported a profitfor the month.

 

 

 

Selected cost data relating to the product and to the first month of operation follow:

 

 

 

                Units produced ……………………………………………………………………… 50, 000

 

                Units sold ………………………………………………………………………………. 40, 000

 

                Variable cost per unit:

 

                                Direct materials………………………………………………………… $     1.00

 

                                Direct labor …………………………………………………………..…. $     0.80

 

                                Variable manufacturing overhead ……………………………  $     0.20

 

                                Variable selling and administrative expenses…………..  $      0.75

 

 

 

 

 

REQUIRED: also does realistic computer animation for special effect in movies.

 

 

 

 

 

1.       Complete the following:

 

a.       Complete the product cost under absorption cost.

 

b.      Redo the company’s income for the month using the absorption costing.

 

c.       Reconcile the variable and absorption costing net operating income (loss) figures.

 

2.       Was the CPA correct in suggesting that the company really earned a “profit” for the month?

 

Explain?

 

3.       During the second month of operations, the company again produced 50,000 units but sold

 

60,000 units (Assume no change in total fixed costs).

 

a.       Prepare a contribution format income statement for the month using variable costing.

 

b.      Prepare an income statement for the month using the absorption costing.

 

c.       Reconcile the variable costing net operating incomes.

 

 

 

 

 

PROBLEM 6-16 Second – Stage Allocation and Product Margins (LO 6-4, LO 6-5)

 

AnimPix, Inc.  is a small company that creates computer-generated animation for films and television. Much of the company’s work consists of short commercials for television, but the company

 

 

 

The young founders of the company have become increasingly concerned with the economics of the business-particularly because many competitors have sprung up recently in the local area.

 

To help understand the company’s cost-structure, an activity-based costing system has been designed.

 

Three major activities carried out in the company; animation concept, animation production, and contract administration. The animation concept activity is carried out at the contract proposal stage when the company bids on projects. This is an intensive activity that involves individuals from all parts of the company bids on the projects. This is an intensive activity that involves individuals from all parts of the company in creating storyboards and prototype stills to be shown to the prospective client. After the client has accepted a project, the animation goes into production and contract administration begins.

 

 

 

Technical staff do almost all the work involved in animation production, whereas the administrative staff is largely responsible for contract administration. The activity cost pools and their activity measure and rates are listed below:

 

 

 

Activity Cost Pool                     Activity Measure                      Activity Rate

 

Animation concept………………… Number of proposals           $ 6, 000 per proposal

 

Animation production……………. Minutes of animation          $ 7, 700 per minute of animation

 

Contract administration…………  Number of contracts            $ 6, 600 per contract

 

 

 

These activity rates include all of the costs of the company, except for the costs of idle capacity and re-organization-sustaining costs. There are no direct labor or indirect materials costs.

 

Preliminary analysis using these activity rates has indicated that the local commercials segment of the market maybe unprofitable. This segment is higly competitive. Producers of local commercials may ask several companies like Anim Pix to bid which results in an unusually low ratio of accepted contracts to bids.

 

 

 

Furthermore, the animation sequences tend to be much shorter for local commercials than for other work. Because animation work is billed at standard rates according to the running time of the completed animation, the revenues from these short projects tend to be below average. Data concerning activity in the local commercials market appear below:

 

 

 

                                                                   Local

 

Activity  Measure                                Commercials

 

Number of proposals ……………………..        20

 

Minutes of animation …………………….        12

 

Number of contracts ………………………          8

 

 

 

The total sales for local commercials amounted to $240,000.

 

 

 

REQUIRED:

 

1.      Determined the cost of serving the local commercial market.

 

2.      Prepare a report showing the margin earned serving the local commercial market. (Remember, this company has no direct materials or direct labor costs.)

 

3.      What would you recommend to management concerning the local commercial market?

 

 

 

 

 

 

 

PROBLEM 6-17  Precision Manufacturing , Inc.

 

Comparing Traditional and Activity – Based Product Margins (LO 6-1, LO 6-3)

 

 

 

 

 

 Precision Manufacturing Inc. (PMI)  makes two type of industrial component parts – the EX300 and the TX500. An absorption costing income statement for the most recent period is shown below:

 

 

 

                                                             Precision Manufacturing Inc.

 

                                                                     Income Statement

 

Sales ………………………………………………………..  $ 1, 700, 000

 

Cost of goods sold……………………………………      1, 200, 000

 

Gross margin……………………………………………          500, 000

 

Selling and administrative expenses…………          550, 000

 

Net operating loss …………………………………..  $      ( 50, 000)

 

 

 

 

 

PMI produced and sold 60,000 units of EX300 at a price of $20 per unit and 12, 500 units of TX500 at a price of $40 per unit. The company’s traditional cost system allocated manufacturing overhead to products using a plantwide overhead rate and direct labor dollar as the allocation base. Additional information relating to the company’s two product lines is shown below:

 

 

 

                                                EX300                          TX500              Total

 

 

 

Direct materials………………… $ 366, 325                      $ 162, 550         $ 528, 875

 

Direct labor………………………. $ 120, 000                      $    42, 500            162, 500

 

Manufacturing overhead…..                                                                   508, 625

 

Cost of goods sold……………..                                                                      $ 1, 200, 000

 

 

 

The company has created an activity-based costing system to evaluate the profitability of its products. PMI’s ABC implementation team concluded that $50,000 and $100,000 of the company’s advertising expenses could directly traced to EX300 and TX500, respectively. The remainder of the selling and administrative expenses was organization – sustaining in nature. The ABC team also distributed the company’s manufacturing overhead to four activities as shown below:

 

 

 

                                                                        Manufacturing                                           Activity           

 

Activity cost Pool (and activity measure)           Overhead           EX 300    TX 500   Total

 

Machining (machine-hours)…………………       $198, 250                  90,000  62,500     152,500

 

Setups (setup hours)…………………………….         150, 000                         75        300             375

 

Product-sustaining costs………………………          100, 000                        1            1                   2

 

Other ( organization-sustaining costs)                60, 375                        NA          NA               NA

 

Total manufacturing overhead cost……..     $ 508,   625

 

 

 

REQUIRED:

 

1.      UsingExhibit 6-12 as a guide, compute the product margins for the EX300 and TX500 under the company’s traditional costing system.

 

2.      Using  Exhibit 6-10 as a guide, compute the product margins for EX300 and TX500 under the activity-based costing system.

 

3.      Using Exhibit 6-13 as a guide, prepare a quantitative comparison of the traditional and activity-based cost assignments. Explain why the traditional and activity – based cost assignments differ.   

 

 

 

 

 

 

 

PROBLEM 6-18  Comparing Traditional and Activity-Based Product Margin (LO 6-1, LO 6-3,

 

LO 6-4, LO 6-5).

 

 

 

Rocky mountain corporation makes two types of hiking boots – Xactive and the Pathbreaker . Data concerning these two product lines appear below:

 

 

 

                                                                                    Xactive                        Pathbreaker

 

Selling price per unit……………………………………………  $ 127. 00                         $ 89. 00

 

Direct materials per unit……………………………………..       64. 80                              51.00

 

Direct labor per unit ……………………………………………       18. 20    &nb

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