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Christopher's Custom Cabinet Company uses a job order costing system with overhead applied as a percentage of direct labor costs. Inventory balances at the beginning of 2009 follow:

 Raw materials inventory $15,000 Work in process inventory 5,000 Finished goods inventory 20,000\begin{array}{lr}\text { Raw materials inventory } & \$ 15,000 \\ \text { Work in process inventory } & 5,000 \\ \text { Finished goods inventory } & 20,000\end{array}

The following transactions occurred during January: (a) Purchased materials on account for 26,000.(b)Issuedmaterialstoproductiontotaling26,000. (b) Issued materials to production totaling 22,000, 90 percent of which was traced to specific jobs and the remainder treated as indirect materials. (c) Payroll costs totaling 15,500wererecordedasfollows:15,500 were recorded as follows: 10,000 for assembly workers

3,000 for factory supervision 1,000 for administrative personnel 1,500 for sales commissions

( d ) Recorded depreciation: $6,000 for machines,$1,000 for office copier. ( e ) Had $2,000 in insurance expire, allocated equally between manufacturing and administrative expenses. ( f ) Paid$6,500 in other factory costs in cash. ( g ) Applied manufacturing overhead at a rate of 200 percent of direct labor cost. ( h ) Completed all jobs but one; the job cost sheet for this job shows $2,100 for direct materials,$2,000 for direct labor, and $4,000 for applied overhead. ( i ) Sold jobs costing$50,000; the company uses cost-plus pricing with a markup of 30 percent.


  1. Set up T-accounts, record the beginning balances, post the January transactions, and compute the final balance for the following accounts: Raw Materials Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Manufacturing Overhead Selling and Administrative Expenses Sales Revenue Other accounts (Cash, Payables, etc.)
  2. Determine how much gross profit the company would report during the month of January before any adjustment is made for the overhead balance.
  3. Determine the amount of over- or underapplied overhead.
  4. Compute adjusted gross profit assuming that any over- or underapplied overhead balance is adjusted directly to Cost of Goods Sold.

Gammaro Company uses standard costing. Tim Sweeney, the new president of Gammaro Company, is presented with the following data for 2017:

Gammaro CompanyIncome Statements for the Year Ended December 31, 2017VariableAbsorptionCostingCostingRevenues$9,350,000$9,350,000Cost of goods sold (at standard cost)4,695,0005,855,000Fixed manufacturing overhead (budgeted)1,350,000-Fixed manufacturing overhead variances (all unfavorable):Spending125,000125,000Production volume-405,000Total marketing and administrative costs (all fixed)1,570,0001,570,000Total costs7,740,0007,955,000Operating income$1,610,000$1,395,000Inventories (at standard costs)December 31, 2016$1,345,000$1,730,000December 31, 201745,000215,000\begin{matrix} \text{Gammaro Company}\\ \text{Income Statements for the Year Ended December 31, 2017}\\ & \text{Variable} & \text{Absorption}\\ & \text{Costing} & \text{Costing}\\ \text{Revenues} & \text{\$9,350,000} & \text{\$9,350,000}\\ \text{Cost of goods sold (at standard cost)} & \text{4,695,000} & \text{5,855,000}\\ \text{Fixed manufacturing overhead (budgeted)} & \text{1,350,000} & \text{-}\\ \text{Fixed manufacturing overhead variances (all unfavorable):}\\ \text{Spending} & \text{125,000} & \text{125,000}\\ \text{Production volume} & \text{-} & \text{405,000}\\ \text{Total marketing and administrative costs (all fixed)} & \text{1,570,000} & \text{1,570,000}\\ \text{Total costs} & \text{7,740,000} & \text{7,955,000}\\ \text{Operating income} & \text{\$1,610,000} & \text{\$1,395,000}\\ \text{Inventories (at standard costs)}\\ \text{December 31, 2016} & \text{\$1,345,000} & \text{\$1,730,000}\\ \text{December 31, 2017} & \text{45,000} & \text{215,000}\\ \end{matrix}

  1. At what percentage of denominator level was the plant operating during 2017? 2. How much fixed manufacturing overhead was included in the 2016 and the 2017 ending inventory under absorption costing? 3. Reconcile and explain the difference in 2017 operating incomes under variable and absorption costing. 4. Tim Sweeney is concerned: He notes that despite an increase in sales over 2016, 2017 operating income has actually declined under absorption costing. Explain how this occurred.

Candyland uses standard costing to produce a particularly popular type of candy. Candyland’s president, Jack McCay, was unhappy after reviewing the income statements for the first three years of business. He said, “I was told by our accountants—and in fact, I have memorized—that our break even volume is 25,000 units. I was happy that we reached that sales goal in each of our first two years. But here’s the strange thing: In our first year, we sold 25,000 units and indeed we broke even. than in our second year we sold the same volume and had a significant, positive operating income. I didn't complain, of course … but here’s the bad part. In our third year, we sold 10% more candy, but our operating income dropped by nearly 90% from what it was in the second year! We didn't change our selling price or cost structure over the past three years and have no price, efficiency, or spending variances … so what’s going on?!”

Absorption Costing 201620172018Sales (units)25.00025.00027.500Revenues$ 2.000.000$ 2.000.000$ 2.200.000Cost of goods sold:Beginning inventory00182.500Production1.825.0002.007.5001.825.000Available for sale1.825.0002.007.5002.007.500Deduct ending inventory0(182.500)0Adjustment for production-volume variance0(150.000)0Cost of goods sold:1.825.0001.675.0002.007.500Gross margin175.000325.000192.500Selling and administrative expenses (all fixed)175.000175.000175.000Operating income$ 0$ 150.000$ 17.500Beginning inventory002.500Production (units)25.00027.50025.000Sales (units)25.00025.00027.500Ending inventory025000Variable manufacturing cost per units$ 13$ 13$ 13Fixed manufacturing overhead costs$ 1.500.000$ 1.500.000$ 1.500.000Fixed manuf. costs allocated per unit produced$ 60$ 60$ 60\begin{matrix} \text{Absorption Costing}\\ \text{ } & \text{2016} & \text{2017} & \text{2018}\\ \text{Sales (units)} & \text{25.000} & \text{25.000} & \text{27.500}\\ \text{Revenues} & \text{\$ 2.000.000} & \text{\$ 2.000.000} & \text{\$ 2.200.000}\\ \text{Cost of goods sold:}\\ \text{Beginning inventory} & \text{0} & \text{0} & \text{182.500}\\ \text{Production} & \text{1.825.000} & \text{2.007.500} & \text{1.825.000}\\ \text{Available for sale} & \text{1.825.000} & \text{2.007.500} & \text{2.007.500}\\ \text{Deduct ending inventory} & \text{0} & \text{(182.500)} & \text{0}\\ \text{Adjustment for production-volume variance} & \text{0} & \text{(150.000)} & \text{0}\\ \text{Cost of goods sold:} & \text{1.825.000} & \text{1.675.000} & \text{2.007.500}\\ \text{Gross margin} & \text{175.000} & \text{325.000} & \text{192.500}\\ \text{Selling and administrative expenses (all fixed)} & \text{175.000} & \text{175.000} & \text{175.000}\\ \text{Operating income} & \text{\$ 0} & \text{\$ 150.000} & \text{\$ 17.500}\\ \text{Beginning inventory} & \text{0} & \text{0} & \text{2.500}\\ \text{Production (units)} & \text{25.000} & \text{27.500} & \text{25.000}\\ \text{Sales (units)} & \text{25.000} & \text{25.000} & \text{27.500}\\ \text{Ending inventory} & \text{0} & \text{2500} & \text{0}\\ \text{Variable manufacturing cost per units} & \text{\$ 13} & \text{\$ 13} & \text{\$ 13}\\ \text{Fixed manufacturing overhead costs} & \text{\$ 1.500.000} & \text{\$ 1.500.000} & \text{\$ 1.500.000}\\ \text{Fixed manuf. costs allocated per unit produced} & \text{\$ 60} & \text{\$ 60} & \text{\$ 60}\\ \end{matrix}

  1. What denominator level is Candyland using to allocate fixed manufacturing costs to the candy? How is Candyland disposing of any favorable or unfavorable production-volume variance at the end of the year? Explain your answer briefly. 2. How did Candyland's accountants arrive at the breakeven volume of 25.000 units? 3. Prepare a variable costing-based income statement for each year. Explain the variation in variable costing operating income for each year based on contribution margin per unit and sales volume. 4. Reconcile the operating incomes under variable costing and absorption costing for each year, and use this information to explain to Jack McCay the positive operating income in 2017 and the drop in operating income in 2018.

The Garvis Company uses an absorption-costing system based on standard costs. Variable manufacturing cost consists of direct material cost of $4.50 per unit and other variable manufacturing costs of$1.50 per unit. The standard production rate is 20 units per machine hour. Total budgeted and actual fixed manufacturing overhead costs are $840,000. Fixed manufacturing overhead is allocated at$14 per machine-hour based on fixed manufacturing costs of 840,000840,000\div$60,000 machine-hours, which is the level Garvis uses as its denominator level. The selling price is$10 per unit. Variable operating (nonmanufacturing) cost, which is driven by units sold, is $2 per unit. Fixed operating (nonmanufacturing) costs are$240,000. Beginning inventory in 2017 is 60,000 units; ending inventory is 80,000 units. Sales in 2017 are 1,080,000 units. The same standard unit costs persisted throughout 2016 and 2017. For simplicity, assume that there are no price, spending, or efficiency variances.

  1. Prepare an income statement for 2017 assuming that the production-volume variance is written off at year-end as an adjustment to cost of goods sold.

  2. The president has heard about variable costing. She ask you to recast the 2017 statement as it would appear under variable costing.

  3. Explain the difference in operating income as calculated in requirements 1 and 2.

  4. Graph how fixed manufacturing overhead is accounted for under absorption costing. That is, there will be two lines: one for the budgeted fixed manufacturing overhead (which is equal to the actual fixed manufacturing overhead in this case) and one for the fixed manufacturing overhead allocated. Show the production-volume variance in the graph.

  5. Critics have claimed that a widely used accounting system has led to undesirable buildups of inventory levels.

(a) Is variable costing or absorption costing more likely to lead to such buildups? Why?

(b) What can managers do to counteract undesirable inventory buildups?


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