The Rehe Comany sells its razors at $3 per unit. The company uses a first-in, first-out actual costing system. A fixed manufacturing cost rate is computed at the end of each year by dividing the actual fixed manufacturing costs by the actual production units. The following data are related to its first two years of operation: 2011 2012
Sales 1000 units
1200 units
Costs:
Variable manufacturing
Fixed manufacturing
Variable operating (marketing)
Fixed operating (marketing)
$ 700
700
1000
400
$ 500
700
1200
400
1. Prepare income statements based on variable costing for each of the two years.
2. Prepare income statements based on absorption costing for each of the two years.
3. Prepare a numerical reconciliation and explanation of the difference between operating income for each year under absorption costing and variable costing.
4. 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 be done to counteract undesirable inventory buildups?

                                                            2011                  2012

Sales                                               1000 units         1200 units

Production                                          1400                  1000  

Costs:  

Variable manufacturing                      $700               $500

per unit $0.50

Fixed manufacturing                           $700               $700

Variable operating (marketing)         $1000             $1200

Fixed operating (marketing)               $400               $400

cogs under absorption costing 2011 = ($1,400 / 1,400) x 1,000 = $1,000

cogs under absorption costing 2012 = $400 + ($1,200 / 1,000) x 800 = $1,360

1.                                    INCOME STATEMENTS

                                       VARIABLE COSTING

                                                              2011                    2012

Total sales revenue:                        $3,000                $3,600            

Opening inventory:                               ($0)                 ($200)

Variable manufacturing:                   ($700)                 ($500)

Ending inventory:                               $200                   $100

Gross contribution margin:             $2,500               $3,000

Variable operating:                         ($1,000)              ($1,200)  

Contribution margin:                        $1,500                $1,800  

Fixed manufacturing:                         ($700)                ($700)

Fixed operating:                                ($400)                ($400)

Net operating income:                       $400                  $700

2.                                   INCOME STATEMENTS

                                    ABSORPTION COSTING

                                                              2011                    2012

Total sales revenue:                        $3,000                $3,600            

COGS:                                             ($1,000)                ($1,360)

Gross margin:                                  $2,000                $2,240

Operating costs:                             ($1,400)               ($1,600)

Net operating income:                       $600                   $640

3. Under variable costing, closing inventory = 400 units x $0.50 (variable production costs per unit) = $200.

Under absorption costing, closing inventory = 400 units x $1 (production cost per unit) = $400

Since closing inventory is $200 higher under absorption costing, then net operating income during 2011 increases by $200.

4. a) Variable costing is more likely to result in inventory buildups. Since variable costing determines the value of closing inventory only using variable manufacturing costs, their value is much lower. E.g. in this case the value of closing inventory 2011 under variable costing is $200, while under absorption costing it is $400. This means that less costs are transferred from one year to another.

b) Cost of goods sold must include all production costs (both variable and fixed). This way COGS costs cannot be over estimated during one year and under estimated the next.

1   all nations face the problem of scarcity because there are limited resources and unlimited wants. nations do not have enough factors of production to produce everything that their population wants. entrepreneurial resources initiate businesses to make new goods and services; labor resources produce goods and services.

2 there are four factors of production: natural resources, labor resources, capital resources, and entrepreneurial resources. natural resources are raw materials from nature that are used to produce goods. trees, water, and grains are natural resources. some natural resources, such as wheat and cattle, are renewable

3 wants

things that you do not need to have in order to survive, but would like to have

needs

things that you must have in order to survive

goods

physical products

services

tasks that a business perform for customers

resources

items that people can use to make or obtain what they need or want

determine

to settle or decide by choice of alternatives or possiblities

4 i really dont know