WEEK 5 (UNIT 4) - TUTORIAL SOLUTIONS

REVIEW QUESTION
7.1 Both absorption and variable costing systems assign direct material, direct labour and variable
manufacturing overhead costs to products in exactly the same way, but they differ over their treatment of
fixed manufacturing overhead. Absorption costing includes fixed manufacturing overhead as a part of
product cost. Variable costing excludes fixed manufacturing overhead from product cost and expenses it in
the period in which it is incurred.
The key distinction between variable and absorption costing is the timing of fixed manufacturing overhead
becoming an expense. Eventually, fixed overhead is expensed under both product costing systems. Under
variable costing, fixed overhead is expensed immediately, when it is incurred. Under absorption costing,
fixed overhead is inventoried and not expensed until the accounting period during which the manufactured
goods are sold.

EXERCISE 7.31 (20 minutes) (appendix) Variable and absorption costing:

manufacturer

1 Porter Ltd
Income statement under absorption costing
Year ended 31 December
Sales revenue (36 000 units at $45/unit) $1 620 000
Less: Cost of goods sold (36 000  $35/unit)* 1 260 000
Gross margin 360 000
Less: Selling and administrative expenses:
Variable $108 000
Fixed 30 000
138 000
Net profit $222 000
2
Porter Ltd
Contribution margin statement under variable costing
Year ended 31 December
Sales revenue (36 000 units at $45/unit) $1 620 000
Less: Variable expenses:
Variable manufacturing costs
(36 000  $27/unit) $972 000
Variable selling & administrative costs 108 000
1 080 000
Contribution margin 540 000
Less: Fixed expenses
Fixed manufacturing overhead $300 000
Fixed selling and administrative expenses 30 000
330 000
Net profit $ 210 000
* Assuming that the production of 25 000 units equalled the normal capacity, the fixed manufacturing overhead per
unit is $8 ($300 000/37 500 units).

3 (a) The absorption costing profit is higher because 1500 units produced are carried forward as finished
goods inventory. Each unit carries forward a cost of $8 for manufacturing overhead that is expensed
under variable costing. Therefore using the absorption costing method the costs in the income
statement are
$12 000 lower than when using the contribution margin approach, where total fixed costs are
expensed as period costs.

(b) The short cut method is based on the change in closing inventory, which represents costs incurred
in the current period which will be released against future revenue. Where production is greater than
sales (as in this case) the higher value of closing inventory deducted from the cost of goods available
for sale shows a lower cost of goods sold— and, therefore, a higher gross profit. The calculation for
this is shown below.

Increase (decrease) fixed manufacturing cost

 = difference in profit
in units in inventory per unit
1500 units  $8 = $12 000 more under
absorption costing
PROBLEM 7.42 (45 minutes) (appendix) Absorption versus variable costing:
manufacturer
1
Cost per unit Variable Absorption
Direct material $6.00 $6.00
Direct labour 3.00 3.00
Variable overhead 4.00 4.00
Fixed overhead * 2.00
$13.00 $15.00
budgeted fixed overhead
* Fixed overhead =
budgeted level of production
$400 000
=
200 000
= $2 per unit

2 (a)
YoYum Ltd
Absorption costing income statement
for the year ended 30 June
Sales revenue (190 000 units sold at $19 per unit) $3 610 000
Less: Cost of goods sold (at absorption cost of $15 per unit) 2 850 000
Gross margin 760 000
Less: Selling and administrative expenses:
Variable (at $2 per unit) 380 000
Fixed 70 000 450 000
Net profit $310 000
 (b)
YoYum Ltd
Variable costing income statement
for the year ended 30 June

Sales revenue (190 000 units sold at $19 per unit) $3 610 000
Less: Variable expenses:
Variable manufacturing costs (at variable cost of $13 per unit 2 470 000
Variable selling and administrative costs (at $2 per unit) 380 000 2 850 000
Contribution margin 760 000
Less: Fixed expenses:
Fixed manufacturing overhead 400 000
Fixed selling and administrative expenses 70 000 470 000
Net profit $290 000

3 Cost of goods sold under absorption costing $2 850 000

Variable cost of goods sold 2 470 000
Difference in cost of goods sold 380 000
Fixed manufacturing overhead as period expense under variable costing 400 000
Total differences between the two methods (20 000)
Net profit under variable costing 290 000
Net profit under absorption costing 310 000
Difference in net profit $(20 000)

4 Difference in fixed overhead expensed under absorption and variable costing

= change in inventory (in units)  predetermined fixed overhead rate per unit
= 10 000 units  $2 per unit
= $20 000
As shown in requirement 2, reported profit is $20 000 lower under variable costing.
5
Units sold 190 000
Sales price $ 20.00
Direct material $ 6.50
Direct labour $ 3.00
Variable overhead $ 4.00
Fixed overhead $ 2.00

(a) Absorption costing

Units Cost Total
Sales revenue 190 000 $ 20.00 $ 3 800 000.00
Less: Cost of goods sold 190 000 $ 15.50 $ 2 945 000.00
Gross margin $ 855 000.00
Less: Selling and admin. exp. 190 000 $ 2.00 $ 380 000.00
Fixed expense $ 70 000.00
Net profit $ 405 000.00

(b) Variable costing

Units Cost Total
Sales revenue 190 000 $ 20.00 $ 3 800 000.00
Less: Variable expense 190 000 $ 13.50 $ 2 565 000.00
Variable selling and admin. exp. 190 000 $ 2.00 $ 380 000.00
Contribution margin $ 855 000.00
Less: Manufacturing overhead $ 400 000.00
Fixed expense $ 70 000.00
Net profit $ 385 000.00

REVIEW QUESTION

19.16
A by-product has little value in comparison with other joint products and its output is not the purpose of the joint
production process. It is not allocated any of the joint processing costs. A common way of dealing with its revenue
and any separable costs is to deduct the net realisable value of the by-product from the joint processing costs
before they are allocated to the remaining joint products.
Examples of by-products (and rethinking about their worth) are found in the second ‘Real life’ in
‘Relevant information for some common decisions’. In the Wallaby Airlines case in the chapter, of a decision to
provide a one-off charter flight, by-products could be the sale of on-board items such as food or duty free products,
or use of in-flight video hire facilities. Other by-products could be more tailored flights in future
EXERCISE 19.30 (15 minutes) (appendix) Joint cost allocation: manufacturer

1 Physical units method:

Joint cost Joint products Quantity at Relative Allocation of

split-off point proportion joint cost

Yummies 12 000 kg 0.60 $108 000*

$180 000

Crummies 8 000 kg 0.40 72 000†

Total 20 000 kg $180 000

* $108 000 = $180 000  0.60

† $72 000 = $180 000  0.40

2 Relative sales value method:

Joint cost Joint Quantity at Sales Sales value at Relative Allocation of

products split-off price split-off point proportion joint cost

Yummies 12 000 kg $9.00 $108 000 0.5455* $98 190

$180 000

Crummies 8 000 kg 11.25 90 000 0.4545* 81 810

Total $198 000 $180 000

*Rounded

3 Constant gross margin method:

Joint Joint Gross Sales Required Separable Allocation of

cost products margin revenue gross margin cost of joint cost
percentage* processing

Yummies 9.09 $108 000 $9 817 – $98 172

$180000

Crummies 9.09 90 000 8 181 81 810

Total $180 000**

* [($108 000 + $90 000) – $180 000]/($108 000 + $90 000) = 9.09% (rounded)
** rounding error of $1
CASE 19.46 (appendix) Joint cost allocation: Manufacturer

1 Muscletuff Separable Megatuff

. sales value: process costs: sales value:
. $200 000 for $40 000 $280 000 for
. 8000 kg 8000 kg
Total joint
cost:

$210 000 in
MiTquik Separable Xtraquik
May
sales value: process costs:
sales value:
$100 000 for $30 000
$190 000 for
2000 kg

2 (a) Physical units method:

Joint cost per Joint Quantity at Relative Allocation of joint

month products split-off point proportion cost

$210 000 Muscletuff 8 000 kg 80% $168 000

MiTquik 2 000 kg 20% 42 000

Total 10 000 kg $210 000

(b) Constant gross margin method:

Sales revenue

Megatuff 8 000  $35 $280 000

Xtraquik 2 000  $95 190 000 $470 000

Less: Production costs:

Production 210 000

Muscletuff 8 000  $5 40 000

MiTquik 2 000  $15 $30 000 280 000

Gross margin $190 000

Separable
Joint cost Gross margin Sales Required gross cost of Allocation of
per run Joint products percentage revenue margin processing joint cost

$210 000 Muscletuff 40.426%* $280 000 $113 192* $40 000 $126 808*

MiTquik 40.426%* 190 000 76 808* 30 000 83 192*

Total $210 000

 (c) Relative sales method

Joint cost per Joint Sales value at Relative Allocation of joint

month products split-off point proportion cost

$210 000 Muscletuff $200 000 67% $140 700

MiTquik $100 000 33% 69 300

Total $300 000 $210 000

(d) Net realisable value method

Joint cost Sales value of Separable cost Net realisable Relative Allocation of
per month Joint products final product of processing value proportion joint cost

$210 000 Muscletuff $280 000 $40 000 $240 000 60% $126 000

MiTquik 190 000 30 000 160 000 40% 84 000

Total $400 000 $210 000

3 Incremental revenue per kg from further processing

into Acceler8 ($130 – $95) $35

Incremental cost per kg from further processing:

Processing cost $40

Packaging costs 6 46

Incremental loss per kg from further processing into Acceler8 $(11)

Conclusion: Do not process Xtraquik into Acceler8. The firm should sell Xtraquik.

4 The joint cost allocation in requirement 2 is irrelevant. The relevant data are the incremental costs and
benefits associated with turning Xtraquik into Acceler8
5 Using an Excel spreadsheet to re-calculate requirements 2 and 3. When joint cost becomes $245 000, the
solution is as follows.

(a) Joint cost per Joint Quantity at Relative

month Allocation of
products split-off point proportion joint cost

$245 000 Muscletuff 8 000 80% $196 000

MiTquik 2 000 20% $49 000

Total 10 000 $245 000

(b) Constant gross margin method:

Sales revenue

Megatuff 8000  $35 $280 000

Xtraquik 2000  $95 190 000 $470 000

Less: Production costs:

Production 245 000

Muscletuff 8000  $5 40 000

MiTquik 2000  $15 30 000 315 000

Gross margin $155 000

Separable
Joint cost Gross margin Sales Required gross cost of Allocation of
per run Joint products percentage revenue margin processing joint cost

$245 000 Muscletuff 32.979%* $280 000 $92 340* $40 000 $147 660 *

MiTquik 32.979%* 190 000 62 660* 30 000 97 340 *

Total $245 000

(c) Joint cost per Joint Sales value at Relative

month Allocation of
products split-off point proportion joint cost

$245 000 Muscletuff $200 000 67% $164 150

MiTquik $100 000 33% $80 850

Total $300 000 $245 000

 Separable
Joint cost Joint Sales value of cost of Net realisable Relative Allocation of
(d) per month products final product processing value proportion joint cost

$245 000 Muscletuff $280 000 $40 000 $240 000 60% $147 000

MiTquik $190 000 $30 000 $160 000 40% $98 000

Total $400 000 $245 000

If the sales price of Acceler8 is $125 per kilogram, the incremental analysis would show a greater loss
of $16.

Incremental revenue per kg from further processing

into Acceler8 $30

Incremental cost per kg from further processing:

Processing cost $40

Packaging costs $6

Incremental loss per kg from further processing into Acceler8 $(16)

6 The joint cost allocation is only useful for product costing in financial reporting. These different costs
resulted from four different cost allocation methods are not useful for production decision making or
product profitability analysis. Incremental analysis is better suited for production decision purposes.