BUS 630 WEEK 3 ASSIGNMENT
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BUS630Chapter5.pdf
Learning Objectives
After studying Chapter 5, you will be able to:
Use three different methods to allocate joint product costs, and explain how to handle situations involving byproducts and scrap.
Recast absorption costing income statements into variable costing income statements, reconcile the differences between the two net incomes, and understand arguments supporting both approaches.
5 Joint Cost Allocation and Variable andAbsorption Costing
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Should We Hide the Joint Cost Assigned to Hides?
Toco Hills Meat Packers handles the slaughtering, processing, packaging, and distribution of cattle. Dianne Leader, the company’s President, has just received the �irst quarter �inancial statements from her Vice- President and Controller, Bruce Berger. She immediately sees that while pro�its from the various meat products are up from the previous quarter, the pro�its from hides are down considerably. She calls Bruce and asks, “Can you tell me why costs for the hides appear to be so high?” Bruce responds, “No, but I’ll look into it and get an answer for you by tomorrow at this time.”
Like clockwork, Bruce knocks on the President’s door, enters, and hands Dianne a one-page report. “Ah, the joint cost allocation to hides seems to be out of line,” Dianne says with a frown. “You know,” Dianne tells Bruce, “if I had to bet on it, I’d wager some big bucks that you changed the way joint costs are assigned to our products.”
Indeed, the way joint costs are assigned to joint products that are produced by a company can greatly affect the reported pro�its from the various products. So, how should these costs be assigned?
5.1 Joint Cost Allocation Production processes can sometimes spawn multiple products from common inputs and processing. These are called joint products. An example is a re�inery where crude oil is processed into joint products of gasoline, heating oil, and motor oil. The costs of materials and processing up until individual products are identi�iable are referred to as joint costs. This point at which the individual products become identi�iable is known as the split-off point. Until this point, the common input is a single product. The joint costs are allocated to the joint products for some product costing purposes such as external �inancial statement presentation and product pricing. In previous chapters, we have allocated costs using cost drivers that measure inputs such as labor hours or machine hours. However, input measures are not feasible for allocating joint costs since the joint products are not individually distinguishable until the split-off point, and hence, one cannot identify the amount of input associated with each product that emerges at the split-off point. Three common joint cost allocation methods—all based on outputs—are discussed next.
Physical Measures of Output
Physical measures of output re�lect some quanti�iable physical characteristics of the joint products. Examples include number of units, weight, liquid volume, and length. The joint costs would be allocated in proportion to each product’s output measure. Consider the Vexler Mining Company, which mines ore, and after separating the ore in a smelter, sells the individual outputs to jewelry and industrial manufacturers. Suppose that $400,000 in materials, labor, and overhead was incurred to mine a total of 100,000 ounces of the following three metals:
Mineral Amount
Gold 10,000 ounces
Silver 20,000 ounces
Copper 70,000 ounces
100,000 ounces
The joint cost allocations are made by multiplying the ratio of the metal’s output to the 100,000 total and multiplying the ratio by the $400,000 joint cost, as follows:
Allocation to gold: (10,000 ÷ 100,000) × $400,000 = $40,000
Allocation to silver: (20,000 ÷ 100,000) × $400,000 = $80,000
Allocation to copper: (70,000 ÷ 100,000) × $400,000 = $280,000
Note that the sum of these three allocated costs equals the $400,000 total joint cost. This method is generally simple to use, but has two potential major drawbacks. First, the outputs may have different units of measure. For instance, consider a petroleum re�inery that produces gasoline and paraf�in from a joint process. A common measure for gasoline, a liquid, would be gallons; for paraf�in, a solid, a common measure would be pounds.
A second limitation is that physical measures may be unrelated to the pro�itability of the joint products. Why is this an important consideration? The reason relates to why joint costs are incurred. Since joint costs are incurred because of the value that will be received from selling the joint products, the allocation of these joint costs should be related to the products’ values. For Vexler Mining Company, 70% of the joint cost was allocated to copper. Suppose, however, that gold accounts for 90% of the three metals’ total revenues. Clearly, the gold is what motivates Vexler to spend $400,000 to mine the ore, yet it receives only 10% (10,000 ÷ 100,000) of the joint costs, while copper is charged with seven times as much.
Relative Sales Value
The relative sales value (RSV) approach allocates joint costs in proportion to the joint products’ total sales values at the split-off point. Assume the following sales values for Vexler Mining Company’s joint products:
Mineral Sales Values
Gold $500,000
Silver 200,000
Copper 100,000
$800,000
Under the RSV method, the joint cost allocations would be as follows:
Allocation to gold: ($500,000 ÷ $800,000) × $400,000 = $250,000
Allocation to silver: ($200,000 ÷ $800,000) × $400,000 = $100,000
Allocation to copper: ($100,000 ÷ $800,000) × $400,000 = $50,000
Note that the sum of these three allocated costs equals the $400,000 total joint cost.
Net Realizable Value
A potential problem with the RSV approach is that sales prices at the split-off point may not be readily available. Moreover, there might not even be a market for one or more of the joint products at the split-off point. Further processing may be necessary to sell some products. The net realizable value (NRV) method uses approximations of sales values at the split-off point. NRV is the total sales revenue of the product in its �inal form less any separable costs. The latter consist of costs incurred after the split-off point, and as such, can be traced to the individual products. Separable costs include processing costs, selling costs, and disposal costs.
Suppose that after Vexler Mining Company smelts its ore, it incurs some costs to get the metals ready for sale to manufacturers. These separable costs, the products’ revenues, and the resulting NRVs are as follows:
Mineral Separable Costs Revenues NRV
Gold $10,000 $550,000 $540,000
Silver 12,000 252,000 240,000
Copper 15,000 135,000 120,000
$900,000
For the NRV method, the joint cost allocations would be as follows:
Allocation to gold: ($540,000 ÷ $900,000) × $400,000 = $240,000
Allocation to silver: ($240,000 ÷ $900,000) × $400,000 = $106,667
Allocation to copper: ($120,000 ÷ $900,000) × $400,000 = $53,333
Note that the sum of these three allocated costs equals the $400,000 total joint cost. Occasionally, a situation may arise where a product’s NRV is negative. When this happens, none of the joint cost should be allocated to that product. The total joint cost would just be allocated to the products having positive NRVs.
The following table summarizes the joint cost allocations for all three methods:
Mineral Physical Output RSV NRVMineral Physical Output RSV NRV
Gold $40,000 $250,000 $240,000
Silver 80,000 100,000 106,667
Copper 280,000 50,000 53,333
$400,000 $400,000 $400,000
Byproducts and Scrap
Byproducts and scrap are products that emerge with joint (main) products but have minor sales value compared to the joint products. Byproducts are often processed after the split-off point, while scrap is usually discarded. The accounting treatment, though, is the same for both byproducts and scrap. Joint costs are not allocated to byproducts or scrap. The rationale for this treatment is that joint costs are incurred to produce the main products—not byproducts or scrap.
Revenue from byproducts or scrap is usually handled in one of two ways:
1. Recognize miscellaneous income from the NRVs of byproducts and scrap. 2. Deduct the NRVs of byproducts and scrap from the joint costs that are allocated to the main products.
The rationale for the second approach builds on the argument we mentioned for not allocating joint costs to byproducts or scrap. That is, the joint production process is undertaken for the pro�its to be earned from main products—not byproducts or scrap. Therefore, no pro�it should be recognized on byproducts or scrap. In effect, the second method shifts any pro�it (NRV) on byproducts and scrap to the main products by reducing the joint costs assigned to the main products.
As an example, suppose that sulphur is a byproduct at Vexler Mining Company. Recall that with the RSV method, we had the following RSVs for the three joint products:
Mineral Sales values
Gold $500,000
Silver 200,000
Copper 100,000
$800,000
Suppose now that sulphur could be sold at the split-off point for $8,000 after incurring separable costs of $2,000. With the miscellaneous income approach, $6,000 ($8,000 – $2,000) in miscellaneous income would appear on Vexler’s income statement from the sale of sulphur. Under the alternate approach, joint costs of $394,000 ($400,000 – $6,000) would be allocated to the main products in proportion to just the main products’ total sales values, as follows:
Allocation to gold: ($500,000 ÷ $800,000) × $394,000 = $246,250
Allocation to silver: ($200,000 ÷ $800,000) × $394,000 = $98,500
Allocation to copper: ($100,000 ÷ $800,000) × $394,000 = $49,250
Annotations for: 5.1 Joint Cost Allocation Highlights
Yellow
1. The joint cost allocations are made by multiplying the ratio of the metal’s output to the 100,000 total and multiplying the ratio by the $400,000 joint cost, as follows:
5.2 Variable and Absorption Costing Variable costing (also known as direct costing) is an approach to product costing that assigns only variable manufacturing costs (direct materials, direct labor, and variable factory overhead) to items produced. Thus, inventoriable costs are limited to the variable manufacturing costs, and period costs include all �ixed costs and variable nonmanufacturing costs. Absorption costing (also known as full costing), the method typically used for external income statement reporting, allocates all manufacturing costs (variable and �ixed) to products. This section compares these two costing methods.
Contemporary Practice 5.1: Usage of Variable Costing
In a survey of 148 German and 130 U.S. companies in a cross section of industries, far more German companies labeled their costing system as variable costing—52% versus 21%. The director of cost accounting and internal audit at Cliffstar remarked, “We like variable costing because it doesn’t ‘muddy up’ the waters with less controllable �ixed overhead.”
Source: Krumwiede, K., & Suessmair, A. (2007, June). Getting down to speci�ics on RCA. Strategic Finance, 51–55.
Variable costing, like absorption costing, can be used in conjunction with actual, normal, or standard costing systems. For simplicity, we will restrict our discussion in this chapter to situations in which actual costing is used.
Characteristics of Variable and Absorption Costing
The two costing methods vary as to the cost elements for product costs, the difference in inventory values, and the difference in pro�its. These differences all result from one basic item—the treatment of �ixed manufacturing costs. Absorption costing includes these costs in product costs while variable costing considers them as period costs to be included with the operating expenses. The following summary contrasts the two costing approaches:
Cost Category Variable Costing Absorption Costing
Direct materials Product Product
Direct labor Product Product
Variable factory overhead Product Product
Fixed factory overhead Period Product
Marketing expenses Period Period
Administrative expenses Period Period
Variable costing typically uses a contribution margin approach as a reporting format. Variable marketing and administrative costs are included in the computation of the contribution margin. However, variable marketing and administrative costs are not product costs. While we will portray variable costing income statements using the contribution format, we will use the traditional format for the absorption costing income statements. A comparison of the two approaches appears below:
Variable Costing Absorption Costing
Variable Costing Absorption Costing
Sales revenue Sales revenue
− Variable cost of goods sold − Cost of goods sold
− Other variable costs = Gross pro�it
= Contribution margin − Other variable costs
− Fixed manufacturing costs − Fixed manufacturing costs
− Fixed nonmanufacturing costs − Fixed nonmanufacturing costs
= Operating income = Operating income
Deciding between variable costing and absorption costing has an impact on inventory values and pro�its because of the variation in the treatment of �ixed factory overhead. Although the pro�it can differ between the two costing methods, pro�it under variable costing is not always higher or lower than absorption costing. The difference between pro�its under the two methods is determined by the relationship of production to sales. Assuming that the �ixed manufacturing costs per unit remain the same from one period to the next, we have three possibilities, as follows:
Net Income
Production units equal sales units AC = VC
Production units greater than sales units (building inventory) AC > VC
Production units less than sales units (liquidating inventory) AC < VC
AC = Absorption costing
VC = Variable costing
The magnitude of any difference in pro�its is a function of the �ixed manufacturing costs per unit and the changes in inventory levels, as we will discuss later.
Comparing Variable Costing and Absorption Costing
Let’s assume that Morris the Florist sells one type of �loral arrangement. In its �irst year, 2018, Morris the Florist produced 100,000 arrangements and sold 75,000 at $25 each. The costs for the year are:
Production Costs (Per Unit):
Materials $3.00
Labor 8.00
Variable overhead 5.00
Fixed overhead ($200,000/100,000 units) 2.00
Marketing and Administrative Costs:
Variable $1.00 per unit sold
Fixed $150,000
The absorption costing income statement that re�lects these results is as follows:
Absorption Costing Income Statement for the Year Ended December 31, 2018
Absorption Costing Income Statement for the Year Ended December 31, 2018
Sales revenue ($25 × 75,000) $1,875,000
Cost of sales:
Variable ($16 × 75,000) $1,200,000
Fixed ($2 × 75,000) 150,000 1,350,000
Gross pro�it $525,000
Marketing and administrative expenses:
Variable ($1 × 75,000) $75,000
Fixed 150,000 225,000
Net pro�it $300,000
A variable costing income statement would be as follows:
Variable Costing Income Statement for the Year Ended December 31, 2018
Sales revenue ($25 × 75,000) $1,875,000
Variable costs:
Production ($16 × 75,000) $1,200,000
Marketing and administrative ($1 × 75,000) 75,000 1,275,000
Contribution margin $600,000
Fixed costs:
Production $200,000
Marketing and administrative 150,000 350,000
Net pro�it $250,000
Notice that the variable costing pro�it is lower than the pro�it from absorption costing. Why does this happen? The next section answers this question.
Reconciliation of Variable and Absorption Costing
The difference in net pro�it �igures between absorption costing and variable costing is due solely to the treatment of �ixed production costs. Absorption costing includes those costs in the inventory costs; variable costing treats them as expenses to be charged to the period incurred. During any given time period, the amount of �ixed costs in inventory will increase or decrease as production differs from sales. If production is greater than sales (as is the case with Morris the Florist in 2018), �ixed costs in the ending inventory are deferred to future periods under absorption costing. That is, �ixed costs are treated as assets by including them as part of inventory, and they will be moved to the income statement as cost of goods sold when sold. Alternatively, all �ixed costs are expensed under variable costing. Therefore, absorption costing will show a higher net pro�it. Conversely, if sales are greater than production, �ixed costs in the beginning inventory are expensed in the current period and added to the �ixed costs incurred during the current period. Therefore, �ixed costs in the income statement under absorption costing are higher than under variable costing, and the result is a lower net pro�it for absorption costing.
In the simpli�ied case in which �ixed overhead costs per unit are the same in beginning and ending inventories, the difference in net pro�its is exactly equal to the change in inventory units times the �ixed overhead rate per unit. For Morris the Florist, the change in inventory is:
Units produced 100,000
Units sold 75,000
Increase in inventory 25,000
Using a �ixed overhead rate of $2 per unit, the difference in net pro�its is: $2 × 25,000 units = $50,000. Let’s check this result:
Absorption costing net pro�it $300,000
Variable costing net pro�it 250,000
Difference $50,000
When the �ixed overhead rates are different in beginning and ending inventories, the reconciliation of net pro�it �igures is performed as follows:
Absorption costing net pro�it
+ Fixed overhead in beginning inventory
– Fixed overhead in ending inventory
= Variable costing net pro�it
To illustrate, suppose that in 2019, Morris the Florist produces 80,000 �loral arrangements and sells 100,000. We will presume the same total �ixed costs, unit variable costs, and selling price as in 2018. Morris the Florist uses a FIFO cost �low. As a result, the �ixed overhead per unit produced during 2019 is $2.50 ($200,000/80,000).
The 2019 absorption costing income statement would be as follows:
Absorption Costing Income Statement for the Year Ended December 31, 2019
Sales revenue ($25 × 100,000) $2,500,000
Cost of sales:
Variable ($16 × 100,000) $1,600,000
Fixed [($2 × 25,000) + ($2.50 × 75,000)] 237,500 1,837,500
Gross pro�it $ 662,500
Marketing and administrative expenses:
Variable ($1 × 100,000) $100,000
Fixed 150,000 250,000
Net pro�it $412,500
Note that the �ixed portion of cost of sales is consistent with the FIFO cost �low assumption. The �irst 25,000 units come from 2018 production, which had a unit cost of $2 for �ixed overhead; the remaining 75,000 units come from 2019 production, which had a unit cost of $2.50 for �ixed overhead.
The 2019 variable costing income statement would be as follows:
Variable Costing Income Statement for the Year Ended December 31, 2019
Sales revenue ($25 × 100,000) $2,500,000
Variable Costing Income Statement for the Year Ended December 31, 2019
Variable costs:
Production ($16 × 100,000) $1,600,000
Marketing and administrative ($1 × 100,000) 100,000 1,700,000
Contribution margin $ 800,000
Fixed costs:
Production $200,000
Marketing and administrative 150,000 350,000
Net pro�it $450,000
We reconcile the 2019 net pro�its as follows:
Absorption costing net pro�it $412,500
+ Fixed overhead in beginning inventory ($2 × 25,000) 50,000
– Fixed overhead in ending inventory ($2.50 × 5,000) (12,500)
= Variable costing net pro�it $450,000
The reconciliation of net pro�its between the two costing methods is independent of inventory cost �low assumptions. A company can use FIFO, LIFO, or some average cost method; the reconciliation of net pro�its follows the same procedures.
Another observation about the difference between the two methods relates to the pro�it patterns over time with respect to production and sales strategies. Let’s consider the case of a constant production schedule over time while sales �luctuate each period. The absorption costing net income will �luctuate up and down with sales, but the constant production will have a leveling effect on the swings. The peaks will not be as high nor as low as the corresponding sales changes. Variable costing net income, on the other hand, will have swings that match those of sales, in both direction and relative magnitude. For the situation where production �luctuates while sales remain rather constant, a different picture appears. Absorption costing net income will �luctuate with production, in both direction and relative magnitude. Variable costing net income will remain constant, corresponding with sales levels.
While absorption and variable costing methods yield different pro�it �igures during periods when units sold do not equal units produced, these are timing differences. If over the course of several time periods, aggregate production equals aggregate sales, then the aggregate pro�its will be the same for both costing methods despite differences in pro�its during speci�ic periods.
Arguments for Either Costing Method
Neither variable costing nor absorption costing is correct or incorrect. Their usefulness correlates with management’s attitudes and with philosophies of organizational behavior. Some companies will �ind variable costing extremely useful, while other companies will �ind it less meaningful. Any manager can make a valid case for either variable or absorption costing. The primary arguments, for and against, are discussed next.
Short Term Versus Long Term. Those who favor variable costing—let’s call them the “variable costers”—believe it focuses on the short-term consequences of accounting and is more realistic of the way managers make decisions. Those who favor absorption costing—let’s call them the “absorption costers”—assume that long-run performance is more important and that absorption costing more appropriately re�lects long-term consequences.
Unethical Behavior By Managers. Variable costers assume that managers can easily adapt to a new accounting method with little additional cost. They further argue that managers will be rewarded for playing games with absorption costing reports. They speci�ically refer to a manager’s ability to manipulate net pro�it by increasing or decreasing inventory levels that are valued under absorption costing. As we have seen, in�lating inventories reduces current period expenses with absorption costing and reducing inventories would increase current period expenses with absorption costing. Managers’ evaluations and bonuses that are based on net pro�its can therefore be impacted by these actions relating to inventories. The absorption costers admit that occasional short-term decisions (e.g., amount of ending inventory to hold) will be made incorrectly. However, over the long term, the mistakes will be more obvious, and the “games” will be discovered by competent superiors. Absorption costers might assert that unethical managers cannot be suddenly rehabilitated by a change in accounting methods.
Variable Versus Fixed Costs. Variable costers believe that costs can be easily and meaningfully divided into variable and �ixed categories and that using a contribution margin is much more useful for planning and decision making and for control and performance evaluation. Since absorption costing is primarily for external reporting purposes, absorption costers do not see this distinction as meaningful for reports. They will also argue that managers can still make the cost behavior distinctions for internal purposes. They also point out that the variable/�ixed split is not easily made in practice.
External Versus Internal Reports. Financial statement reporting using generally accepted accounting principles, as well as tax reporting for the Internal Revenue Service, require absorption costing. Variable costers argue that allowing external reporting requirements to dominate how useful and meaningful information should be reported is not a valid philosophy for competent management. Since information should be geared to the needs of management, external requirements should not drive the internal accounting system. Absorption costers argue that to have one set of requirements for external reporting and another set for internal reporting gives managers con�licting and inconsistent information. It also forges an image that the company is hiding something in the two approaches.
Effects of New Manufacturing Environments
Since the major variation between the two methods is the treatment of �ixed costs as product or period costs, the difference in net pro�its disappears when little or no inventory of work in process or �inished goods exists. For companies implementing JIT production procedures, inventories will be eliminated or substantially reduced. Hence, the particular costing method chosen loses signi�icance in this environment. Also, this controversy is irrelevant to service organizations that do not carry inventories.
In automated production environments, whether JIT or not, the bulk of labor and factory overhead costs is �ixed. Variable costs represent a low percentage of total manufacturing costs. In these environments, therefore, variable costing loses much of its appeal because the product cost will be a small fraction of the total manufacturing cost.
Summary & Resources
Chapter Summary Joint costs are allocated to joint products using either physical measures of output, the relative sales value method, or the net realizable value method. No joint costs are allocated to byproducts or scrap, and their net realizable values are either treated as miscellaneous income or as deductions from the costs allocated to the main products.
Variable costing includes only variable manufacturing costs as an element of product cost. The traditional method of income statement preparation is called absorption costing. It includes �ixed manufacturing costs as an element of product cost. As a result of this difference, net pro�it under the two methods will not necessarily be the same. Anytime production exceeds sales, absorption costing yields a higher net pro�it; when sales exceeds production, variable costing yields a higher net pro�it. The arguments for and against using either costing method apply to individual situations and management philosophy. Neither method is inherently correct or incorrect.
Key Terms
absorption costing A product costing method that allocates all manufacturing costs (variable and �ixed) to products.
byproducts Products produced from a joint manufacturing process that have minor sales value and are typically processed further beyond the split-off point.
direct costing A product costing method that allocates only variable manufacturing costs to items produced.
full costing A product costing method that allocates all manufacturing costs (variable and �ixed) to products.
joint costs The costs of materials and processing common to the production of multiple products that emerge from the joint production process.
joint products The products that emerge from a process where there are common inputs so that the individual products are initially indistinguishable.
net realizable value (NRV) The total sales revenue from the �inal product less its total separable costs.
relative sales value (RSV) An approach that allocates joint costs based on revenues that can be received from selling the products at the split-off point.
scrap Products produced from a joint manufacturing process that have minor sales value and are not processed further beyond the split-off point.
separable costs Costs incurred beyond the split-off point.
split-off point The point in the joint production process at which the individual products can be identi�ied.
variable costing A product costing method that allocates only variable manufacturing costs to items produced.
Problem for Review Ludwig’s Plumbing Products purchases raw materials and processes them into more re�ined products. In July, Ludwig’s purchased raw materials for $40,000. Conversion costs of $60,000 were incurred up to the split-off point, at which time two salable products were produced: Product A and Product B. Product B can be further processed into Product C. The July production and sales data were:
Production Sales Sales Price
Product A 1,200 tons 1,200 tons $50 per ton
Product B 800 tons
Product C 500 tons 500 tons $200 per ton
All 800 tons of Product B were further processed, at an incremental cost of $20,000, to yield 500 tons of Product C. There were no byproducts or scrap from this further processing of Product B.
There is an active market for Product B. Ludwig’s could have sold all of its July production of Product B for $75 per ton.
Questions:
1. Allocate the joint costs using the relative sales value method. 2. Allocate the joint costs using the physical measures method. 3. Allocate the joint costs using the net realizable value method.
Solution:
1. RSV method:
RSV of Product A = 1,200 × $50 = $60,000
RSV of Product B = 800 × $75 = $60,000
The total joint cost of $100,000 ($40,000 + $60,000) would be allocated equally to each of Products A and B (i.e., $50,000 to each).
2. Physical measures method:
Allocation to Product A = (1,200 / 2,000) × $100,000 = $60,000
Allocation to Product B = (800 / 2,000) × $100,000 = $40,000
3. NRV method:
NRV of Product A = 1,200 × $50 = $60,000
NRV of Product B = (500 × $200) – $20,000 = $80,000
Allocation to Product A = ($60,000 / $140,000) × $100,000 = $42,857
Allocation to Product B = ($80,000 / $140,000) × $100,000 = $57,143
Questions for Review and Discussion 1. What are the two criticisms of allocating joint costs based on physical measures of output? 2. Explain the practical problem that sometimes prevents the use of the relative sales value method. 3. Differentiate between variable costing and absorption costing. 4. How is it possible to increase net pro�it using absorption costing when sales are not increasing? 5. A company had a highly labor-intensive manufacturing process. Recently it implemented robotics and a
number of other technological changes that made the process capital intensive. What impact would these changes make on the inventory valuations for variable costing and for absorption costing?
Exercises 5-1. Joint Costs Allocated to Services. Randy Gold & Associates, a CPA �irm, provides audit, tax, and consulting services. The �irm spent $800 recruiting a particular client, George Gottlieb, who contracted for all three services after a round of golf, a sumptuous meal, and a bottle of �ine wine. After the �irm’s work for Gottlieb was completed, the following information was available:
Service Fees Charged
Traceable Costs
Labor Overhead
Audit $14,000 $5,200 $4,000
Tax 10,000 3,000 2,300
Consulting 22,000 9,100 5,500
Question:
Using the NRV method, allocate the joint cost to the three services.
5-2. Joint Cost Allocations and Ending Inventories. Falk Corporation crushes and re�ines mineral ore into three products in a joint operation. There were no beginning inventories of any products. Joint costs are $420,000, resulting in the production of 20,000 pounds of Adelia, 60,000 pounds of Dalewood, and 100,000 pounds of Bramble. Adelia is processed further at a cost of $100,000, and Dalewood is processed further at a cost of $200,000. Bramble does not require any further processing.
The results for the current year are:
Adelia: 19,000 lbs. sold at $20/lb.
Dalewood: 58,000 lbs. sold at $6/lb.
Bramble: 95,000 lbs. sold at $1/lb.
Question:
Determine the cost of the ending inventories using the NRV method to allocate joint costs.
5-3. Joint Cost Allocation and Income Statements. Lowenstein Promotions, Inc. produces rock concerts across the country. A recent concert by the Twins was also recorded as a CD. The live concert attracted 9,000 people who paid $35 per ticket, and the CD is projected to sell 26,000 units at $11 each. Joint costs of the concert and CD amounted to $300,000. Separable costs are $2 per ticket and $3 per unit for the CDs.
Questions:
1. Comment on the feasibility of allocating the joint costs based on physical measures.
2. Using the NRV method, compute the amount of joint costs to allocate to the live concert and to the CDs. 3. Prepare product-line income statements for the live concert and for the CDs.
5-4. Joint Cost Allocation With a Byproduct. Paul Fay Fisheries spent $11,000 to catch 3,000 pounds of tuna, 12,000 pounds of shell�ish, and 500 pounds of various other �ish during July. The tuna was sold to Shinderman Industries for $8,000, and the shell�ish was sold to Lisa’s Diner for $17,000. The other �ish was converted to �ish oil, which is treated as a byproduct. Separable costs amounted to $200 for the �ish oil, which was sold to Jake’s Food Products for $900. Paul Fay Fisheries uses physical output to allocate joint costs.
Questions:
Explain how the NRV from the byproduct would be treated and determine the joint cost allocations for each of the following two alternatives:
1. Miscellaneous income approach 2. Reduction of joint cost approach
5-5. Absorption Costing. Leff Corporation incurred the following costs during the year:
Direct materials $10,000
Direct labor 30,000
Other costs: Variable Fixed
Manufacturing $15,000 $25,000
Marketing 5,000 2,000
Administrative 1,000 6,000
Question:
Under absorption costing, determine the amount that would be classi�ied as product costs.
5-6. Determining Ending Inventory. Goldie Industries uses an absorption costing system. The following data pertain to June:
Operating income $70,000
Beginning inventory 12,000 units
Fixed overhead application rate $2 per unit (May and June)
Joe Pearl, the owner, has determined that the operating income would be $90,000 under variable costing.
Question:
How many units are in the June ending inventory?
5-7. Inventory and Cost of Goods Sold. Karchava Industries is headquartered in Tbilisi, Republic of Georgia, and has three manufacturing plants near the Black Sea. Nino Aladashvili, the company’s cost accountant, reports the following data for October:
Units: Beginning inventory 135,000
Production ?
Sales 250,000
Ending inventory 142,000
Costs (in lari): Beginning inventory 7,000,000
Variable manufacturing costs 19,000,000
Fixed manufacturing costs 8,000,000
Variable selling & administrative costs 9,000,000
Questions:
1. Compute the unit cost of the inventory produced during October using variable costing. 2. Compute the unit cost of the inventory produced during October using absorption costing. 3. If the company uses absorption costing and assumes a FIFO cost �low, what is the cost of goods sold for
October?
5-8. Variable Costing Income Statement. Nahmias Bee Hives produces honey for sale to various food manufacturers. The income statement for last year, prepared on an absorption costing basis, is as follows:
Number of containers produced and sold 250,000
Sales revenue $2,000,000
Cost of goods sold 1,500,000
Gross pro�it $ 500,000
Operating expenses (includes variable costs of $125,000) 225,000
Pro�it before income taxes $ 275,000
Income taxes 110,000
Pro�it after income taxes $ 165,000
The �ixed production cost per container of honey was $2.00.
Question:
Revise the income statement on a variable costing basis.
5-9. Comparing Operating Pro�its. Mark Silber & Associates produces a product selling for $7 per unit; 100,000 units were produced and 80,000 units were sold during the year. The company had no inventory at the beginning of the year. Data for the year were as follows:
Fixed Costs Variable Costs
Direct materials 0 $1.50 per unit produced
Direct labor 0 $1.00 per unit produced
Factory overhead $150,000 $0.50 per unit produced
Administrative $80,000 $0.50 per unit sold
Questions:
1. What is the operating pro�it using variable costing? 2. What is the operating pro�it using absorption costing?
Problems
5-10. Joint Cost Allocation Using NRV. Capland Advertising Agency produced television and magazine ads for a client, Sharfstein Enterprises. The ads were developed with a common theme, and in so doing, $49,000 in joint costs were incurred. Separable costs totaled $60,000 for the TV ads and $20,000 for the magazine ads. The agency received $95,000 in fees for the TV ads and $42,000 for the magazine ads.
Question:
Allocate the joint costs using the net realizable value method.
5-11. Joint Cost Allocation and Inventory Costs. Jerry’s Wine Garden produces three wine products (Red, White, and Rose) as the result of initial joint processing plus separable processing after the split-off point. Records for July show the following:
Red White Rose Total
Materials used — — — $150,000
Direct labor 70,000
Production overhead cost — — — 100,000
Separable processing costs $50,000 $80,000 $70,000 —
Bottles produced 6,000 12,000 6,250 —
Bottles sold 4,000 9,000 4,250 —
Sales price $50.00 $37.50 $40.00
Question:
Compute the total cost of the ending inventory for each product, assuming no beginning inventory and using the NRV method for joint cost allocation.
5-12. Determination of Joint Cost. Habif Co. produces products ALPHA and BETA from a joint manufacturing process. For ALPHA, 4,000 units were produced having a sales value at the split-off point of $15,000. If ALPHA were processed further, the additional costs would be $3,000 and the sales value would be $20,000. For BETA, 2,000 units were produced having a sales value at the split-off point of $10,000. If BETA were processed further, the additional costs would be $1,000 and the sales value would be $12,000. Joint costs allocated to ALPHA amounted to $9,000.
Questions:
1. If the relative sales value approach were used, what would be the amount of total joint product costs? 2. If the net realizable value approach were used, what would be the amount of total joint product costs? 3. If the physical measures approach were used, what would be the amount of total joint product costs?
5-13. Determination of Sales Value at Split-Off. Ripans Industries manufactures three products from a joint process: X, Y, and Z. The following information is provided by the plant manager, Rick Halpern:
Product X Product Y Product Z Total
Units produced 4,000 2,000 1,000 7,000
Joint cost $36,000 ? ? $60,000
Sales value at split-off ? ? $15,000 $100,000
Separable costs $7,000 $5,000 $12,000 $24,000
Sales value of �inal product $75,000 $30,000 $20,000 $125,000
Joint costs are allocated using the relative sales value method.
Question:
Calculate the sales value at the split-off point for Product X.
5-14. Operating Incomes for Two Periods. Schumer Motors manufactures cars and sells them for $24,000 each. The controller, Dick Peppy, provided the following data for November and December:
November December
Number of cars:
Beginning inventory 0 ?
Production 500 400
Sales 350 520
Variable costs:
Mfg. cost per car produced $10,000 $10,000
Marketing cost per car sold $3,000 $3,000
Fixed costs:
Mfg. costs $2,000,000 $2,000,000
Marketing costs $600,000 $600,000
Questions:
1. Calculate operating income for November using: a. Variable costing b. Absorption costing
2. Assuming a LIFO cost �low, calculate operating income for December using: a. Variable costing b. Absorption costing
5-15. Variable and Absorption Costing and Pro�it at the Break-Even Point. The President of Robbins Supply Company, Trudy Raymond, is surprised to learn that the company earned a pro�it in 2019 even though sales were at the break-even point (before considering non-production costs).
“When we were going over the budget for 2019,” she said, “I was told that we would have a poor year and could expect to break even with sales of only 206,000 units. Now, I �ind that we earned a modest pretax pro�it with sales of 206,000 units, although selling prices and costs were as budgeted. I am not complaining about a pro�it, mind you, but I can’t understand how a pro�it can be made when operating at the break-even point.”
Data pertaining to 2019 are as follows:
Unit selling price $35
Unit variable cost 20
Unit contribution margin $15
$3,090,000 (�ixed production cost) / $15 (unit contribution margin) = 206,000 units break even
Fixed production costs are applied to products at $10 per unit. The inventory of �inished goods was 30,000 units on January 1, 2019, and 133,000 units on December 31, 2019. The marketing and administrative expenses were �ixed in the amount of $90,000.
Questions:
1. Prepare an income statement for 2019 using absorption costing. 2. Prepare an income statement for 2019 using variable costing. 3. Explain to the President how a pro�it was made when using absorption costing even though sales were at
the break-even point. 4. Explain whether the absorption costing income statement or the variable costing income statement gives
the more realistic results.
5-16. Conversion of Absorption Costing to Variable Costing. Yaffe Electrical Supply Company manufactures electric switches and timing devices in three operating divisions: Utility, Household, and Commercial. An income statement, showing the results for each division, is given for 2018. The company had total �ixed manufacturing overhead of $8,900,000. Inventories were increased during the year in anticipation of more sales volume in 2019.
Yaffe Electrical Supply Company income Statement for the Year 2018 (in Thousands)
Utility Household Commercial Total
Net sales $6,200 $5,150 $6,300 $17,650
Costs of goods sold:
Inventory, beginning $540 $240 $150 $930
Production cost 5,400 4,000 4,200 13,600
Cost of goods available for sale $5,940 $4,240 $4,350 $14,530
Less inventory, ending 900 640 900 2,440
Cost of goods sold $5,040 $3,600 $3,450 $12,090
Manufacturing pro�it $1,160 $1,550 $2,850 $5,560
The Plant Controller, Jennifer Barry, believes that pro�its may be higher than they would be otherwise because of �ixed costs being carried over to the next year as a part of inventory. She would like to have the statement revised to a variable costing basis and would like to know the manufacturing contribution margin for each division.
Additional analyses show the units and unit variable costs as follows. There are no partially completed units.
Utility Household Commercial
Units in beginning inventory 30,000 15,000 10,000
Units produced 300,000 250,000 280,000
Units in ending inventory 50,000 40,000 60,000
Unit variable manufacturing cost $6 $6 $5
Questions:
1. Prepare an income statement on a variable costing basis that shows a contribution margin and direct pro�its by division and in total.
2. Prepare a reconciliation between the variable costing and absorption costing income statements. This reconciliation should show results by division and in total.
3. How much of the �ixed cost was carried over to 2019 as a part of ending inventory cost for each division?
5-17. Conversion of Absorption Costing to Variable Costing. Grinzaid Pet Shops purchase a variety of household pets (mostly dogs), and they also breed their own pets, for sale to customers. The following income statement for July 2019 was prepared by the Corporate Controller, Sam Marks, using absorption costing:
Sales (200 pets) $22,000
Cost of sales:
July 1 inventory $5,000
Breeding and purchase costs 10,000
July 31 inventory (2,500) 12,500
Gross pro�it $9,500
Fixed selling and administrative expenses 3,700
Operating income $5,800
During 2019, the average unit variable costs have not changed, and �ixed “production” overhead has remained at $2,000 per month. During July, 160 pets were either born or purchased by the store owner, Lisa Marks. Assume that all inventories of pets are “�inished”—there is no beginning or ending “work in process.”
Questions:
1. Prepare an income statement for July using variable costing. 2. Reconcile the absorption and variable costing operating incomes.
Case: Strazynski Cosmetics
Strazynski Cosmetics has four manufacturing plants where it processes a chemical, Idov, into three products. The process works in such a way that Idov is broken down into a high-grade facial cleanser (FC) and a low-grade chemical. The low-grade chemical is then processed into a liquid bath soap (LBS) and a moisturizing skin cream (MSC). All three products are sold to wholesalers that distribute them to retailers, hospitals, and various other institutions.
Strazynski Cosmetics used 12,000 gallons of Idov last month. It cost $300,000 in materials, labor, and overhead to procure Idov and turn it into the FC and low-grade chemical. The total cost of producing LBS and MSC from the low-grade chemical was $70,000. The breakdown of production for the month was as follows:
FC 10,000 ounces
LBS 20,000 ounces
MSC 50,000 ounces
The sales price of FC is $40 an ounce; of LBS, $10 an ounce; and of MSC, $1 an ounce. Additional processing and selling costs, entirely separate and traceable to each product, amounted to $20,000 for FC, $160,000 for LBS, and $40,000 for MSC.
When joint costs are allocated, the net realizable value method is used. There were no beginning or ending inventories in any of the four manufacturing plants. All of the production was sold during the month.
Question:
Prepare product line income statements (absorption costing) through gross pro�it for each of the three products.
