Question :

Absorption costing versus Variable costing. The Mavis Company uses an absorption-costing system based on standard costs. Net variable manufacturing cost, with direct material cost, is $3 per unit; the standard production rate is 10 units per machine-hour. Net budgeted and actual fixed manufacturing overhead costs are $420,000. Fixed manufacturing overhead is billed at $7 per machine-hour ($420,000 ÷ 60,000 machine-hours of denominator level). Selling price is $5 per unit. Variable operating nonmanufacturing cost, which is driven by units sold, is $1 per unit. Fixed operating nonmanufacturing costs are $120,000.

Starting inventory in 2012 is 30,000 units; ending inventory is 40,000 units. Sales in 2012 are 540,000 units. The same standard unit costs persisted all through 2011 and 2012. For simplicity, suppose that there are no prices, efficiency variances or spending.

Required

1. Prepare an income statement for 2012 consider 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 asks you to recast the 2012 statement as it could appear under variable costing.

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

4. Graph how fixed manufacturing overhead is accounted for over absorption costing. That is, there can be two lines: one for the budgeted fixed manufacturing overhead (which is equivalent to the actual fixed manufacturing overhead in this case) and one for the fixed manufacturing overhead allocated. Demonstrate how the production-volume variance might be shown in the graph.

5. Critics have claimed that a generally used accounting system has led to undesirable buildups of inventory levels. (a) Is variable costing or absorption costing more probable to lead to such buildups? Why? (b) What will be done to counteract undesirable inventory buildups?