Sec D 1 Absorption and Variable Costing – Theory

Question 1

.1Which method of inventory costing treats direct manufacturing costs and manufacturing overhead
costs, both variable and fixed, as inventoriable costs?
A. Direct costing.
B. Variable costing.
C. Absorption costing.
D. Conversion costing.

Answer 1

Answer (C) is correct.
Absorption (full) costing considers all manufacturing costs to be inventoriable as product costs. These
costs include variable and fixed manufacturing costs, whether direct or indirect. The alternative to
absorption is known as variable (direct) costing

Question 2

2Which one of the following statements is true regarding absorption costing and variable costing?
A. Overhead costs are treated in the same manner under both costing methods.
B. If finished goods inventory increases, absorption costing results in higher income.
C. Variable manufacturing costs are lower under variable costing.
D. Gross margins are the same under both costing methods.

Answer 2

Answer (B) is correct.
Under variable costing, inventories are charged only with the variable costs of production. Fixed
manufacturing costs are expensed as period costs. Absorption costing charges to inventory all costs of
production. If finished goods inventory increases, absorption costing results in higher income because
it capitalizes some fixed costs that would have been expensed under variable costing. When inventory
declines, variable costing results in higher income because some fixed

Question 3

3Absorption costing and variable costing are two different methods of assigning costs to units
produced. Of the four cost items listed below, identify the one that is not correctly accounted for as a product cost.
Part of Product Cost Under
Absorption Variable
Costing Costing
A. Manufacturing supplies Yes Yes
B. Insurance on factory Yes No
C. Direct labor cost Yes Yes
D. Packaging and shipping costs Yes Yes

Answer 3

Answer (D) is correct.
Under absorption costing, all manufacturing costs, both fixed and variable, are treated as product costs.
Under variable costing, only variable costs of manufacturing are inventoried as product costs. Fixed
manufacturing costs are expensed as period costs. Packaging and shipping costs are not product costs
under either method because they are incurred after the goods have been manufactured. Instead, they
are included in selling and administrative expenses for the period.

Question 4

4When a firm prepares financial reports by using absorption costing,
A. Profits will always increase with increases in sales.
B. Profits will always decrease with decreases in sales.
C. Profits may decrease with increased sales even if there is no change in selling prices and costs.
D. Decreased output and constant sales result in increased profits.

Answer 4

Answer (C) is correct.
In an absorption costing system, fixed overhead costs are included in inventory. When sales exceed
production, more overhead is expensed under absorption costing due to fixed overhead carried over
from the prior inventory. If sales increase over production, more than one period’s overhead is
recognized as expense. Accordingly, if the increase in overhead expensed is greater than the
contribution margin of the increased units sold, profit may be lower with an increased level of sales.

Question 5

5The contribution margin is the excess of revenues over
A. Cost of goods sold.
B. Manufacturing cost.
C. Direct cost.
D. All variable costs

Answer 5

Answer (D) is correct.
Contribution margin is the excess of revenues over all variable costs (including both manufacturing
and nonmanufacturing variable costs) that vary with an output-related cost driver. The contribution
margin equals the revenues that contribute toward covering the fixed costs and providing a net income.

Question 6

6A company pays bonuses to its managers based on operating income. The company uses absorption
costing, and overhead is applied on the basis of direct labor hours. To increase bonuses, the managers may do all of
the following except
A. Produce those products requiring the most direct labor.
B. Defer expenses such as maintenance to a future period.
C. Increase production schedules independent of customer demands.
D. Decrease production of those items requiring the most direct labor.

Answer 6

Answer (D) is correct.
Under an absorption costing system, income can be manipulated by producing more products than are
sold because more fixed manufacturing overhead will be allocated to the ending inventory. When
inventory increases, some fixed costs are capitalized rather than expensed. Decreasing production,
however, will result in lower income because more of the fixed manufacturing overhead will be
expensed in the current period.

Question 7

7Which one of the following is an advantage of using variable costing?
A. Variable costing complies with the U.S. Internal Revenue Code.
B. Variable costing complies with generally accepted accounting principles.
C. Variable costing makes cost-volume relationships more easily apparent.
D. Variable costing is more relevant to long-run pricing strategies.

Answer 7

Answer (C) is correct.
Under variable costing, only the variable costs of manufacturing attach to the units of output; fixed
costs are expensed in the period in which they are incurred. Thus, the variations in cost directly
attributable to changes in production level are immediately apparent under variable costing.

Question 8

8A corporation pays bonuses to its managers based on operating income, as calculated under variable
costing. It is now 2 months before year end, and earnings have been depressed for some time. Which one of the
following actions should the production manager definitely implement to maximize the bonus for this year?
A. Step up production so that more manufacturing costs are deferred into inventory.
B. Cut $2.3 million of advertising and marketing costs.
C. Postpone $1.8 million of discretionary equipment maintenance until next year.
D. Implement, with the aid of the controller, an activity-based costing and activity-based management
system.

Answer 8

Answer (C) is correct.
Because the production manager wishes to maximize the bonus for the coming year, the action the
manager must take will necessarily have most of its effect in the short run. The action the manager
should take to achieve this goal is to defer costs under the manager’s control until the following period.

Question 9

9When comparing absorption costing with variable costing, which of the following statements
is not true?
A. Absorption costing enables managers to increase operating profits in the short run by increasing
inventories.
B. When sales volume is more than production volume, variable costing will result in higher operating
profit.
C. A manager who is evaluated based on variable costing operating profit would be tempted to increase
production at the end of a period in order to get a more favorable review.
D. Under absorption costing, operating profit is a function of both sales volume and production volume.

Answer 9

Answer (C) is correct.
Absorption (full) costing is the accounting method that considers all manufacturing costs as product
costs. These costs include variable and fixed manufacturing costs whether direct or indirect. Variable
(direct) costing considers only variable manufacturing costs to be product costs, i.e., inventoriable.
Fixed manufacturing costs are considered period costs and are expensed as incurred. If production is
increased without increasing sales, inventories will rise. However, all fixed costs associated with
production will be an expense of the period under variable costing. Thus, this action will not artificially
increase profits and improve the manager’s review.

Question 10

10Which one of the following is the best reason for using variable costing?
A. Fixed factory overhead is more closely related to the capacity to produce than to the production of
specific units.
B. All costs are variable in the long term.
C. Variable costing is acceptable for income tax reporting purposes.
D. Variable costing usually results in higher operating income than if a company uses absorption costing.

Answer 10

Answer (A) is correct.
Because fixed factory overhead is more closely related to the capacity to produce than to the
production of specific units, variable costing more accurately depicts the variations in cost resulting
from changes in the level of output

Question 11

11If a manufacturing company uses variable costing to cost inventories, which of the following costs
are considered inventoriable costs?
A. Only raw material, direct labor, and variable manufacturing overhead costs.
B. Only raw material, direct labor, and variable and fixed manufacturing overhead costs.
C. Only raw material, direct labor, variable manufacturing overhead, and variable selling and administrative
costs.
D. Only raw material and direct labor costs.

Answer 11

Answer (A) is correct.
Under variable costing, only variable costs (direct materials, direct labor, and variable overhead) are
considered product costs.

Question 12

12An airline is in the process of preparing a contribution margin income statement that will allow a
detailed look at its variable costs and profitability of operations. Which one of the following cost combinations
should be used to evaluate the variable cost per flight of the company’s flights along a specific route?
A. Flight crew salary, fuel, and engine maintenance.
B. Fuel, food service, and airport landing fees.
C. Airplane depreciation, baggage handling, and airline marketing.
D. Communication system operation, food service, and ramp personnel.

Answer 12

Answer (B) is correct.
Fuel, food service, and airport landing fees are all variable and traceable to individual flights

Question 13

13A firm uses direct (variable) costing for internal reporting and absorption costing for the external
financial statements. A review of the firm’s internal and external disclosures will likely find
A. A difference in the treatment of fixed selling and administrative costs.
B. A higher inventoriable unit cost reported to management than to the shareholders.
C. A contribution margin rather than gross margin in the reports released to shareholders.
D. Internal income figures that vary closely with sales and external income figures that are influenced by
both units sold and productive output.

Answer 13

Answer (D) is correct.
Under variable costing, only costs that vary with the level of production are treated as product costs.
Thus, internal income figures will vary closely with sales. Under absorption costing, all production
costs (both variable and fixed) are treated as product costs. Thus, external income figures are
influenced by both units sold and productive output.

Question 14

14Which of the following correctly shows the treatment of (1) factory insurance, (2) direct labor, and
(3) finished goods shipping costs under absorption costing and variable costing?
Absorption Costing Variable Costing
Product Period Product Period
Cost Cost Cost Cost
A. 1, 2 3 2 1, 3
B. 2 1, 3 1, 2 3
C. 1, 2 3 1 2, 3
D. 1 2, 3 2, 3 1

Answer 14

Answer (A) is correct.
Factory insurance (item 1) is a factory operating cost, one of the three components of manufacturing
overhead (the other two being indirect materials and indirect labor). Since it is a manufacturing cost, it
must be treated as a product cost under absorption costing, and since it is fixed over the relevant range,
it must be treated as a period cost under variable costing. Direct labor (item 2) is treated as a product
cost under both systems. Finished goods shipping (item 3) is a variable selling and administrative cost,
and, as such, is treated as a period cost under both systems.

Question 15

15When comparing absorption costing with variable costing, the difference in operating income can
be explained by the difference between the
A. Units sold and the units produced, multiplied by the unit sales price.
B. Ending inventory in units and the beginning inventory in units, multiplied by the budgeted fixed
manufacturing cost per unit.
C. Ending inventory in units and the beginning inventory in units, multiplied by the unit sales price.
D. Units sold and the units produced, multiplied by the budgeted variable manufacturing cost per unit.

Answer 15

Answer (B) is correct.
Absorption and variable costing differ in their treatment of fixed overhead: It is capitalized as
inventory under absorption costing and not under variable costing. Thus, the difference in operating
income between the two can be explained by the difference between the ending inventory in units and
the beginning inventory in units, multiplied by the budgeted fixed manufacturing cost per unit

Question 16

16A company has significant fixed overhead costs in the manufacturing of its sole product, auto
mufflers. For internal reporting purposes, in which one of the following situations would ending finished goods
inventory be higher under direct (variable) costing rather than under absorption costing?
A. If more units were produced than were sold during a given year.
B. If more units were sold than were produced during a given year.
C. In all cases when ending finished goods inventory exists.
D. None of these situations.

Answer 16

Answer (D) is correct.
The monetary value of ending inventory is never higher under direct costing than under absorption
costing because fewer costs are capitalized under direct costing.

Question 17

17A corporation produces and sells smart phones. The following information relates to operations for
the last year:
Variable cost per unit $5.20
Total fixed manufacturing overhead cost $260,000
Total fixed selling and administrative cost $180,000
Units produced and sold 400,000
Using absorption costing, what was the cost per unit last year?
A. $4.55
B. $5.00
C. $5.85
D. $6.30

Answer 17

Answer (C) is correct.
Under absorption costing, the fixed portion of manufacturing overhead is “absorbed” into the cost of
each unit of product. Product cost thus include all manufacturing costs, both fixed and variable. The
total manufacturing cost is equal to $2,340,000 [($5.20 × 400,000) + $260,000]. The cost per unit is
thus $5.85 ($2,340,000 ÷ 400,000).

Question 18

18The primary difference between absorption and variable costing is that variable costing treats
A. Only direct materials and direct labor as product cost.
B. Direct materials, direct labor, the variable portion of manufacturing overhead, and an allocated portion of
fixed manufacturing overhead as product costs.
C. Only direct materials, direct labor, the variable portion of manufacturing overhead, and the variable
portion of selling and administrative expenses as product cost.
D. Only direct materials, direct labor, and the variable portion of manufacturing overhead as product costs.

Answer 18

Answer (D) is correct.
Variable costing treats only direct materials, direct labor, and the variable portion of manufacturing
overhead as product costs.

Question 19

19Management would like to determine profitability of its Alpha product line. To eliminate the
possibility of profit distortion due to changes in production, the managers should primarily review
A. Variable (direct) costing income statements.
B. Absorption costing income statements.
C. Multi-step income statements.
D. Cash flow statements.

Answer 19

Answer (A) is correct.
Under variable costing, fixed manufacturing costs are not included in product costs. Rather, they are
period costs and expensed in the current period as incurred. Consequently, any variability in profits
will not be attributed to changes in production. Instead, profits will vary closely with sales. Thus,
managers should primarily review variable costing income statements to eliminate the possibility of
profit distortion due to changes in production.

Question 20

20In which one of the following situations will ending inventory on the balance sheet computed under
absorption costing be exactly equal to ending inventory computed under variable costing?
A. When the number of units produced equals the number of units sold.
B. When there is no fixed factory overhead cost.
C. When the denominator variance is zero.
D. When there is no variable overhead cost.

Answer 20

Answer (B) is correct.
Fixed factory overhead cost is treated as a product cost under absorption costing and as a period cost
under variable costing. Under variable costing, only variable costs are assigned to units of product and
therefore included in the inventory. Under absorption costing, both variable factory overhead costs and
fixed factory overhead costs are assigned to units of product and therefore included in the inventory.
Thus, ending inventory is the same under both absorption costing and variable costing only when there
is no fixed factory overhead cost.

Question 21

21Which of the following costs are generally included in a calculation of operating income when
using absorption costing?
I. Fixed direct manufacturing costs
II. Variable direct manufacturing costs
III. Variable manufacturing overhead costs
IV. Fixed manufacturing overhead costs
A. II and III only.
B. I and IV only.
C. I, II, and III only.
D. I, II, III, and IV.

Answer 21

Answer (D) is correct.
Under absorption costing, the fixed portion of manufacturing overhead is absorbed into the cost of
each unit product. Product cost thus includes all manufacturing costs, both fixed and variable.

Question 22

22Which one of the following is true with respect to variable and absorption costing systems?
A. Variable costing systems include fixed manufacturing overhead as period costs.
B. Absorption costing systems include fixed manufacturing overhead as period costs.
C. Variable costing systems include variable manufacturing overhead as period costs.
D. Absorption costing systems include variable manufacturing overhead as period costs.

Answer 22

Answer (A) is correct.
Variable costing capitalizes on the variable costs of production. Fixed manufacturing overhead is
treated as a period cost and is expensed in the period that the cost is incurred.

Question 23

23The costing method that is properly classified for both external and internal reporting purposes is
External Internal
Reporting Reporting
A. Activity-based costing No Yes
B. Job-order costing No Yes
C. Variable costing No Yes
D. Process costing No No

Answer 23

Answer (C) is correct.
Activity-based costing, job-order costing, process costing, and standard costing can all be used for both
internal and external purposes. Variable costing is not acceptable under GAAP for external reporting
purposes.

Question 24

24Which of the following statements is correct regarding the difference between the absorption
costing and variable costing methods?
A. When production equals sales, absorption costing income is greater than variable costing income.
B. When production equals sales, absorption costing income is less than variable costing income.
C. When production is greater than sales, absorption costing income is greater than variable costing income.
D. When production is less than sales, absorption costing income is greater than variable costing income.

Answer 24

Answer (C) is correct.
When production exceeds sales, ending inventory increases. Under absorption costing, some fixed
costs are included in ending inventory. Under variable costing, all fixed costs are expensed.
Accordingly, income is higher under absorption costing.

Question 25

25In an income statement prepared as an internal report, total fixed costs normally are shown
separately under
Absorption Costing Variable Costing
A. No No
B. No Yes
C. Yes Yes
D. Yes No

Answer 25

Answer (B) is correct.
In a variable-costing income statement, all variable costs are deducted from sales revenue to arrive at
the contribution margin. Total fixed costs are then deducted from the contribution margin to determine
operating income. In an absorption-costing income statement, fixed factory overhead included in the
cost of goods sold is deducted from sales revenue in the calculation of the gross margin. Other fixed
costs are among the amounts subtracted from the gross margin to determine operating income.

Question 26

Which one of the following items would not be considered a manufacturing cost?
 A. Plant property taxes for an ice cream maker.
 B. Cream for an ice cream maker.
 C. Tires for an automobile manufacturer.
 D. Sales commissions for a car manufacturer

Answer 26

D.
For a car manufacturer, any costs for things used to make cars are manufacturing costs. Sales
commissions are not costs for things used to make cars. Therefore, they are not manufacturing
costs.

Question 27

Normal costing systems are said to offer a user several distinct benefits when compared with actual
costing systems. Which one of the following is not a benefit associated with normal costing
systems?
 A. Improved accuracy of job and product costing.
 B. A more economical way of attaching overhead to a job or product.
 C. A smoothing of product costs throughout the period.
 D. More timely costing of jobs and products.

Answer 27

A.
The difference between normal and actual costing systems is in the way the amount of overhead to
be applied to production is calculated.
When normal costing is being used, a predetermined overhead rate is calculated (called an
estimated normalized rate), using the expected overhead costs divided by the expected usage of the
allocation base (machine hours or direct labor hours). When the overhead is applied to production,
this predetermined overhead rate is multiplied by the amount of the allocation base (machine hours
or direct labor hours) that was actually used to produce the product during the period. (Note: this is
in contrast to standard costing, where the predetermined overhead rate is multiplied by the amount
of the allocation base allowed for the actual output.)
When actual costing is being used, no predetermined overhead rate is calculated. Instead, at the
end of each period (month, quarter, whatever), the total actual overhead costs incurred for the period
are calculated and the total is divided by the total actual number of units produced to calculate the
amount of overhead to be allocated to each unit produced.

Question 28

Adams Manufacturing, Inc. produces farm tractors. The details of its budgeted cost of goods
manufactured schedule should come from which of the following schedules?
 A. Direct materials used, direct labor, manufacturing overhead, and the change in work-in-process.
 B. Purchases, raw material, work-in-process, and finished goods.
 C. Cost of goods sold plus or minus the change planned in finished goods.
 D. Purchases, direct labor, manufacturing overhead, finished goods, and work-in-process.

Answer 28

a.
Cost of goods manufactured is:
Direct Materials Used + Direct Labor Used + Manufacturing Overhead Applied + Beginning WIP
Inventory − Ending WIP Inventory = Cost of Goods Manufactured.
Direct Materials Used is Beginning Direct Materials Inventory + Purchases + Transportation In − Net
Returns − Ending Direct Materials Inventory.

Question 29

Use of a standard cost system can include all of the following advantages except that it
 A. assists in performance evaluation.
 B. allows employees to better understand what is expected of them.
 C. emphasizes qualitative characteristics.
 D. permits development of flexible budgeting

Answer 29

C.
Standard costing prescribes expected performance and provides control, which is quantitative, not
qualitative