Profit Centers: Comparison of Variable and Full Costing (Underapplied Overhead) MarkHancock Inc. manufactures a specialized surgical instrument called the HAN-20. The firm has grownrapidly in recent years because of the product’s low price and high quality. However, sales havedeclined this year primarily due to increased competition and a decrease in the surgical proceduresfor which the HAN-20 is used. The firm is concerned about the decline in sales and has hired a consultant to analyze the firm’s profitability. The consultant was provided the following information:[LO 18-3, 18-4][LO 18-3, 18-4]2018 2019Sales (units) 3,200 2,800Production 3,800 2,300Budgeted production and sales 4,000 3,400Beginning inventory 800 1,400Data per unit (all variable)Price $ 2,095 $ 1,995Direct materials and labor 1,200 1,200Selling costs 125 125Fixed costsManufacturing overhead $700,000 $595,000Selling and administrative 120,000 120,000Top management at Hancock explained to the consultant that a difficult business environment forthe firm in 2018 and 2019 had caused the firm to reduce its price and production levels and reduceits fixed manufacturing costs in response to the decline in sales. Even with the price reduction, thereFinal PDF to printerChapter 18 Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard 811blo17029_ch18_775-825.indd 811 02/19/18 09:10 AMwas a decline in sales in both years. This led to an increase in inventory in 2018, which the firm wasable to reduce in 2019 by further reducing the level of production. In both years, Hancock’s actualproduction was less than the budgeted level so that the overhead rate for fixed overhead, calculatedfrom budgeted production levels, was too low, and a production volume variance was calculatedto adjust cost of goods sold for the underapplied fixed overhead (the calculation of the productionvolume variance is explained fully in Chapter 15 and reviewed briefly below).The production volume variance for 2018 was determined from the fixed overhead rate of $175per unit ($700,000/4,000 budgeted units). Because the actual production level was 200 units short ofthe budgeted level in 2018 (4,000 − 3,800), the amount of the production volume variance in 2018was 200 × $175 = $35,000. The production volume variance is underapplied because the actualproduction level is less than budgeted, and the production volume variance is therefore added backto cost of goods sold to determine the amount of cost of goods sold in the full costing income statement. The full costng income statement for 2018 is shown below:Sales $6,704,000Cost of goods sold:Beginning inventory $1,100,000Cost of goods produced 5,225,000Cost of goods available for sale $6,325,000Less ending inventory 1,925,000Cost of goods sold: $4,400,000Plus unfavorable production volume variance 35,000Adjusted cost of goods sold $4,435,000Gross margin $2,269,000Less selling and administrative costsVariable $ 400,000Fixed 120,000 520,000Operating income $1,749,000Required1. Using the full costing method, prepare the income statement for 2019.2. Compute operating income for each period under variable costing, and explain the difference inoperating income from that obtained in requirement 1.3. Write a brief memo to the firm to explain the difference in operating income between variable costingand full costing
Process Costing
Process costing is a sort of operation costing which is employed to determine the value of a product at each process or stage of producing process, applicable where goods produced from a series of continuous operations or procedure.
Job Costing
Job costing is adhesive costs of each and every job involved in the production processes. It is an accounting measure. It is a method which determines the cost of specific jobs, which are performed according to the consumer’s specifications. Job costing is possible only in businesses where the production is done as per the customer’s requirement. For example, some customers order to manufacture furniture as per their needs.
ABC Costing
Cost Accounting is a form of managerial accounting that helps the company in assessing the total variable cost so as to compute the cost of production. Cost accounting is generally used by the management so as to ensure better decision-making. In comparison to financial accounting, cost accounting has to follow a set standard ad can be used flexibly by the management as per their needs. The types of Cost Accounting include – Lean Accounting, Standard Costing, Marginal Costing and Activity Based Costing.
Profit Centers: Comparison of Variable and Full Costing (Underapplied
Hancock Inc. manufactures a specialized surgical instrument called the HAN-20. The firm has grown
rapidly in recent years because of the product’s low price and high quality. However, sales have
declined this year primarily due to increased competition and a decrease in the surgical procedures
for which the HAN-20 is used. The firm is concerned about the decline in sales and has hired a consultant to analyze the firm’s profitability. The consultant was provided the following information:
[LO 18-3, 18-4]
[LO 18-3, 18-4]
2018 2019
Sales (units) 3,200 2,800
Production 3,800 2,300
Budgeted production and sales 4,000 3,400
Beginning inventory 800 1,400
Data per unit (all variable)
Price $ 2,095 $ 1,995
Direct materials and labor 1,200 1,200
Selling costs 125 125
Fixed costs
Manufacturing overhead $700,000 $595,000
Selling and administrative 120,000 120,000
Top management at Hancock explained to the consultant that a difficult business environment for
the firm in 2018 and 2019 had caused the firm to reduce its price and production levels and reduce
its fixed
Final PDF to printer
Chapter 18 Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard 811
blo17029_ch18_775-825.indd 811 02/19/18 09:10 AM
was a decline in sales in both years. This led to an increase in inventory in 2018, which the firm was
able to reduce in 2019 by further reducing the level of production. In both years, Hancock’s actual
production was less than the budgeted level so that the overhead rate for fixed overhead, calculated
from budgeted production levels, was too low, and a production volume variance was calculated
to adjust cost of goods sold for the underapplied fixed overhead (the calculation of the production
volume variance is explained fully in Chapter 15 and reviewed briefly below).
The production volume variance for 2018 was determined from the fixed overhead rate of $175
per unit ($700,000/4,000 budgeted units). Because the actual production level was 200 units short of
the budgeted level in 2018 (4,000 − 3,800), the amount of the production volume variance in 2018
was 200 × $175 = $35,000. The production volume variance is underapplied because the actual
production level is less than budgeted, and the production volume variance is therefore added back
to cost of goods sold to determine the amount of cost of goods sold in the full costing income statement. The full costng income statement for 2018 is shown below:
Sales $6,704,000
Cost of goods sold:
Beginning inventory $1,100,000
Cost of goods produced 5,225,000
Cost of goods available for sale $6,325,000
Less ending inventory 1,925,000
Cost of goods sold: $4,400,000
Plus unfavorable production volume variance 35,000
Adjusted cost of goods sold $4,435,000
Gross margin $2,269,000
Less selling and administrative costs
Variable $ 400,000
Fixed 120,000 520,000
Operating income $1,749,000
Required
1. Using the full costing method, prepare the income statement for 2019.
2. Compute operating income for each period under variable costing, and explain the difference in
operating income from that obtained in requirement 1.
3. Write a brief memo to the firm to explain the difference in operating income between variable costing
and full costing
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