Responsibility Accounting and Transfer Pricing

(C. Variable Costing & Segmented Reporting)

C. VARIABLE COSTING AND SEGMENTED REPORTING

B. Profits fluctuate with sales

C. An idle facility variation is calculated
D. Product costs include direct (variable) administrative costs.

THEORIES:
Direct costing
1. A basic tenet of direct costing is that period costs should be currently expensed. What is the
rationale behind this procedure?
A. Period costs are uncontrollable and should not be charged to a specific product.
B. Period costs are generally immaterial in amount and the cost of assigning the amounts to
specific products would outweigh the benefits.
C. Allocation of period costs is arbitrary at best and could lead to erroneous decisions by
management.
D. Because period costs will occur whether or not production occurs, it is improper to
allocate these costs to production and defer a current costs of doing business.

5. Which of the following is an argument against the use of direct (variable) costing?
A. Absorption costing overstates the balance sheet value of inventories.
B. Variable factory overhead is a period cost.
C. Fixed factory overhead is difficult to allocate properly.
D. Fixed factory overhead is necessary for the production of a product.
10. Advocates of variable costing for internal reporting purposes do not rely on which of the
following points?
A. The matching concept
B. Price-volume relationships
C. Absorption costing does not include selling and administrative expenses as part of
inventoriable cost
D. Production influences income under absorption costing

17. In a variable costing system, product cost includes

A. direct materials, direct labor, variable overhead
B. direct materials, direct labor, fixed overhead
C. direct labor, variable overhead, fixed overhead
D. direct materials, variable overhead, fixed overhead

13. Which costing method is not acceptable to the SFAS external reporting?
A. absorption costing
C. full costing
B. variable costing
D. all of these are acceptable

2. Which of the following must be known about production process in order to institute a direct
costing system?
A. The variable and fixed components of all costs related to production.
B. The controllable and noncontrollable components of all costs related to production.
C. Standard production rates and times for all elements of production.
D. Contribution margin and breakeven point for all goods in production.

16. Variable costing can be used for

A. external reporting
B. internal reporting
C. either external reporting or internal reporting
D. neither external reporting nor internal reporting

3. Under the direct costing concept, unit product cost would most likely be increased by
A. A decrease in the remaining useful life of factory machinery depreciated on the units-ofproduction method.
B. A decrease in the number of units produced.
C. An increase in the remaining useful life of factory machinery depreciated on the sum-ofthe-years-digits method.
D. An increase in the commission paid to salesmen for each unit sold.

12. Which of the following is not true of variable costing?

A. Profits may increase though sales decrease.
B. Profits fluctuate with sales.
C. The cost of the product consists of all variable production costs.
D. The income statement under variable costing does not include overhead volume
variance.

4. Which of the following statements is true for a firm that uses variable (direct) costing?
A. The cost of a unit of product changes because of changes in the number of units
manufactured.

Contribution margin format income statement

15. When variable costing is used, the income statement is usually prepared using
A. a contribution margin format
C. a functional format
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B. an operational format

D. all of these
22. Net earnings determined using full absorption costing can be reconciled to net earnings
determined using direct costing by computing the difference between
A. Inventoried fixed costs in the beginning and ending inventories and any deferred over- or
underapplied fixed factory overhead.
B. Inventoried discretionary costs in the beginning and ending inventories.
C. Gross margin (absorption costing method) and contribution margin (direct costing
method).
D. Sales as recorded under the direct costing method and sales as recorded under the
absorption costing method.

Absorption costing
8. Absorption costing of inventories, as required by GAAP, has been criticized for encouraging
managers to increase year-end inventories in order to boost reported profits. Which of the
following techniques is the most effective at resolving this problem?
A. Senior management control of inventory levels
B. Adoption of just-in-time (JIT) production system
C. Reward managers based upon the residual income approach
D. Use variable costing to determine income for bonus purposes
11. When absorption costing is used, all of the following costs are considered product costs
except
A. direct labor
C. variable selling and administrative costs
B. variable overhead
D. fixed overhead

23. Net profit under absorption costing may differ from net profit determined under direct costing.
How is this difference calculated?
A. Change in the quantity of all units in inventory times the relevant fixed costs per unit.
B. Change in the quantity of all units produced times the relevant fixed costs per unit.
C. Change in the quantity of all units in inventory times the relevant variable cost per unit.
D. Change in the quantity of all units produced times the relevant variable cost per unit.

21. Unabsorbed fixed overhead costs in an absorption costing system are

A. Fixed factory costs not allocated to units produced.
B. Variable overhead costs not allocated to units produced.
C. Excess variable overhead costs.
D. Costs that should be controlled.

Sensitivity analysis
20. The level of production affects income under which of the following methods?
A. absorption costing
C. variable costing
B. both absorption and variable costing
D. neither absorption nor variable costing

Variable costing vs. Absorption costing

6. What is the primary difference between variable and absorption costing?
A. inclusion of fixed selling expenses in product costs
B. inclusion of variable factory overhead in period costs
C. inclusion of variable selling expenses in product costs
D. inclusion of fixed factory overhead in product costs
7. Which of the following statements is true?
A. Absorption costing net income exceeds variable
produced and sold are equal.
B. Variable costing net income exceeds absorption
produced exceed units sold.
C. Variable costing net income exceeds absorption
produced equal units sold.
D. Absorption costing net income exceeds variable
produced are greater than units sold.

18. Variable-costing income will usually exceed absorption costing income when
A. sales exceed production
C. production exceeds sales
B. production and sales are equal
D. none of these
19. Variable costing net income is
A. higher than absorption net income when more units are sold than produced
B. lower than absorption net income when more units are produced than sold
C. the same as absorption net income when all units produced are sold
D. all of the above

costing net income when units

costing net income when units

9. A manufacturing company prepares income statements using both absorption and variable
costing methods. At the end of a period actual sales revenues, total gross profit, and total
contribution margin approximated budgeted figures, whereas net income was substantially
greater than the budgeted amount. There were no beginning or ending inventories. There
most likely explanation of the net income increase is that, compared to budget, actual

costing net income when units

costing net income when units
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A.
B.
C.
D.

Manufacturing fixed costs had increased.

Selling and administrative fixed expenses had decreased.
Sales prices and variable costs had increased proportionately.
Sales prices had declined proportionately less than variable costs.

5.
6.
A.
B.

14. When variable costing is used, fixed manufacturing overhead is recognized as an expense
when the
A. cost is incurred
C. product is sold
B. product is completed
D. product is inventoried

direct fixed selling costs

common fixed selling costs
2, 3, 5, 6
1, 2, 4, 5

C. 2, 3, 4, 5
D. 1, 4, 5, 6

28. Which of the following costs would continue to be incurred even if a segment is eliminated?
A. direct fixed expenses
B. common fixed costs
C. variable cost of goods sold
D. variable selling and administrative expenses

Segment reporting
24. A segment is any part of an organization about which a manager seeks
A. cost data
C. quantitative data
B. revenue data
D. any of the above

Cost allocation policy

31. Which of the following is a good reason for allocating indirect costs to operating departments?
A. The company could lose money if the operating departments do not pay for the services
they use.
B. To remind managers of the need to cover indirect costs.
C. To encourage managers to use more services.
D. To determine the true costs of operating departments.

26. Which of the following could be considered a segment?

A. division
C. product line
B. sales territory
D. all of these
25. The guideline(s) used in assigning costs to a segment include(s) whether
A. costs are fixed
C. costs are directly traceable
B. costs are variable
D. all of the above

33. The cost allocation policy most likely to encourage use of a service is based on
A. budgeted total costs of the service department
B. actual total costs of the service department
C. budgeted variable costs for the service department
D. actual variable costs for the service department

27. Segment margin is equal to

A. sales less variable costs
B. sales less variable costs and direct fixed costs
C. sales less variable costs and indirect fixed costs
D. sales less cost of goods sold

32. The term dual rates refers to

A. allocating costs to several operating departments
B. allocating fixed costs based on capacity requirements and variable costs based on use
C. allocating both actual costs and budgeted costs
D. using the budgeted rate to allocate some costs, the actual rate to allocate others

29. Revenue less variable costs and direct fixed costs equals
A. contribution margin
C. income before taxes
B. segment margin
D. income after taxes

34. The WORST method of allocating service department costs is to allocate

A. total actual costs based on actual use of the service
B. total budgeted costs based on long-term expected use of the service
C. total budgeted cost based on actual use of the service
D. none of the above, because all the above are equally undesirable

30. Indicate which of the following costs would be avoided if a segment is eliminated.
1. variable manufacturing costs
2. direct fixed costs
3. common fixed costs
4. variable selling costs

PROBLEMS:
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Variable costing
Ending inventory
i. The following information pertains to Sharapova Corporation:
Beginning inventory
Ending inventory
Direct labor per unit
Direct materials per unit
Variable overhead per unit
Fixed overhead per unit
Variable selling costs per unit
Fixed selling costs per unit
What is the value of ending inventory using the variable costing method?
A. P155,000
C. P100,000
B. P125,000
D. P195,000

Unit costs
iii. During May, Roy Co. produced 10,000 units of Product X. Costs incurred by Roy during May
were as follows
Direct materials
P10,000
Direct labor
20,000
Variable manufacturing overhead
5,000
Variable selling and general
3,000
Fixed manufacturing overhead
9,000
Fixed selling and general
4,000
Total
P51,000
What are the unit costs under absorption and variable costing methods, respectively?
A. P5.10; P3.80
C. P4.40; P3.50
B. P3.80 P5.10
D. P3.50: P4.40

0 units
5,000 units
P10
8
2
5
6
8

Difference in income
iv. Consider the following:
Sales price, per unit
P18 per unit
Standard absorption cost rate
P12 per unit
Standard variable cost rate
P8 per unit
Variable selling expense rate
P2 per unit
Fixed selling and administrative expenses
P40,000
Fixed manufacturing overhead
P60,000
Last period, 13,000 units were produced. In the current period, 15,000 units were produced.
In each period, 13,000 units were sold. What is the difference in reported income under
absorption and variable costing for the current period?
A. The variable-costing income exceeded absorption-costing income by P4,000.
B. The absorption-costing income exceeded variable-costing income by P8,000.
C. The variable-costing income exceeded absorption-costing income by P6,000.
D. Net income will not be different between the two methods.

Absorption costing
Gross margin
ii. A company manufactures a single product for its customers by contracting in advance of
production. Therefore, the company only produces units that will be sold by the end of each
period. During the last period, the following sales were made and costs incurred:
Sales
P40,000
Direct materials
9,050
Direct labor
6,000
Rent (9/10 factory, 1/10 office)
3,000
Depreciation on factory equipment
2,000
Supervision (2/3 factory, 1/3 office)
1,500
Salespeoples salaries
1,300
Insurance (2/3 factory, 1/3 office)
1,200
Office supplies
750
Advertising
700
Depreciation on office equipment
500
Interest on loan
300
Based on the above data, the gross margin percentage for the last period (rounded to nearest
percent) was
A. 41%
C. 46%
B. 44%
D. 49%

v. The Blue Company has failed to reach its planned activity level during its first two years of
operation. The following table shows the relationship between units produced, sales, and
normal activity for these years and the projected relationship for Year 3. All prices and costs
have remained the same for the last two years and are expected to do so in Year 3. Income
has been positive in both Year 1 and Year 2.
Units Produced
Sales
Planned Activity
Year 1
90,000
90,000
100,000

Variable costing vs. Absorption costing

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income before taxes would have been

A. P 9.50 higher
B. P 8.50 higher

Year 2
95,000
95,000
100,000
Year 3
90,000
90,000
100,000
Because Blue Company uses an absorption costing system, one would predict gross margin
for Year 3 to be
A. Greater than Year 1.
C. Equal to Year 1.
B. Greater than Year 2.
D. Equal to Year 2.

C. P11.00 higher
D. P 8.33 higher

ix. At its present level of operations, a small manufacturing firm has total variable costs equal to
75% of sales and total fixed costs equal to 15% of sales. Based on variable costing, if sales
change by P1.00, income will change by
A. P 0.25
C. P 0.75
B. P 0.12
D. P 0.10

Reconciliation
Income under absorption costing
vi. A company had income of P50,000 using direct costing for a given period. Beginning and
ending inventories for that period were 13,000 units and 18,000 units, respectively. Ignoring
income taxes, if the fixed overhead application rate were P2.00 per unit, what would the
income have been using absorption costing?
A. P40,000
B. P50,000
C. P60,000
D. Cannot be determined from the information given.

Segmented Income Statement

Effect of dropping a department
x. Zambales Mining Co. mines three products. Gold Ore sells for P1,000,000 per ton, variable
costs are P600,000 per ton, and fixed mining costs are P5,000,000. The segment margin
for 2005 was P(1,000,000). The management of Zambales Mining was considering
dropping the mining of Gold Ore. Only one-half of the fixed expenses are direct and would
be eliminated if the segment was dropped. If Gold Ore were dropped, net income for
Zambales Mining would
A. Increase by P1,000,000
C. Decrease by P1,000,000
B. Increase by P1,500,00
D. Decrease by P1,500,000

Income under variable costing

vii. Luna Company had income of P65,000 using absorption costing for a given period.
Beginning and ending inventories for that period were 13,000 units and 18,000 respectively.
Ignoring income taxes, if the fixed overhead application rate were P2.50 per unit, what
would the income have been using variable costing?
A. P 77,500
C. P 52,500
B. P 60,000
D. P 20,000

xi. Aging Company plans to discontinue a segment with a P32,000 segment margin. Common
expenses allocated to the segment amounted to P45,000, of which P20,000 cannot be
eliminated if the segment were closed. The effect of closing down the segment on Aging
Companys before tax profit would be
A. P12,000 decrease
C. P 7,000 decrease
B. P12,000 increase
D. P 7,000 increase

Unit contribution margin

viii. The following information was extracted from the first year of absorption-based accounting
records of Soulmate Co.
Total fixed costs incurred
P100,000
Total variable costs incurred
50,000
Total period costs incurred
70,000
Total variable period costs incurred
30,000
Units produced
20,000
Units sold
12,000
Unit sales Price
P
12
Based on variable costing, if Soulmate Co. had sold 12,001 units instead of 12,000, its

Use this data to respond to questions 16 through 17.

Omid Publishing Company has three divisions: A, B, and C. The revenues of these divisions are
P29,000, 48,000, and 63,000 respectively. Variable costs of these divisions amount to 57%, 59%,
and 64% of the given revenues. The divisions' short-term controllable fixed costs are P4,200,
5,200, and 6,200 respectively. The divisions' long-term controllable fixed costs amount to P3,800,
4,900, and 5,700 in the order given. The company's uncontrollable costs amount to P7,150, and
income tax is at 20% of operating income.
xii. Long-term controllable margin for division A amounts to
A. P4,470
C. P12,470
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B. P8,270

D. P16,470

100%

xiii. Short-term controllable margin for division B amounts to

A. P9,580
C. P19,680
B. P14,480
D. P23,580

xiv. The amount of fixed factory costs applied to product during the first six months under
absorption costing would be
A. Overapplied by P20,000.
C. Underapplied by P40,000.
B. Equal to the fixed costs incurred.
D. Underapplied by P80,000

Comprehensive
Questions 10 through 13 are based on the following annual flexible budget which has been
prepared for use in making decisions relating to Product X.
Budgeted units
100,000
150,000
200,000
Sales Volume
P800,000
P1,200,000
P1,600,000
Manufacturing costs:
Variable
P300,000
P 450,000
P 600,000
Fixed
200,000
200,000
200,000
P500,000
P 650,000
P 800,000
Selling expenses:
Variable
P200,000
P 300,000
P 400,000
Fixed
160,000
160,000
160,000
P360,000
P 460,000
P 560,000
Income (or loss)
(P60,000)
P 90,000
P 240,000

xv. Reported net income (or loss) for the first six months under absorption costing would be
A. P160,000
C. P 80,000
B. P 40,000
D. P (40,000)
xvi. Reported net income (or loss) for the firs six months under direct costing would be
A. P144,000.
C. P 72,000
B. P0
D. P(36,000)
xvii. Assuming that 90,000 units of Product X were sold during the first six months and that this is
to be used as a basis, the revised budget estimate for the total number of units to be sold
during this year would be
A. 360,000.
C. 240,000
B. 200,000.
D. 300,000

The 200,000-unit budget has been adopted and will be used for allocating fixed manufacturing
costs to units of Product X. At the end of the first six months the following information is available:
Units
Production completed
120,000
Sales
60,000

i.

All fixed costs are budgeted and incurred uniformly throughout the year and all costs incurred
coincide with the budget.

Answer: C
Direct materials
Direct labor
Variable overhead
Total unit cost- variable costing
Value of ending inventory (5,000 x P20)

ii. Answer: C
Sales
Cost of goods sold
Direct materials
Direct labor
Rent (0.9 x P3,000)
Depreciation
Supervision (2/3 x P1,500)
Insurance (2/3 x P1,200)

Over- and underapplied fixed manufacturing costs are deferred until year-end. Annual sales have
the following seasonal pattern:
Portion of Annual Sales
First quarter
10%
Second quarter
20%
Third quarter
30%
Fourth quarter
40%
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P 8
10
2
P20
P100,000
P40,000
P9,050
6,050
2,700
2,000
1,000
800

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(C. Variable Costing & Segmented Reporting)

Gross margin
Gross margin percentage (P18,400 P40,000)

P18,400
46%

iii. Answer: C
Direct materials
Direct labor
Variable overhead
Total variable product cost
Variable unit cost (P35,000 10,000)
Add Fixed overhead per unit (P9,000 10,000)
Absorption unit cost

P10,000
20,000
5,000
P35,00
P3.50
0.90
P4.40

Variable Cost Per unit

Product: (50,000 30,000) / 20,000 =
Selling & Adm. (variable period costs)
Total variable cost/unit
* Total variable costs variable period cost
(selling & adm.) = variable product cost.
ix. Answer: A
1.00 - (1.00 x .75) = P0.25

x. Answer: A
The only relevant information to compute the effect of dropping the mining of gold ore is the
negative segment margin. If the product line is dropped, the company can avoid the
negative margin of P1 million.

iv. Answer: B
Fixed overhead rate per unit:
P12 P8
P4
Difference in income:
2,000 x P4
P8,000
During the current year, the companys production equaled the budgeted. The inventory
increased. Therefore, absorption costing income is higher than the variable costing income.

xi. Answer: C
Avoidable common expenses
Segment margin lost
Decrease in profit

v. Answer: C
The production and unit sales during year 3 matched with year 1.
vi. Answer: C
The income under absorption costing is higher by P10,000 because the amount of fixed
overhead that related to unsold units was deferred and was included as cost of finished goods
inventory. The variable costing income statement immediately wrote the entire fixed overhead
that was incurred during the year as period cost.
Fixed overhead deferred as product cost: 5,000 x P2
P10,000
Absorption income
(P50,000 + P10,000)
P60,000
vii. Answer: C
Absorption income
Less Fixed Overhead in decrease in inventory
Income, Variable costing

(18,000 15,000) x 2.50

30,000/12,000

P1.00
2.50
P3.50

65,000
12,500
52,500

viii. Answer: B
CMR per unit = Selling Price Unit variable cost
P8.50 = P12.00 P3.50

xii. Answer: A
Revenues
Variable cost (P29,000 x 0.57)
Contribution margin
Less Short-term controllable fixed cost
Short-term controllable margin
Long-term controllable fixed cost
Long-term controllable margin

P29,000
16,530
12,470
4,200
8,270
3,800
P 4,470

xiii. Answer: B
Revenues
Variable cost (P48,000 x 0.59)
Contribution margin
Short-term controllable fixed cost
Short-term controllable margin Div B

P48,000
28,320
19,680
5,200
P14,480

xiv. Answer: A
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P 25,000
32,000
P( 7,000)

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Budgeted actual fixed overhead

(0.5 x P200,000)
Applied fixed overhead
(120,000 x P1.00)
Overapplied fixed overhead (favorable volume variance)

P100,000
120,000
P 20,000

xv. Answer: B
Sales (60,000 x P8)
Cost of goods sold (60,000 x P4)
Gross profit
Selling and other expenses (60,000 x 2) + P80,000
Absorption profit
xvi. Answer: B
Total contribution margin (60,000 x P3)
Less: Fixed manufacturing OH
Fixed selling and other expenses
Variable costing profit
CM per unit (P1.6M P0.6M P0.4M) 200,000)

P480,000
240,000
240,000
200.000
P 40,000

P100,000
80,000

P180,000
180,000
NIL
P3.00

xvii. Answer: D
The sales pattern indicated that sales for the first semester was 30%. The assumption was
that the pattern was still valid. Therefore the assumed 90,000 units would be 30 percent of
expected annual sales.
(90,000 0.3) = 300,000 units

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