Please Note: This is a brand new textbook and these solutions have not been checked for accuracy.

There may well

be mistakes. You should regularly check the announcements page on Blackboard for any updates or corrections
throughout semester. Email the Tutor-in-charge if you believe any of the following solutions are incorrect.

ACCT2012 Week 7 Homework Solutions Semester 1, 2009

4.22 Australian accounting standard AASB 102 has several requirements relating to inventories
arising from production:
The cost of inventories produced are to include the costs of:
• direct materials
• direct labour and on-costs
• sub-contracted work, and
• a systematic allocation of production overheads.
The balance sheet must disclose separately the accounting policies adopted for measuring
inventories, including work in process and finished goods. Both of these requirements involve
costs determined using job costing systems and process costing systems. The valuing of work in
process using process costing is not dealt with until Chapter 5.

PROBLEM 7.51 (50 minutes) (appendix) Normal costing; profit under

absorption and variable costing: manufacturer

1 (a)
Furry Pillows Pty. Ltd.
Income Statement Under Absorption Costing
Year Ended 30 June

Sales revenue (9,000 at $40/unit) $360 000

Less: Cost of goods sold (9,000 × $19.40)* 174 600
Gross margin 185 400
Less: Selling and administrative expenses
Variable 9 000
Fixed 60 000
69 000
Net profit $116 400

(b)
Furry Pillows Pty Ltd
Income Statement Under Variable Costing
Year Ended 31 30 June

Sales revenue (9,000 units at $40/unit) $360 000

Less: Variable expenses
Variable manufacturing costs
(9,000 at $14.40) 129 600
Variable selling & administrative costs 9 000
138 600
Contribution margin 221 400
Less: Fixed expenses
Fixed manufacturing overhead 50 000
Fixed selling and administrative expenses 60 000
Net profit $111 400

*As there are no work in process inventories, or beginning finished goods inventory, all

manufacturing costs are related to finished goods.

Direct material $80 000

Direct labour 40 000
Variable manufacturing overhead24 000
Variable cost of manufacture $144 000 or $14.40/unit
Fixed manufacturing overhead 50 000
Absorption cost of manufacture$194 000 or $19.40/unit

1
Please Note: This is a brand new textbook and these solutions have not been checked for accuracy. There may well
be mistakes. You should regularly check the announcements page on Blackboard for any updates or corrections
throughout semester. Email the Tutor-in-charge if you believe any of the following solutions are incorrect.

2 The absorption costing profit is higher because 1,000 units produced are carried forward as
finished goods inventory. Each unit carries forward a cost of $5.00 for manufacturing overhead,
that is expensed under variable costing.

3
Inventory calculations (units):
Finished-goods inventory, January 1 ............................................................................ 0 units
Add: Units produced ..................................................................................................... 10 000 units
Less: Units sold ............................................................................................................ 9 000 units
Finished-goods inventory, December 31 ...................................................................... 1 000 units

Finished Goods Absorption Costing Variable Costing

1 000 units × $19.40 $19 400
1 000 units × $14.40 $14 400

4 The major arguments for variable costing are:

(a). Variable costing provides useful information for short-term decisions, such as
whether to make or buy a component, and pricing.
(b) Under variable costing, profit is a function of sales and the classification of costs
as fixed or variable makes it simple to plan costs and profits.
(c) Cost volume profit analysis requires a variable costing format.
(d) Variable costing provides a useful perspective of the impact that fixed costs have
on profits by bringing them together and highlighting them, instead of having them
scattered throughout the statement.
The major arguments for absorption costing are:
(a) In the modern business environment, there is likely to be a high level of fixed
overhead and, therefore, a relatively small percentage of manufacturing costs
may be assigned to products under variable costing. At Furry Pillows more than
one quarter of the manufacturing cost is fixed manufacturing overhead.
(b) In the longer term a business must cover its fixed costs too, and many managers
prefer to use absorption cost in cost-based pricing decisions. They argue that
fixed manufacturing overhead is a necessary cost incurred in the production
process.
Generally the arguments in favour of variable costing are considered to outweigh those
in favour of absorption costing. If fixed overhead costs are high, a significant proportion
of manufacturing costs may not be assigned to products under variable costing.
However, absorption costing does not solve this problem effectively, because of the
distortions caused by using volume-based cost drivers to assign fixed manufacturing
overhead costs to products. Perhaps it would be better to recommend a new approach
to costing, such as activity-based costing, rather than either of these two conventional
costing systems.