[Anonymous]

Wiley Question –

At the end of Killo Co.’s first year of operations, 1,000 units of inventory remained on hand. Variable and fixed manufacturing costs per unit were $90 and $20, respectively. If Killo uses absorption costing rather than direct (variable) costing, the result would be a higher pretax income of

A. $0.

B. $20,000.

C. $70,000.

D. $90,000.

Answer: B, $20,000.

Absorption costing includes both variable and fixed manufacturing costs as product costs. Direct costing includes only variable manufacturing costs as product cost and expenses fixed manufacturing costs as a period expense. In this case, absorption costing includes $20,000 of fixed manufacturing costs (1,000 x $20) in ending inventory while direct costing expenses the full amount of fixed manufacturing costs. Pretax income is consequently $20,000 higher for absorption costing.

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If you are using absorption costing rather than variable costing, you would include the additional $20,000 fixed manufacturing costs, so wouldn’t that make income LOWER rather than HIGHER?

[jeff]

Fixed manufacturing costs (FMC) are treated differently under absorption costing (AC) than under variable costing (VC).

Specifically:

-Under AC, FMC is treated as a part of unit product cost, whereas

-Under VC, all FMC is expensed in the period in which it is incurred.

Killo's ending inventory would be valued as follows:

-Under AC 1,000 units × $110 = $110,000

-Under VC 1,000 units × $ 90 = $ 90,000

The difference of $20,000 is the amount by which AC income would exceed VC income.

Jeff Elliott, CPA (KS) | Another71 | NINJA CPA | NINJA CMA | NINJA CPE

[jeff]

Fixed manufacturing costs (FMC) are treated differently under absorption costing (AC) than under variable costing (VC).

Specifically:

-Under AC, FMC is treated as a part of unit product cost, whereas

-Under VC, all FMC is expensed in the period in which it is incurred.

Killo's ending inventory would be valued as follows:

-Under AC 1,000 units × $110 = $110,000

-Under VC 1,000 units × $ 90 = $ 90,000

The difference of $20,000 is the amount by which AC income would exceed VC income.

Jeff Elliott, CPA (KS) | Another71 | NINJA CPA | NINJA CMA | NINJA CPE

[red3biggs]

I completely understand why this problem is tricking you up.

Total Fixed costs would be completely expensed in direct costing.

In absorption, the fixed costs are added to the unit costs (inventory) and removed from the COGS. It would leave the per unit costs in the remaining inventory. (Direct Costs + Fixed Costs)/units produced = Per unit costs.

Per Unit Costs x ending inventory

In the problem given, per unit is $20 higher in absorption than direct. And the period expenses would be 1,000 x 20 less.

Sales – COGS [(90+20) x units sold] = NI before tax

Sales – COGS (90 x units sold) – fixed costs (20 x units produced) = NI before tax

Notice that the total units produced is 1,000 units higher than the units sold (ending inventory of 1,000)

AUD: 8/17/2012
REG: 4/29/2013
BEC: 7/8/2013
FAR: 1/16/2014

[red3biggs]

I completely understand why this problem is tricking you up.

Total Fixed costs would be completely expensed in direct costing.

In absorption, the fixed costs are added to the unit costs (inventory) and removed from the COGS. It would leave the per unit costs in the remaining inventory. (Direct Costs + Fixed Costs)/units produced = Per unit costs.

Per Unit Costs x ending inventory

In the problem given, per unit is $20 higher in absorption than direct. And the period expenses would be 1,000 x 20 less.

Sales – COGS [(90+20) x units sold] = NI before tax

Sales – COGS (90 x units sold) – fixed costs (20 x units produced) = NI before tax

Notice that the total units produced is 1,000 units higher than the units sold (ending inventory of 1,000)

AUD: 8/17/2012
REG: 4/29/2013
BEC: 7/8/2013
FAR: 1/16/2014

[Anonymous]

Oh, gotcha, higher ending inventory means lower COGS. Wow I read that question and answer explanation wrong, silly me.

[Anonymous]

Oh, gotcha, higher ending inventory means lower COGS. Wow I read that question and answer explanation wrong, silly me.

[Author]

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