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Varilux manufactures a single product and sells it for $10 per unit. At the beginning of the year, there were 1,000 units in inventory. Upon further investigation, you discover that units produced last year had $3 of fixed manufacturing costs and $2 of variable manufacturing costs. During the year, Varilux produced 10,000 units of product. Each unit produced generated $3 of variable manufacturing cost. Total fixed manufacturing cost for the current year was $40,000. Selling and administrative costs consisted of $12,000 of variable costs and $18,000 of fixed costs. There were no inventories at the end of the year.
Required: Prepare two income statements for the current year: one on a variable cost basis and the other on an absorption cost basis. Explain any difference between the two net income numbers and provide calculations supporting your explanation of the difference.
10-14 Avant Designs
Avant Designs designs and manufactures polished-nickel fashion bracelets. It offers two bracelets: Aztec and Mayan. The following data summarize budged operations for the current year:
Summary of Budgeted Operations
Budgeted fixed manufacturing overhead for the year was $258,000.
a. Prepare the budgeted income statement for the year using variable costing.
b. Prepare the budgeted income statement for the year using absorption costing. Budgeted fixed manufacturing overhead is allocated to the two bracelets using machine minutes.
c. Explain the difference in the two net income figures computed in parts (a) and (b). That is, reconcile any difference in earnings and explain why it occurs.
11-4 Milan Pasta
At its Lyle Avenue plant, Milan Pasta produces two types of pasta: spaghetti and fettuccine. The two pastas are produced on the same machines, with different settings and slightly different raw materials. The fettuccine, being a wider noodle and more susceptible to curling edges, require more inspection time. The total daily cost of inspection is $500. Here are daily production data for the two products.
Machine minutes per pound
Inspection hours per product line
a. Calculate the inspection cost per pound of pasta using traditional absorption costing with number of machine hours as the allocation base.
b. Calculate the inspection cost per pound of pasta using activity-bases costing. Assume inspection time is the cost driver.
c. Analyze why inspection costs differ between the methods used in (a) and (b).
DVDS manufactures and sells DVD players in two countries. It manufactures two models---Basic and Custom---in the same plant. The Basic DVD has fewer options and provides lower-quality output than the Custom DVD. The basic model is sold only in a developing country and the custom model is sold only in a developed country. DVDS pays income taxes to the country where the final sale of the DVD player takes place. The following table summarizes DVDS operations.
Summary of Operations
Quantity produced and sold
Income tax rate
Besides direct materials and direct labor, manufacturing overhead amounts to $2 million and is currently assigned to products based on direct labor dollars. Manufacturing overhead is a fixed cost (does not vary with the number of units produced.)
a. Calculate the unit manufacturing costs of the Basic and Custom DVD models using traditional absorption costing. Manufacturing overhead is allocated based on direct labor dollars.
b. DVDS hires a consulting firm to analyze its costing methods. After performing an extensive review, the consultants determine that the vast majority of the $2 million of overhead varies with the number of different parts in the two DVD models. The number of parts drives purchasing department activities. More engineering time is spent on the more complex Custom DVD models. More accounting depreciation of assembly and testing equipment is incurred producing the Custom DVD model than the Basic DVD model. The Basic DVD has 140 different parts. Calculate the unit manufacturing costs of the Basic and Custom DVD models using activity-based costing.
c. Should DVDS change its costing methodology from its traditional absorption costing to ABC? Explain why it should or should not.
11-12 Wedig Diagnostics
Wedig Diagnostics manufactures two laser photometers that are used in preparing DNA tests. The U.S. model is designed for use in the United States and the EU model is designed to meet the specifications in most of the European Union. Both models are manufactured in the United States. The EU models are shipped to Wedig’s wholly owned European subsidiary, which sells them. All units manufactured are sold. The following table summarizes the selling process, direct materials and labor, and number of units sold.
U.S. Model EU Model
Number of units sold annually
The EU units are sold in U.S. dollars. Wedig has total manufacturing overhead of $39 million annually. This overhead is allocated to both U.S. and EU models using total direct labor dollars. Wedig transfers its EU model to its European subsidiary at full cost (direct materials and labor plus allocated overhead). Assume that Wedig pays U.S. taxes only on the profits it makes on sales in the United States and the Wedig EU subsidiary pays taxes only on the profits it makes on sales in the EU. The U.S. income tax rate is 30 percent and the Wedig European subsidiary has a tax rate of 15 percent.
Wedig hires a consulting firm to perform an ABC analysis of its overhead costing methodology. This analysis reveals that the $39 million of overhead consists of three cost pools: batch-related costs ($12 million), parts-related costs ($9 million), and direct labor-related costs ($18 million). Each model is produced in batches, and batch-related costs consist of engineering, quality control, and machining costs that vary with the number of batches produced. The u.S. model is produced in 45 batches each year and the EU model is produced in 55 batches a year.
The U.S. and EU models differ in terms of the number of different parts in each unit. The U.S. model has 40 different part numbers and the EU model has 80 different part numbers. Parts-related costs consist of the costs of operating the purchasing department (excluding the costs of the parts purchased), inspecting the parts upon arrival, inventorying the parts, and managing the parts inventory. Parts-related costs vary with the number of part numbers in each product. Finally, the direct labor-related costs consist of human resources, accounting, and other overhead costs that vary with the amount of direct labor in each model.
a. Calculate the unit manufacturing cost of the U.S. and EU models using total direct labor dollars to allocate the $39 million of manufacturing overhead.
b. Calculate the unit manufacturing cost of the U.S. and EU models using the ABC analysis to allocate the $39 million of manufacturing overhead.
c. Prepare income statements (including income tax expense) for Wedig and its European subsidiary using the unit manufacturing costs calculated in part (a) (overhead is allocated using total direct labor dollars)
d. Prepare income statements (including income tax expense) for Wedig and its European subsidiary using the unit manufacturing costs calculated in part (b) (overhead is allocated using the ABC analysis).
e. Discuss the advantages and disadvantages of using direct labor versus ABC to allocate the $39 million of overhead.