Question

3) 7 Sees sells bottled water for $5 per bottle. The firm had no beginning inventory at the start of the month, budgeted production of 1,000 bottles, and production capacity of 1,200 bottles. Actual production and sales were 900 bottles and 700 bottles, respectively. Costs during the month were as follows:

Variable manufacturing costs $2 per bottle produced

Variable marketing costs $0.40 per bottle sold

Fixed manufacturing costs $900

Fixed marketing costs $500

a) What is cost of goods sold during the month if the company uses VARIABLE costing?

b) What is the value of inventory at the end of the month if the company uses VARIABLE costing?

c) What is the value of inventory at the end of the month if the company uses ABSORPTION costing?

d) What are profits during the month if the company uses ABSORPTION costing?

e) Are profits higher under variable or absorption costing?

CHOOSE ONE: VARIABLE ABSORPTION SAME FOR BOTH

f) Assuming sales remain at 700 bottles, what is the maximum profit the company can earn during the month if it uses ABSORPTION costing?

Answer 1

a.

Cost of goods sold using variable costing

= Variable manufacturing cost per bottle x Number of bottles sold

= $2 x 700

= $1400

b.

Value of inventory using variable costing

= Variable manufacturing costs per bottle x Number of bottles in the ending inventory

= $2 x (900 - 700)

= $400

c.

Under absorption costing, fixed manufacturing costs are included in the product cost.

Therefore,

Value of inventory using absorption costing

= (Variable manufacturing cost per bottle + Fixed manufacturing costs per bottle) x Number of bottles

= ($2 + $900/900) x (900 - 700)

= $600

d.

Profits during the month using absorption costing will be calculated as follows:

Sales (700 units x $5)	3500
Less: Cost of goods sold (700 units x $3)	2100
Gross profit	1400
Less: Variable marketing costs (700 units x $0.40)	280
Less: Fixed marketing costs	500
Profits during the month	620

Profits during the month using absorption costing are $620.

e.

When the number of units manufactured is higher than the number of units sold, profits are always higher under abroption costing.

f.

The maximum profit that can be earned during the month using absorption costing will be calculated assuming that 1,200 bottles were produced.

Then fixed manufacturing costs per bottle will be $900/1,200 = $0.75

Calculate maximum profit as follows:

Sales (700 units x $5)	3500
Less: Cost of goods sold (700 units x $2.75)	1925
Gross profit	1575
Less: Variable marketing costs (700 units x $0.40)	280
Less: Fixed marketing costs	500
Profits during the month	795

Maximum profit that can be earned is $795.