Question

Part 1:

Charlie manufactures and sells high-quality, handmade wooden angels.

He began the current year with zero finished goods inventories. He expected FMOH would be $33,000 and allocated using labor costs which were estimated to be $33,000 as well.

During the year, Charlie produced angels that used $24,000 in materials and $30,000 in labor.

At year end, Charlie estimated the 1,000 units in ending finished goods inventory included $5,000 of materials and $7,500 of labor. No variable manufacturing overhead costs were estimated or actually incurred.

Charlie would like to know:

1. What is the inventoriable cost per unit of finished goods using absorption costing and what amount will appear on the balance sheet for ending finished goods inventory?
2. If variable costing was used to value ending finished goods inventory, will the inventoriable cost per unit amount be higher, lower or the same? Why?

Part 2:

Charlie is considering changing the method to allocate FMOH and using material costs as the allocation basis. Material costs were estimated to be $26,400 for the year.

If this change is made, would the value of ending finished goods inventory using absorption costing increase, decrease or stay the same?

Would this change affect what is reported as net operating income on the GAAP Income Statement?

Answer 1

Part 1:-

Predetermined Rate = Budgeted FOH/Budgeted Labor Cost

= $33,000/$33,00

= 1 per Labor Cost

Total Inventoriable Cost that would Appear In Balance Sheet if Absorption Method is Used:-

Direct Materials = $ 5,000

Direct Labor = $ 7,500

FOH (1*$7,500)= $ 7,500

Total Inventoriable Cost $20,000

Ending Inventory is 1,000 Units

So the Per unit cost under Absorption method will be:-

$20,000/1,000

= $20 per unit.

If Variable Method is used instead of Absorption then, both per unit cost and total cost in inventory will lower than the absorption costing balance, this is because FOH is treated as inventoriable cost in Absorption method and period cost in Variable costing. Total FOH in ending inventory was $7,500 which means a per unit FOH cost of $7.5 ($7,500/1,000). This $7.5 is not shown as inventory cost in variable method and ($20-$7.5) $12.5 will the per unit cost of inventory under variable method.

Part 2:-

If predetermined rate is taken on the basis of Direct Material cost instead of Direct Labor cost then,

Predetermined rate = $33,000/$26,400

= 1.25 per Direct Material.

So the per unit cost will be:-

Direct Materials $ 5,000

Direct Labor $ 7,500

FOH(1.25*5,000) $ 6,250

Tota Cost $18,750

Inventory was 1,000 units so the per unit cost will be:-

$18,750/1,000

= $18.75

By using Direct material as Allocation base the per unit cost of product decreased from $20 to $18.75. Cost decreased means Income increased.