1- Variable and Full Costing
The following information relates to Porter Manufacturing for fiscal 2006, the company's first year of operation.:

Selling price per unit $ 120
Direct material per unit $ 60
Direct labor per unit $ 20
Variable manufacturing overhead per unit $ 5
Variable selling cost per dollar of sales $ 0.10
Annual fixed manufacturing overhead $ 2,000,000
Annual fixed selling expense $ 1,000,000
Annual fixed administrative expense $ 800,000
Units produced $ 200,000
Units sold $ 170,000

First, we need to compute the unit product cost under both full and variable costing.

Absorption costing

Direct materials 60
Direct labor 20
Variable manufacturing overhead 5
Fixed manufacturing overhead ($2,000,000/200,000 units) 10
95

Variable costing

Direct materials 60
Direct labor 20
Variable manufacturing overhead 5
85

A. Prepare an income statement using full costing

Units Sold 170,000
Sales ($120 x 170,000 units) 20,400,000
Cost of Goods Sold Expense:
Beginning Inventory 0
Cost of Production:
Direct Materials ($60 x 200,000 units) 12,000,000
Direct Labor ($20 x 200,000 units) 4,000,000
Variable manufacturing overhead 1,000,000
Fixed manufacturing overhead 2,000,000
19,000,000
Total Costs Available for Sale 19,000,000
Less: Ending Inventory of Finished Goods 2,850,000
($95 x 30,000 units)
Cost of Goods Sold Expense 16,150,000
Gross Margin 4,250,000
Selling and Administrative Expenses:
Variable selling cost 17,000
($0.10 x 170,000 units)
Fixed selling expense 1,000,000
Fixed administrative expense 800,000
1,817,000
Net Income 2,433,000

B. Prepare an income statement using variable costing

Units Sold 170,000
Sales ($120 x 170,000 units) 20,400,000
Total Variable Costs:
Beginning Inventory 0
Cost of Production:
Direct Materials ($60 x 200,000 units) 12,000,000
Direct Labor ($20 x 200,000 units) 4,000,000
Variable manufacturing overhead 1,000,000
17,000,000
Total Costs Available for Sale 17,000,000
Less: Ending Inventory of Finished Goods 2,550,000
($85 x 30,000 units)
Variable Cost of Goods Sold Expense 14,450,000
Variable selling cost 17,000
Total Variable Expenses 14,467,000
Total Contribution Margin 5,933,000
Total Fixed Costs:
Fixed manufacturing overhead 2,000,000
Fixed selling expense 1,000,000
Fixed administrative expense 800,000
3,800,000
Net Income 2,133,000

C. Calculate the amount of fixed manufacturing overhead that will be included in ending inventory under full costing and reconcile it to the difference between income computed under variable full costing.

You can prepare a report by using the following equation.

Difference in profits = difference in units sold x fixed overhead cost
and produced per unit

= (Qs - Qp) x $10 per unit

= 30,000 units x $10 per unit

= $300,000

2- Allocating Services Department Costs

World Airlines has three service departments: (1) ticketing, (2) baggage handling, and (3) engine maintenance. The service department costs are estimated for separate cost pools formed by department and are allocated to two revenue-producing departments: (1) domestic flights and (2) international flights. World does not differentiate between fixed and variable costs in making allocations. The following date relate to the allocations:

Budgeted Data
__________________________
Costs Air Miles
Ticketing $4,000,000
Baggage handling $2,000,000
Engine maintenance $6,000,000
Domestic flights 5,000,000
International flights 20,000,000

A. Allocate the service department costs to the revenue-producing departments using air miles as the allocation base.

Ticketing $4,000,000
Baggage handling $2,000,000
Engine maintenance $6,000,000
Total cost $12,000,000

Domestic flights 5,000,000
International flights 20,000,000
Total air miles 25,000,000

Service department costs per air mile = $12,000,000/25,000,000
= $0.48

Domestic flights 5,000,000 x $0.48 = $2,400,000
International flights 20,000,000 x $0.48 = $9,600,000

B. Evaluate the cause-and-effect relationship resulting from the use of air miles as the allocation base. In which of the cost pools do you think the cause-and-effect relationship is the strongest? Suggest alternative allocation bases for the two remaining cost pools with the weakest cause-and-effect relationship.

Engine maintenance is the cost pool that the cause-and-effect relationship is the strongest because it is directly related to the air miles. For the two remaining cost pools, I would like to suggest allocation of cost based on tickets issued and number of bags handling.