Happy Valley Prison, is a Federal Correctional Institution, housing low-security
ID: 2427013 • Letter: H
Question
Happy Valley Prison, is a Federal Correctional Institution, housing low-security inmates. One way for inmates to earn “special privileges” is for them to work in the prison’s license plate manufacturing facility.
Happy Valley uses standard costing, and allocates overhead based on the number of plates produced. Happy Valley uses absorption costing and weighted average. Any estimation error is closed to cost of goods sold at the end of each month.
At the start of March, Happy Valley has no WIP, and finished good inventory of 2000 plates. Each plate in beginning inventory has $2 of variable cost and $1 of fixed overhead.
During March, Happy Valley expects to produce 1000 plates and has expected costs of $2000 (variable costs) and $1300 (fixed overhead). All of these expectations are met, except that March’s fixed overhead costs are actually $1900. At the end of March, Happy Valley has 1500 units in finished goods inventory and no WIP.
A) What will be the value of Happy Valley’s finished goods inventory at the end of March? What would be the value if Happy Valley used variable costing instead?
B) How much will be recorded as cost of goods sold on Happy Valley’s income statement for March? How much would be recorded if Happy Valley used variable costing instead?
C) John is in charge of production, and gets to determine the actual number of plates produced in June. He must announce this in advance (so that planned production will equal actual production), and he has no control over any other numbers. Would it be easier to John to increase June’s gross margin per plate sold under absorption costing system or under a variable costing system? Briefly explain.
D) Mary is in charge of sales, and can determine the actual number of plates sold in June (by accelerating sales from July or deferring sales to July). Would it be easier for Mary to increase June’s gross margin per plate sold under an absorption costing system or under a variable costing system? Briefly explain.
Explanation / Answer
Absorption costing No. of units A Varible cOst per unit B Fixed Cost per unit C Absorption Costing A*(B+C) Opening Inventory 2000 $2 $1 $6,000 Purchases 1000 2 $1.00 $3,000 Finished Goods underapplied 1000*.9 $900 Cost of Good manufactured $9,900 Ending Inventory 1500 2 1 for 500 and 1.9 for 1000 units 5400 Ans 1 Cost of Good Sold 1500 $4,500 Ans 2 Note: The overhead applied rate is $1 but in actula during March the overhead rate is $1.9 that means it is intially underapplied so as 1500 units are sold which will be from Beginning Inventory so overheadf will be $1 and for Finished goods 500 from beginning Inventory and 1.9 is the actual charge for 1000 units Variable Costing Varible cOst per unit B Amount Ending Inventory 1500 $2 $3,000 Ans 1 Cost of Good Sold 1500 2 $3,000 Ans2 C & D Under absorption costing if units of plates will be increased that the fixed cost will be decreased as it is based on no. of units so gross margin will increse but under variable costing method there will be no extra effect on gross margin as the cost will also increase in the same proportion as increase in sales as both are directlt related, so no effect on gross margin So for John and Mary under absorption costing it is easier to increase the gross margin as the fixed expenses per unit will decrease with the increase in output
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