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Qualifying Exam Review 2024

Module MS02: Absorption and Variable Costing and CVP Analysis

ABSORPTION AND VARIABLE COSTING

Absorption costing (full costing) – a costing method that includes all manufacturing costs (direct
materials, direct labor, variable and fixed factory overhead) in cost of a unit of product. It treats

Variable costing (direct costing) - a costing method that includes only variable manufacturing costs
(direct materials, direct labor and variable manufacturing overhead) in the cost of a unit of
product. It treats fixed factory overhead as a period cost.

Period Cost versus Product Cost

Period Costs Product Costs
Refers to an item charged against current revenue Refers to an item included in product costing which
on the basis of time period regardless of the is apportioned between the sold and unsold units.
difference between production and sales volume.
Does not form part of the cost of inventory. The portion of the cost, which has been allocated to
the unsold units, becomes part of the inventory.
Diminishes income for the current period by its full Diminishes current income by that portion thereof
amount. identified with the sold units only with the remainder
being deferred to the next accounting period as
part of the cost of ending inventory.

Differences between Variable and Absorption

Absorption Variable
Cost segregation Seldom segregates costs into Costs are segregated into
variable and fixed costs variable and fixed
Cost of Inventory Cost of inventory includes all the Cost of inventory includes only
manufacturing costs: materials, the variable manufacturing costs:
labor, variable factory overhead, materials, labor, and variable
and fixed factory overhead factory overhead
Treatment of fixed factory Fixed factory overhead is treated Fixed factory overhead is treated
overhead as product cost. as period cost.
Income statement Distinguishes between Distinguishes between variable
production and other costs. and fixed costs.
Net Income Net income between the two methods may differ from each other
because of the difference in the amount of fixed overhead costs
recognized as expense during an accounting period. This is due to
variations between sales and production. In the long run, however,
both methods give substantially the same results since sales cannot
continuously exceed production, nor production can continually
exceed sales.

Type of costs Absorption Costing Variable costing

Direct materials  
Direct Labor  
Variable Overhead  
Fixed Overhead  X
Variable Selling and Admin X X
Fixed Selling and Admin X X

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 Absorption Variable
Rationale All manufacturing costs are Fixed factory overhead is
necessary for production to take incurred in order to have the
place and should not be ignored capacity to produce units in a
in determining product cost given period. These costs are
incurred whether or not the
capacity is actually used to
make output and should be
charged against the period and
not in the product cost
Acceptability Consistent with accounting Violates the „matching principles‟
standards (recognition of expense by
matching it with the related
revenue in the same accounting
period)
Inventory Fixed factory overhead is Fixed factory overhead is
considered as a product cost. treated as a period cost. The
The peso amount of inventory is peso amount of inventory is
always greater than variable always lesser than absorption
costing costing.

Reconciliation of Operating income

The main reason for the difference of income between the two methods – TIMING DIFFERENCE (when
to recognize fixed factory overhead as expense)

Production versus Sales Effect in Inventory Difference in income

Production > Sales Increase AC income > VC income
Production < Sales Decrease AC income < VC income
Production = Sales No change AC income = VC income

ARGUMENTS FOR THE USE OF VARIABLE COSTING

1. Variable costing reports are simpler and more understandable.
2. Data needed for break-even and cost-volume-profit analyses are readily available.
3. The problems involved in allocating fixed costs are eliminated.
4. Variable costing is more compatible with the standard cost accounting system.
5. Variable costing reports provide useful information for pricing decisions and other decision-making
problems encountered by management.

ARGUMENTS AGAINST VARIABLE COSTING

1. Segregation of costs into fixed and variable might be difficult, particularly in the case of mixed costs.
2. The matching principle is violated by using variable costing which excludes fixed overhead from
product costs and charges the same to period costs regardless of production and sales.
3. With variable costing, inventory costs and other related accounts, such as working capital, current ratio,
and acid-test ratio are understated because of the exclusion of fixed overhead in the computation of
product cost.

THROUGHPUT COSTING (or SUPERVARIABLE COSTING)

An extreme form of variable costing in which only direct material costs are included as inventoriable costs.
All other costs are costs of the period in which they are incurred.

Throughput margin = Revenue – Direct material cost of the goods sold

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Concept Review:

1. The term that means all manufacturing costs (direct and indirect, fixed and variable) which can
contribute to the production of the product are traced to output and inventories is:
a. job order costing c. absorption costing
b. process costing d. direct costing

2. The term that is most descriptive of the type of cost accounting often called direct costing is:
a. out-of-pocket costing c. relevant costing
b. variable costing d. prime costing

3. Costs treated as product costs under direct costing are:

a. prime costs only c. all variable costs
b. variable production cost only d. all variable and fixed manufacturing costs

4. The basic assumption made in direct costing with respect to fixed costs is that fixed cost is:
a. a controllable cost c. an irrelevant cost
b. a product cost d. a period cost

5. Operating income computed using the direct costing would generally exceed operating income
computed using the absorption costing if:
a. units sold exceed units produced
b. units sold are less than units produced
c. units sold equal units produced
d. the unit fixed cost is zero

6. A company has operating income of ₱50,000 using direct costing for a given period. Beginning and
ending inventories for that period were 13,000 units and 18,000 units, respectively. If the fixed factory
overhead application rate is ₱2 per unit, the operating income using the absorption costing is:
a. ₱40,000 c. ₱60,000
b. ₱50,000 d Not determinable from the information given

7. Absorption costing differs from variable costing in the:

a. Fact that standard costs can be used with absorption costing but not with direct costing
b. Kinds of activities for which each can be used to report
c. Amounts of costs assigned to individual units of product
d. Amount of fixed costs that will be incurred

8. When a firm uses direct costing

a. the cost of a unit product changes because of changes in the number of units manufactured
b. profits fluctuate with sales
c. an idle capacity variance is calculated by a direct costing method.
d. product costs include variable administrative costs.

9. When using direct-costing information, the contribution margin discloses the excess of:
a. revenue over fixed cost
b. projected revenue over the break-even point
c. revenue over variable cost
d. variable over fixed cost

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10. Operating income under absorption costing can be reconciled to operating income determined under
direct costing by computing the difference between:
a. inventoried fixed costs in the beginning and ending inventories and any deferred over or
underapplied fixed factory overhead.
b. inventoried discretionary costs in the beginning and ending inventories
c. gross profit (absorption costing method) and contribution margin (direct costing)
d. sales recorded under the absorption costing method

11. Under the direct costing concept, unit product cost would most likely be increased by:
a. a decrease in the remaining useful life of factory machinery depreciated by the units-of
production method
b. a decrease in the number of units produced
c. a decrease in the remaining useful life of factory machinery depreciated by the sum-of-the-
years-digits method
d. an increase in the commission paid to salespersons for each unit sold.

ITEMS 12 and 13 ARE BASED ON THE FOLLOWING INFORMATION:

Selected information concerning the operations of Naniid Company for the year ended December 31,
2022, is available as follows:

Units produced 10,000

Units sold 9,000
Direct materials used ₱40,000
Direct labor cost incurred 20,000
Fixed factory overhead 25,000
Variable factory overhead 12,000
Fixed selling and administrative expenses 30,000
Variable selling and administrative expenses 4,500
Finished goods inventory, January 1, 2021 None

There were no work-in-process inventories at the beginning and end of 2022.

12. What would be Naniid‟s finished goods inventory cost at December 31, 2022, under the variable
(direct) costing method?
a. ₱7,200 c. ₱8,000
b. ₱7,650 d. ₱9,700

13. Which costing method, absorption or variable, would show a higher operating income for 2022 and by
what amount?
Costing method Amount
a. Absorption costing ₱2,500
b. Variable costing ₱2,500
c. Absorption costing ₱5,500
d. Variable costing ₱5,500

14. A corporation began its operations on January 1, 2022, and produces a single product that sells for
₱9.00 per unit. The company uses an actual (historical) cost system. 100,000 units were produced and
90,000 units were sold in 2022. There was no work-in-process inventory at December 31, 2022.
Manufacturing costs and administrative expenses for 2022 were as follows:

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 Fixed costs Variable costs
Raw materials – ₱ 1.75 per unit produced
Direct labor – ₱ 1.25 per unit produced
Factory overhead ₱100,000 ₱ 0.50 per unit produced
Selling and administrative 70,000 ₱ 0.60 per unit sold

What would be the company‟s operating income for 2022 using the direct costing method?
a. ₱181,000 c. ₱281,000
b. ₱271,000 d. ₱371,000

15. Operating income using direct costing as compared to absorption costing would be higher
a. when the quantity of beginning inventory equals the quantity of ending inventory.
b. when the quantity of beginning inventory is more than the quantity of ending inventory.
c. when the quantity of beginning inventory is less than the quantity of ending inventory.
d. under no circumstances.

16. When using full absorption costing, what costs attendant to an element of production (material, labor,
and overhead) are used in order to compute variances from standard amount?
a. Controllable costs c. Variable costs
b. Total costs d. Fixed costs

17. What factor, related to manufacturing costs, causes the difference in net earnings computed using
absorption costing and net earnings computed using direct costing?
a. Absorption costing considers all costs in the determination of net earnings, whereas direct
costing considers only direct costs.
b. Absorption costing allocates fixed costs between cost of goods sold and inventories, while
direct costing considers all fixed costs to be period costs.
c. Absorption costing “inventories” all direct costs, but direct costing considers direct costs to be
period costs.
d. Absorption costing “inventories” all fixed costs for the period in ending finished goods inventory,
but direct costing expenses all fixed costs.

18. A basic tenet of direct costing is that period costs should be currently expensed. What is the basic
rationale behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific product.
b. Period costs are generally immaterial in amount and the cost of assigning the amount to
specific products would outweigh the benefits.
c. Allocation of period costs is arbitrary at best and could to erroneous decisions by management.
d. Period costs will occur whether or not production occurs and so it is improper to allocate these
costs to production and defer a current cost of doing business.

19. The contribution margin increases when sales volume remains the same and
a. variable cost per unit decreases. c. fixed costs decrease.
b. variable cost per unit increases. d. fixed costs increase.

20. The production volume variance occurs when using

a. the absorption costing approach because of production exceeding the sales.
b. the absorption costing approach because production differs from that used in setting the fixed
overhead rate used in applying fixed overhead to production.
c. the variable costing approach because of sales exceeding the production for the period.
d. the variable costing approach because of production exceeding the sales for the period.
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IV. COST-VOLUME-PROFIT (CVP) ANALYSIS

 Cost-Volume-Profit (CVP) Analysis is a short-run model that focuses on relationships among

selling price, variable costs, fixed costs, volume, and profit.
 A useful planning tool that can provide information about the impact on profits when changes
are made in the cost structure on in sales levels.

CVP Analysis Assumptions

 Revenue and cost behavior patterns are constant per unit and linear within the relevant range
 Total contribution margin is linear within relevant range and increases proportionally with
output
 Total fixed cost remains constant within the relevant range
 Mixed costs can be accurately separated into their fixed and variable elements
 Sales and production are equal thus there is not material fluctuations in inventory levels
 In a multiproduct firm, the sales mix will remain constant
 Labor productivity, production technology and market conditions will not change

If there is an increase in Then the profit will

Selling Price Increase
Unit variable cost Decrease
Fixed cost Decrease
Unit sales (volume) Increase

Contribution Margin – the difference between the sales and variable cost. It can be expressed in a
per unit basis or in total basis.

Contribution Margin Ratio

Per Unit basis

Contribution Margin per unit
Selling Price

Total basis
Contribution Margin per unit
Sales Revenue

Change basis
Change in Contribution Margin
Change in Sales

In reference to VC Ratio
1 – VC Ratio

Breakeven Point – a level of activity, in units (break-even volume) or in pesos (break-even sales),
at which the total revenues equal total costs. At the breakeven point, there is neither a profit or a
loss.

BEP in units = Fixed Cost

CM/unit

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 BEP in pesos = Fixed Cost
CM Ratio

= BEP in units x Selling Price

Required Selling Price, Unit and Peso Sales to Achieve a Target Profit

Sales (units) for a target profit = Fixed cost + desired profit

CM per unit

Sales (pesos) for a target profit = Fixed cost + desired profit

CM Ratio

Sales (pesos) with target return on sales = Fixed Cost

CM Ratio - ROS

Sales Mix – relative combination of quantities of sales of various products that make up the total
sales of a company.

Overall BEP in units = Fixed cost

Weighted Average CM per unit

Margin of safety – is the difference between actual or budgeted sales and breakeven sales. It
indicates the maximum amount by which sales could decline without incurring loss.

Margin of safety = Sales – Breakeven Sales

Margin of safety ratio = Margin of safety/Sales

Degree of Operating Leverage – measures how a percentage change in sales will affect company
profits. It indicates how sensitive the company is to sales volume increases or decreases.

DOL = Contribution Margin / Profit before tax

Concept Review:

1. In planning its operations for 20B based on a sales forecast of P6,000,000, Thone, Inc.,
prepared the following estimated data:
COST AND EXPENSES
Variable Fixed
Direct materials P1,600,000
Direct labor 1,400,000
Factory overhead 600,000 P 900,000
Selling expenses 240,000 360,000
Administrative expenses 60,000 140,000
P3,900,000 P1,400,000

What would be the amount of sales in pesos at the break-even point?

a. P2,250,000 c. P4,000,000
b. P3,500,000 d. P5,300,000
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2. Merissi Company is planning to sell 100,000 units of Product Y for P12 a unit. The fixed cost is
P280,000. In order to realize a profit of P200,000, what would the variable cost be?
a. P480,000 c. P300,000
b. P720,000 d. P220,000

3. Bibot Company has projected cost of goods sold of P4,000,000, including fixed cost of
P800,000. Variable cost is expected to be 75% of net sales. What will be the projected net sales?
a. P4,266,667 c. P3,333,333
b. P4,800,000 d. P4,400,000

4. The Little Star Company is planning to sell 200,000 units of Product M. The fixed cost is
P400,000 and the variable cost is 60% of the selling price. In order to realize a profit of
P100,000, the selling price per unit would have to be
a. P3.75 c. P6.00
b. P4.17 d. P6.25

5. Within the relevant range, the amount of variable cost per unit
a. differs at each production level.
b. remains constant at each production level.
c. increases as production increases.
d. decreases as production increases.

6. If the fixed cost attendant to a product increases, while variable cost and sales price remain
constant, what will happen to (1) contribution margin and (2) break-even point?

Contribution Margin Break-even Point

a. Increase Decrease
b. Decrease Increase
c. Unchanged Increase
d. Unchanged Unchanged

Item 7-8
The production specialists of Won Corporation are considering the purchase of new
manufacturing equipment with a higher production capacity. Analysis shows that with the
increased production, sales volume can be increased by as much as 50%. However, fixed
manufacturing costs will increase by 60%. Variable manufacturing costs, on the other hand, is
expected to drop from P2.00 to P1.80 per unit. There will be no change in the total fixed selling
and administrative expenses and in the variable selling and administrative expenses per unit.
The selling price per unit, likewise, will remain the same. Presented below are the results of the
operations of Won Corporation for the previous year: (Note: Won has since been operating at full
capacity)

Sales (200,000 units) P1,000,000

Manufacturing cost of goods sold:
Fixed P200,000
Variable 400,000 (600,000)
Selling and administrative expense
Fixed P49,750
Variable 60,000 (109,750)
P 290,250
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 7. Should Wilson decide to purchase the equipment, what would be the break-even point in
terms of units?
a. 86,120 c. 150,200
b. 127,500 d. 150,000

8. What is the maximum income (before taxes) that Won can earn after the purchase of
equipment?
a. P210,250 c. P500,250
b. P550,000 d. P502,500

9. The contribution margin ratio always increases when:

a. break-even point decreases
b. break-even point increases
c. variable cost as a percentage of net sales increases
d. variable cost as a percentage of net sales decreases

10. Merchants, Inc. sells Product X to retailers for P200. The unit variable cost is P40 with a
selling commission of 10%. Fixed manufacturing cost totals P1,000,000 per month, while fixed
selling and administrative cost equals P420,000. The income tax rate is 30%. The target sales if
after tax income is P123,200 would be:
a. 19,950 units c. 18,750 units
b. 15,640 units d. 11,400 units

11. Sari-sari Corporation is a multiple-product firm. In their review of operations, they decided to
shift the sales mix from less profitable products to more profitable products, accounting for 35% of
gross sales. This will cause the company‟s break-even point to:
a. decrease c. increase
b. change by 15% d. not change

12. The sales mix for Rejuv Enterprise is as follows:

Product A: 12 units @ P5.25 sales price; P4.85 variable cost per unit.
Product B: 10 units @ P7.50 sales price; P6.95 variable cost per unit.
Product C: 6 units @ P12.25 sales price; P10.35 variable cost per unit.

Rejuv Enterprise's fixed costs are P75,950.

What is the composite break-even point?

a. 98,000 c. 2,000
b. 3,500 d. 4,000

13. Alfonzo Corporation had sales of P120,000 for the month of May. It has a margin of safety
ratio of 25 percent, and an after-tax return on sales of 6 percent. The company assumes its sales
being constant every month. If the tax rate is 40 percent, how much is the annual fixed cost?
a. P 36,000 c. P432,000
b. P 90,000 d. P360,000

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14. The Allow Late Watch Company manufactures a line of ladies‟ watches which are sold
through discount houses. Each watch is sold for P1,500; the fixed costs are P3,600,000 for
30,000 watches or less; variable cost is P900 per watch.
a. 2.0 c. 5.0
b. 0.5 d. 0.2

15. Jade Company plans to market a new product. Based on its market studies Jade estimates
that it can sell 5,500 units in 20B. The selling price will be P2 per unit. Variable cost is estimated
to be 40% of the selling price. Fixed cost is estimated to be P6,000. What is the break-even
point?
a. 3,750 units c. 5,500 units
b. 5,000 units d. 7,500 units

16. Which of the following statements is true?

a. A shift in sales mix toward less profitable products will cause the over-all break-even
point to fall.
b. One way to compute break-even point is to divide total sales by the cost margin ratio.
c. Once the break-even point has been reached, net income will increase by the
unit contribution margin for each additional unit sold.
d. As sales exceed the break-even point, a high contribution margin ratio will result in
lower profit, rather than a low contribution margin ratio.

Item 17-19

Chuchay Manufacturing Company produces two products for which the following data have been
tabulated. Fixed manufacturing cost is applied at a rate of P1.00 per machine hour.

Per unit Chu Chay

Selling price P4.00 P3.00
Variable manufacturing cost 2.00 1.50
Fixed manufacturing cost 0.75 0.20
Variable selling cost 1.00 1.00

The sales manager has had a P160,000 increase in the budget allotment for advertising and
wants to apply the money to the most profitable product. The products are not substitutes for one
another in the eyes of the company‟s customers.

17. Suppose the sales manager chooses to devote the entire P160,000 to increased advertising
for Chu. The minimum increase in sales units of Chu required to offset the increased advertising
is
a. 640,000 units c. 128,000 units
b. 160,000 units d. 80,000 units

18. Suppose the sales manager chooses to devote the entire P160,000 to increased advertising
for Chay. The minimum increase in revenues of Chay required to offset the increased advertising
would be
a. P160,000 c. P 960,000
b. P320,000 d. P1,600,000

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19. Suppose Chuchay has only 100,000 machine hours that can be made available to produce
additional units of Chu and Chay. If the potential increase in sales units for either product
resulting from advertising is far in excess of this production capacity, which product should be
advertised and what is the estimated increase in contribution margin earned?
a. Product Chu should be produced, yielding a contribution margin of P75,000.
b. Product Chu should be produced, yielding a contribution margin of P133,333.
c. Product Chay should be produced, yielding a contribution margin of P187,500.
d. Product Chay should be produced, yielding a contribution margin of P250,000.

20. Rings, Etc., Inc. manufactures and sells key rings embossed with college names and slogans.
Last year, the key rings sold for P75 each, and the variable cost to manufacture them was P22.50
per unit. The company needed to sell 20,000 key rings to break-even. The net income last year
was P50,400.

The company expects the following for the coming year:

1. The selling price of the key rings will be P90.
2. Variable manufacturing cost per unit will increase by one third.
3. Fixed cost will increase by 10%.
4. The income tax rate will remain unchanged.

For the company to break-even for the coming year, the company should sell
a. 22,600 units c. 19,250 units
b. 21,250 units d. 21,600 units

- END OF MODULE 2 -

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