Question

Variable costing and absorption costing, the Z-Var Corporation. (R. Marple, adapted) It is the end of 2017. Z-Var Corporation began operations in January 2016. The company is so named because it has no variable costs (Zero VARiable). All its costs are fixed; they do not vary with output. Z-Var Corp. is located on the bank of a river and has its own hydroelectric plant to supply power, light, and heat. The company manufactures a synthetic fertilizer from air and river water and sells its product at a price that is not expected to change. It has a small staff of employees, all paid fixed annual salaries. The output of the plant can be increased or decreased by pressing a few buttons on a keyboard. The following budgeted and actual data are for the operations of Z-Var. The company uses budgeted production as the denominator level and writes off any production-volume variance to cost of goods sold
2016 2017
Sales 30,000 tons 30,000 tons
Production 60,000 tons 0 tons
Selling price $90 per ton $90 per ton
Costs (all fixed):
Manufacturing $2,580,000 $2,580,000
Operating (nonmanufacturing) $102,000 $102,000

Required:
a. Prepare income statements with one column for 2016, one column for 2017, and one column for the two years together using (a) variable costing and (b) absorption costing.
b. What is the breakeven point under (a) variable costing and (b) absorption costing?
c. What inventory costs would be carried in the balance sheet on December 31, 2016 and 2017 under each method?
d. Assume that the performance of the top manager of Z-Var is evaluated and rewarded largely on the basis of reported operating income. Which costing method would the manager prefer? Why?

Answer 1

Answer:

Z-Var Corporation

1a. Income Statements (using variable costing)

                                                        2016             2017

Sales revenue                        $2,700,000   $2,700,000

Variable costs                                          0                     0

Contribution margin              $2,700,000   $2,700,000

Costs (all fixed):

Manufacturing                        $2,580,000  $2,580,000

Operating (nonmanufacturing) $102,000      $102,000

Total fixed costs                    $2,682,000  $2,682,000

Net income                                  $18,000        $18,000

1b. Income Statements (using absorption costing)

                                                        2016             2017

Sales revenue                         $2,700,000   $2,700,000

Costs (all fixed):

Manufacturing                         $2,580,000  $2,580,000

Gross profit                                 $120,000      $120,000

Operating (nonmanufacturing)  $102,000      $102,000

Net income                                    $18,000        $18,000

3. Inventory costs in the Balance Sheets of December 31, 2016 and 2017:

a. Variable costing = $0 for both years

b. Absorption costing = $1,290,000 ($2,580,000 * 30,000/60,000) for 2016 and $0 for 2017.

4. There is no difference because there are no variable costs.

Explanation:

a) Data and Calculations:

                                                        2016             2017

Sales                                        30,000 tons 30,000 tons

Production                              60,000 tons           0 tons

Selling price                            $90 per ton  $90 per ton

Costs (all fixed):

Manufacturing                        $2,580,000  $2,580,000

Operating (nonmanufacturing) $102,000      $102,000