Kinney 8e SM Ch03

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Predetermined Overhead Rates, Flexible Budgets, and Absorption/Variable Costing

1. Although both variable and mixed costs change in total with activity measure changes, the difference is that variable costs change in direct proportion to such activity changes and mixed costs do not. Since a mixed cost has both a fixed and variable component, the cost per unit at different activity levels is not constant as it is with a variable cost.

2. No, these are not always the best points of observation. First, the points must be within the relevant range of activity. Second, to be useful, the points must be reflective of the entire data set of observation points. If the high and low points do not meet these two conditions,
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A company is concerned about behavioral classification because (as long as the company is operating in the relevant range of activity) variable costs will change in a direct relationship with changes in some underlying activity measure, but fixed costs will remain constant. If variable and fixed costs are combined and shown merely as functional categories, management will not be able to see how each functional category of cost will change with changes in activity.

8. Absorption costing is required for external reporting. The rationale is that fixed manufacturing overhead is a product cost and, thus, it should be added to variable production cost and assigned to inventory. The total cost per unit will be shown as an expense only in the period in which the related products are sold.

9. Use of monetary, quantitative information varies greatly between external and internal users. External users emphasize profitability potential; internal users emphasize information that helps make sales, production, and capital expenditure decisions. Both absorption and variable costing have a place in decision making. Accountants and decision makers need to understand the applications and limitations of the two techniques within the context of past, present, and future cost information needs. No matter which type of costing a firm uses, the firm’s total revenue must cover all costs – both
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