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Pearce Company, Morrison Sanitation, absorption step-down

Problem 1

The Pearce Company had the following actual data for 2008:
Units of finished goods
Opening inventory -
Production 14,000
Sales 12,500
Ending inventory 1,500

The basic production data at standard unit costs for the two years were:

Direct materials $25
Direct labor 17
Variable factory overhead 3
Standard variable costs per unit $45

Fixed factory overhead was budgeted at $100,000 per year. The expected volume of production was 15,000 units, so the fixed overhead rate was $100,000 ÷ 15,000 = $6.67 per unit.

Budgeted sales price was $72 per unit. Selling and administrative expenses were budgeted at variable, $8.50 per unit sold; and fixed, $82,000 per year.
Assume that there were absolutely no variances from any standard variable costs or budgeted selling prices or budgeted fixed costs in 2008.

There are no beginning or ending inventories of work in process.


1. For 2008, 1) prepare an income statements based on standard variable (direct) costing, and 2) an income statement based on standard absorption costing. (Prepare your statements in Excel â?" show your work.)

2. Explain why operating income differs between variable costing and absorption costing. Be specific.

Problem 2

Morrison Sanitation provides cleaning services for a variety of clients. The company has two producing departments, Government and Commercial, and two service departments, Personnel and Administrative. The company has decided to allocate all service department costs to the producing departments--Personnel on the basis of number of employees, and Administrative on the basis of direct department costs. The budget for 2008 shows:

Personnel Administrative Government Commercial
Direct department costs $100,000 $120,000 $300,000 $420,000
Number of employees 7 13 38 26
Direct-labor hours 28,000 50,000
Square feet cleaned 4,800,000 10,500,000

Required: Using an Excel spreadsheet (See formatting requirements for Excel file.)

1. Allocate service department costs using the direct method.

2. Allocate service department costs using the step-down method. Personnel costs should be allocated first.

3. Suppose the company prices by the hour in the Government Department and by the square foot cleaned in Commercial. Using the results of the step-down allocations in Requirement 2,

a. Compute the cost of providing one direct-labor hour of service in the Government Department.
b. Compute the cost of cleaning one square foot of space in the Commercial Department.

Submit your Excel file to the Assignments Page.

Solution Preview

Your tutorial is in Excel. You have two tabs, one for each problem. You click inside the cell and see the computation at the top of the screen. For the ...