Chapter 20, Problem 20.1APR

(a)

To determine

Absorption Costing

Absorption costing is compulsory under Generally Accepted Accounting Principles (GAAP) for financial statements circulated to the external users. Under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Fixed factory overhead and variable factory overhead included as a part of factory overhead.

Variable Costing

Managers frequently use variable costing for internal purposes for taking decision making. The cost of goods manufactured includes direct materials, direct labor, and variable factory overhead. Fixed factory overhead treated as period (fixed) expense.

To Determine: The income statement according to the absorption costing concept for the Company FPF.

Answer to Problem 20.1APR

Calculate the income statement according to the absorption costing concept for the Company FPF as shown below:

Company FPF
Absorption costing income statement for the month ended
May 31, 2016
Particulars	$	$
Sales		6,480,000
Less: Cost of goods sold
Cost of goods manufactured	5,760,000
Ending inventory (2)	(576,000)
Total cost of goods sold		5,184,000
Gross profit		1,296,000
Less: Selling and administrative expenses		936,000
Income from operations		360,000

Table (1)

Explanation of Solution

Working notes:

1. 1. Calculate the value of ending inventory per unit.

$\begin{array}{c}\text{Ending inventory =}\frac{\text{Cost of goods manufactured}}{\text{Units manufactured}}\\ =\frac{\$5,760,000}{40,000\text{ Units}}\\ =\$144\text{per unit}\end{array}$ (1)

2. Calculate the value of ending inventory

$\begin{array}{c}\text{Ending inventory = }\left[\begin{array}{l}\text{Units manufactured }\times \\ \text{Ending inventory rate per unit (1)}\end{array}\right]\\ =4,000\text{ Units}\times \text{\$144}\\ \text{=\$576,000}\end{array}$ (2)

Conclusion

Therefore, income from operations under absorption costing concept of Company FPF is $360,000.

(b)

To determine

The income statement according to the variable cost concept for the Company FPF.

Answer to Problem 20.1APR

Calculate the income statement according to the variable costing concept for the Company FPF as shown below:

Company FPF
Variable costing income statement for the month ended
May 31, 2016
Particulars	$	$
Sales		6,480,000
Less: Variable cost of goods sold
Variable cost of goods manufactured (3)	5,200,000
Ending inventory (5)	(520,000)
Total variable cost of goods sold		4,680,000
Manufacturing margin		1,800,000
Less: Variable selling and administrative expenses		648,000
Contribution margin		1,152,000
Less: Fixed costs
Fixed manufacturing costs	560,000
Fixed selling and administrative expenses	288,000
Total fixed cost		848,000
Income from operations		304,000

Table (2)

Explanation of Solution

Working notes:

1. Calculate cost of goods manufactured

$\begin{array}{c}\text{Cost of goods manufactured = }\left[\begin{array}{l}\text{Total manufacturing cost}-\\ \text{Fixed manufacturing cost}\end{array}\right]\\ =\$5,760,000-\$560,000\\ =\$5,200,000\end{array}$ (3)

2. Calculate the value of ending inventory per unit.

$\begin{array}{c}\text{Ending inventory =}\frac{\text{Cost of goods manufactured}}{\text{Units manufactured}}\\ =\frac{\$5,200,000}{40,000\text{ Units}}\\ =\$130\text{per unit}\end{array}$ (4)

3. Calculate the value of ending inventory

$\begin{array}{c}\text{Ending inventory = }\left[\begin{array}{l}\text{Units manufactured }\times \\ \text{Ending inventory rate per unit (4)}\end{array}\right]\\ =4,000\text{ Units}\times \text{\$130}\\ \text{=\$520,000}\end{array}$ (5)

Conclusion

Therefore, income from operations under variable costing concept of Company FPF is $304,000.

(c)

To determine

To Identify: The reason for the difference between in the amount of income from operations reported in absorption costing income statement and variable costing income statement.

Explanation of Solution

The difference between the absorption and variable costing income from operations of $56,000 $\left(\$360,000–\$304,000\right)$ can be explained as follows:

Increase in inventory = 4,000 units $\left(40,000\text{ Units}-36,000\text{ Units}\right)$

Fixed factory overhead per unit = $14 $\left(\frac{\$560,000}{40,000\text{ Units}}\right)$

$\begin{array}{c}\begin{array}{l}\text{Difference in income}\\ \text{ from operations}\end{array})\text{=}\left(\begin{array}{l}\text{Increase in inventory}\times \text{Fixed }\\ \text{factory overhead per unit}\end{array}\right)\\ \text{=}4,0\text{00}\text{units }\times \text{\$14}\text{per unit}\\ \text{=}\text{\$56,000}\end{array}$

Under absorption costing method, the fixed factory overhead cost included in the cost of goods sold is coordinated with the incomes. As an effect, 4,000 units that were produced, but unsold it includes fixed factory overhead cost, which is not involved in the cost of goods sold.

Under variable costing, all of the fixed factory overhead cost is subtracted in the period in which it is incurred, regardless of the amount of inventory change. Therefore, when inventory rises, the absorption costing income statement will have a higher income from operations than will the variable costing income statement.