Concept explainers
(a)
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
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.
The income statement according to the absorption costing concept for the Company KF.
(a)
Answer to Problem 1PA
Calculate the income statement according to the absorption costing concept for the Company KF as shown below:
Company KF | ||
Absorption costing income statement for the month ended | ||
August, 31 | ||
Particulars | $ | $ |
Sales | 10,800,000 | |
Less: Cost of goods sold | ||
Cost of goods manufactured | 9,600,000 | |
Ending inventory (2) | (960,000) | |
Total cost of goods sold | 8,640,000 | |
Gross profit | 2,160,000 | |
Less: Selling and administrative expenses | 1,260,000 | |
Income from operations | 900,000 |
Table (1)
Explanation of Solution
Working notes:
1. Calculate the value of ending inventory per unit.
2. Calculate the value of ending inventory
Therefore, income from operations under absorption costing concept of Company KF is $900,000.
(b)
The income statement according to the variable cost concept for the Company KF.
(b)
Answer to Problem 1PA
Calculate the income statement according to the variable costing concept for the Company KF as shown below:
Company KF | ||
Variable costing income statement for the month ended | ||
August, 31 | ||
Particulars | $ | $ |
Sales | 10,800,000 | |
Less: Variable cost of goods sold | ||
Variable cost of goods manufactured (3) | 9,280,000 | |
Ending inventory (5) | (928,000) | |
Total variable cost of goods sold | 8,352,000 | |
Manufacturing margin | 2,448,000 | |
Less: Variable selling and administrative expenses | 1,080,000 | |
Contribution margin | 1,368,000 | |
Less: Fixed costs | ||
Fixed manufacturing costs | 320,000 | |
Fixed selling and administrative expenses | 180,000 | |
Total fixed cost | 500,000 | |
Income from operations | 868,000 |
Table (2)
Explanation of Solution
Working note:
1. Calculate cost of goods manufactured
2. Calculate the value of ending inventory per unit.
3. Calculate the value of ending inventory
Therefore, income from operations under variable costing concept of Company KF is $868,000.
(c)
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.
(c)
Explanation of Solution
The difference between the absorption and variable costing income from operations of $32,000
Increase in inventory = 8,000 units
Fixed factory overhead per unit = $4
Under absorption costing method, the fixed
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.
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