Concept explainers
Absorption and variable costing income statements
During the first month of operations ended July 31, YoSan Inc. manufactured 2,400 flat panel televisions, of which 2,000 were sold. Operating data for the month are summarized as follows:
Instructions
- 1. Prepare an income statement based on the absorption costing concept.
- 2. Prepare an income statement based on the variable costing concept.
- 3. Explain the reason for the difference in the amount of operating income reported in (1) and (2).
(a)
Calculate the income statement according to the absorption costing concept for Y Incorporation.
Explanation of Solution
Absorption Costing
Absorption costing is compulsory under Generally Accepted Accounting Principles (GAAP) for financial statements which are circulated to the external users. The cost of goods manufactured includes direct materials, direct labor, and factory overhead costs under absorption costing. Fixed factory overhead and variable factory overhead included as a part of factory overhead.
Variable Costing
Variable costing is the method that is used by the management (managers) for decision making purposes. The cost of goods manufactured includes direct materials, direct labor, and variable factory overhead. Fixed factory overhead is treated as period (fixed) expense.
Calculate the income statement according to the absorption costing concept for the Y Incorporation as shown below:
Y Incorporation | ||
Absorption costing income statement | ||
for the month ended July, 31 | ||
Particulars | $ | $ |
Sales | 2,150,000 | |
Less: Cost of goods sold | ||
Cost of goods manufactured | 1,824,000 | |
Ending inventory (2) | (304,000) | |
Total cost of goods sold | 1,520,000 | |
Gross profit | 630,000 | |
Less: Selling and administrative expenses | 300,000 | |
Income from operations | 330,000 |
Table (1)
Working note (1):
Calculate the value of ending inventory per unit.
Working note (2):
Calculate the value of ending inventory
Therefore, income from operations under absorption costing concept of Y Incorporation is $330,000.
(b)
Calculate the income statement according to the variable cost concept for the Y Incorporation.
Explanation of Solution
Calculate the income statement according to the variable costing concept for the Y Incorporation as shown below:
Y Incorporation | ||
Variable costing income statement | ||
for the month ended July, 31 | ||
Particulars | $ | $ |
Sales | 2,150,000 | |
Less: Variable cost of goods sold | ||
Variable cost of goods manufactured (3) | 1,536,000 | |
Ending inventory (5) | (256,000) | |
Total variable cost of goods sold | 1,280,000 | |
Manufacturing margin | 870,000 | |
Less: Variable selling and administrative expenses | 204,000 | |
Contribution margin | 666,000 | |
Less: Fixed costs | ||
Fixed manufacturing costs | 288,000 | |
Fixed selling and administrative expenses | 96,000 | |
Total fixed cost | 384,000 | |
Income from operations | 282,000 |
Table (2)
Working note (3):
1. Calculate cost of goods manufactured
Working note (4):
Calculate the value of ending inventory per unit.
Working note (5):
Calculate the value of ending inventory
Therefore, income from operations under variable costing concept of Y Incorporation is $282,000.
(c)
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 $48,000
Increase in inventory = 400 units
Fixed factory overhead per unit = $4
Under absorption costing method, the fixed factory overhead cost included in the cost of goods sold is coordinated with the incomes. As an effect, 400 units that were produced, but unsold include 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 the variable costing income statement.
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Chapter 7 Solutions
Managerial Accounting
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