1.
Explain the reason why the ending balance of finished goods inventory for year 1 is higher if company L is using absorption costing and variable costing.
1.
Explanation of Solution
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
Absorption Costing: “Absorption costing is a method that allocates “direct labor, direct materials, fixed manufacturing overhead and variable manufacturing overhead” to products and it is required by GAAP for the purpose of external reporting”.
Explain the reason why the finished goods inventory for year 1 is higher if company L is using absorption costing and variable costing as follows:
Company L has 500 units
2.
Explain the reason why the ending balance of finished goods inventory for year 2 is same under both absorption and variable costing.
2.
Explanation of Solution
Explain the reason why the ending balance of finished goods inventory for year 2 is same under both absorption and variable costing as follows:
The ending balance of finished goods inventory for year 2 is same under both absorption and variable costing because company L has no finished goods inventory on hand at the end of the year 2. In this case, the total production units for two year
3.
Explain whether the given relationship between the absorption and variable costing will always true at any balance sheet date.
3.
Explanation of Solution
Explain whether the given relationship between the absorption and variable costing will always true at any balance sheet date as follows:
Yes, this relationship will always true at any balance sheet date, because the cost of inventory under absorption costing will be higher than the inventory cost measured under variable costing. Under absorption costing, the fixed manufacturing overhead is inventoried as a product cost, whereas under variable costing, the fixed manufacturing overhead is not inventoried as a product cost, instead it is treated as a period costs and expensed during the period in which it is incurred.
4.
Calculate the declined amount of finished goods inventory during year 2 under absorption costing and variable costing.
4.
Explanation of Solution
Calculate the declined amount of finished goods inventory during year 2 under absorption costing and variable costing as follows:
Particulars | Finished-Goods Inventory | ||
End of Year 1 (A) | End of Year 2 (B) |
Amount of Decline | |
Absorption costing | $ 10,500 | $ 0 | $ 10,500 |
Variable costing | $ 3,500 | $ 0 | $ 3,500 |
Table (1)
5.
Calculate the difference in the amount of declined finished goods inventory under absorption and variable costing, calculate the difference in the reported operating income for year 2 under absorption and variable costing, and compare both differences.
5.
Explanation of Solution
Calculate the difference in the amount of declined finished goods inventory under absorption and variable costing:
Particulars | The decline amount of finished goods during year 2 |
Absorption costing | $ 10,500 |
Less: Variable costing | $ 3,500 |
Difference | $ 7,000 |
Table (2)
Calculate the difference in the reported operating income for year 2 under absorption and variable costing:
Particulars | Reported operating income for year 2 |
Absorption costing (5) | $ 13,500 |
Less: Variable costing (6) | $ 20,500 |
Difference | -$ 7,000 |
Table (3)
Working note (1):
Calculate the value of sales revenue for both years.
Particulars | Production units (A) | Year 1 |
Year 2 |
Sales revenue | 2,500 units | $15.00 | $1,875,000 |
Table (4)
Working note (2):
Calculate the cost of goods manufactured for both years.
Year 1:
Year 2:
Working note (3):
Calculate the cost of ending inventory for year 1:
Note: The ending inventory for year 1 is considered as the beginning inventory for year 2.
Working note (4):
Calculate the cost of ending inventory for year 1:
Working note (5):
Calculate the operating income under absorption costing.
Operating income statement under absorption costing method | ||
Particulars | Year 1 | Year 2 |
Sales revenue (1) (C) | $ 125,000 | $ 125,000 |
Less: Cost of goods sold: | ||
Beginning finished-goods inventory (3) | $ 0 | $10,500 |
Cost of goods manufactured (2) | 63,000 | 56,000 |
Cost of goods available for sale | $63,000 | $66,500 |
Ending finished-goods inventory (3) | 10,500 | $ 0 |
Cost of goods sold (D) | $52,500 | $66,500 |
Gross margin | $72,500 | $58,500 |
Less: Selling and administrative expenses | $ 45,000 | $ 45,000 |
Operating income | $27,500 | $13,500 |
Table (5)
Working note (6):
Calculate the operating income under variable costing.
Particulars | Year 1 | Year 2 |
Sales revenue (E) (1) | $ 125,000 | $ 125,000 |
Less: Cost of goods sold: | ||
Beginning finished-goods inventory | $ 0 | $3,500 |
Cost of goods manufactured | 21,000 | 14,000 |
Cost of goods available for sale | $21,000 | $17,500 |
Ending finished-goods inventory (4) | $3,500 | $0 |
Cost of goods sold | $17,500 | $17,500 |
Add: Variable selling and administrative costs | $25,000 | $25,000 |
Total variable costs (F) | $42,500 | $42,500 |
Contribution margin | $82,500 | $82,500 |
Less: Fixed costs: | ||
Manufacturing | $42,000 | $42,000 |
Selling and administrative | $20,000 | $20,000 |
Total fixed costs | $62,000 | $62,000 |
Operating income | $20,500 | $20,500 |
Table (6)
6.
Explain whether the given relationship between the absorption and variable costing will always true at any balance sheet date.
6.
Explanation of Solution
Explain whether the given relationship between the absorption and variable costing will always true at any balance sheet date as follows:
Yes, this relationship will always true at any balance sheet date. There are two ways to explain this issue.
1. Based on theoretical: The value of inventory increase the reported operating income under absorption costing than variable costing, because the fixed manufacturing cost is a product cost and the fixed manufacturing cost is included in the inventory cost under absorption costing. Hence, the balance of finished goods inventory is higher under absorption costing than the variable costing. Whereas, under variable costing the fixed manufacturing cost is not included in the inventory cost because under variable costing, only period costs are included in the inventory cost.
The
2. Based on the
Note: a = absorption costing, v = variable costing, I = inventory and RE = retained earnings.
The elements that are affected in the accounting equation are inventory (I) and retained earnings (RE). When the inventory is greater under absorption costing, then the owner’s equity must be higher under abortion costing.
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