Question

Jorgansen Lighting, Inc., manufactures heavy-duty street lighting systems for municipalities. The company uses variable costing for internal management reports and absorption costing for external reports to shareholders, creditors, and the government. The company has provided the following data:
Year 1 year 2 year 3

Inventories:
Beginning (units) 200 170 180
Ending (units) 170 180 220
Variable costing net
operating income $1,080,400 $1,032,400 $996,400


The company's fixed manufacturing overhead per unit was constant at $560 for all three years.


Requirement 1:
Determine each year’s absorption costing net operating income. Present your answer in the form of a reconciliation report for year 1, 2 and 3.

Year 1 Year 2 Year 3
Beginning inventories

Ending inventories

Change in inventories

Fixed manufacturing overhead in beginning inventories

Fixed manufacturing overhead in ending inventories

Fixed manufacturing overhead deferred in (released from) inventorie

Variable costing net operating income

Add (deduct) fixed manufacturing overhead cost deferred in (released from) inventory under absorption costing



Absorption costing net operating income

Requirement 2:
In Year 4, the company's variable costing net operating income was $984,400 and its absorption costing net operating income was $1,012,400.

(a) Did inventories increase or decrease during Year 4?


(b) How much fixed manufacturing overhead cost was deferred or released from inventory during Year 4?

Deferred or released ???
Ffixed manufacturing overhead cost $

Answer 1

Concepts and reason

Costing: It is a process of ascertaining the cost. The cost can be for a product, job, contract or service. It involves the study of cost principles, standards and rules concerning the determination of cost of a product.

Financial Statement: The basic financial statement includes the balance sheet which shows the entities overall assets, liabilities and the net worth as on date, income statement which shows the net income generated by the entity over a specified time period and the cash flow statements which shows the cash outflows and inflows over a period of time from all the entries.

Fundamentals

Sales: It is the main revenue of the organization. The units sold during the period are multiplied by the selling price per unit in order to determine the amount of sales.

Net operating income (NOI): The profit earned after reducing variable expenses and fixed expenses out of the amount of sales is the net operating income. Expenses are related to manufacturing and operations of the business.

Variable cost: The cost and expenses which change with the level of activity. The expenses which change with every extra unit produced. More the company produce, more will be the variable cost.

Fixed cost: The cost and expenses which do not change with the change in the level of activity. The expenses whose amount and nature of the occurrence, both are fixed. If the company does not produce any output, still the fixed expenses need to be paid.

Manufacturing Overheads: It is the aggregate of Indirect Material, Indirect Expenses and Indirect Labor which are incurred for the work in process inventory in the factory. These are the cost which cannot directly belong to a particular unit of a product.

Manufacturing Cost: It is the cost incurred in manufacturing a product. This cost includes all the direct and indirect cost incurred in the manufacturing of the product. It is the combination of direct material, direct labor, and the manufacturing overheads.

Income statement: All companies in order to determine the net profit or net loss prepare income statement. It is one of the important financial statements. It is prepared by deducting all revenue expenses from total revenue receipt during that period for which statement is prepared.

Variable costing contribution approach: It is a method of computing the net operating income (NOI) with the help of contribution margin. In this method, contribution margin is computed first by reducing all the variable cost from the sales revenue. The fixed expenses are deducted from the contribution margin in order to compute the net operating income.

Absorption Costing approach: It is a full costing method in which all the fixed, as well as variable cost, are deducted from the sales revenue in order to compute the net operating income (NOI).

Reconciliation of net operating income by variable costing approach with absorption costing approach: When production is more than the sales, than the NOI (net operating income) under absorption costing is more than the operating income under the variable costing contribution approach. It is because of the fixed manufacturing overhead which is deferred in the closing inventory.

(1)

Compute the absorption costing net operating income for Year 1.

Working Notes:

Compute the change in inventory units for Year 1.

$\begin{array}{c}\\{\rm{Change}}\,{\rm{in}}\,{\rm{inventory}} = {\rm{Beginning}}\,{\rm{Inventory}} - {\rm{Ending}}\,{\rm{Inventory}}\\\\ = 200\,{\rm{units}} - 170\,{\rm{units}}\\\\ = 30\,{\rm{units}}\\\end{array}$

Compute the fixed manufacturing overhead in the beginning inventory.

$\begin{array}{c}\\{\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Beginning}}}} = {\rm{Beginning}}\,{\rm{Inventory}}\,{\rm{units}} \times {\rm{Fixed}}\\\\\,{\rm{manufacturing overhead}}\,\,{\rm{per}}\,{\rm{unit}}\\\\ = 200\,{\rm{units}} \times \$ 560\\\\ = \$ 112,000\\\end{array}$

Compute the fixed manufacturing overhead in the ending inventory.

$\begin{array}{c}\\{\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Ending}}}} = {\rm{Ending}}\,{\rm{Inventory}}\,{\rm{units}} \times {\rm{Fixed}}\\\\\,{\rm{manufacturing overhead}}\,\,{\rm{per}}\,{\rm{unit}}\\\\ = 170\,{\rm{units}} \times \$ 560\\\\ = \$ 95,200\\\end{array}$

Compute the fixed manufacturing overhead deferred or (release) from the inventory.

$\begin{array}{c}\\{\rm{Deferred}}\,{\rm{in}}/\left( {{\rm{release}}} \right) = {\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Ending}}}} - {\rm{Fixed}}\,{\rm{Manufacturing}}\\\\\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Beginning}}}}\\\\ = \$ 95,200 - \$ 112,000\\\\ = - \$ 16,800\\\end{array}$

Compute the absorption costing net operating income for Year 1.

$\begin{array}{c}\\{\rm{Absorption}}\,{\rm{Costing}}\,{\rm{NOI}} = {\rm{Variable}}\,{\rm{Costing}}\,{\rm{NOI}} - {\rm{Fixed}}\,{\rm{manufacturing}}\,{\rm{overhead}}\,\\\\{\rm{from}}\,{\rm{inventory}}\,{\rm{released}}\,{\rm{duringthe}}\,{\rm{period}}\\\\ = \$ 1,012,400 - \$ 16,800\\\\ = \$ 1,063,600\\\end{array}$

Compute the absorption costing net operating income for Year 2.

Working Notes:

Compute the change in inventory units for Year 2.

$\begin{array}{c}\\{\rm{Change}}\,{\rm{in}}\,{\rm{inventory}} = {\rm{Beginning}}\,{\rm{Inventory}} - {\rm{Ending}}\,{\rm{Inventory}}\\\\ = 170\,{\rm{units}} - 180\,{\rm{units}}\\\\ = - 10\,{\rm{units}}\\\end{array}$

Compute the fixed manufacturing overhead at the beginning inventory of Year 2.

$\begin{array}{c}\\{\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Beginning}}}} = {\rm{Beginning}}\,{\rm{Inventory}}\,{\rm{units}} \times {\rm{Fixed}}\\\\\,{\rm{manufacturing overhead}}\,\,{\rm{per}}\,{\rm{unit}}\\\\ = 170\,{\rm{units}} \times \$ 560\\\\ = \$ 95,200\\\end{array}$

Compute the fixed manufacturing overhead in the ending inventory.

$\begin{array}{c}\\{\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Ending}}}} = {\rm{Ending}}\,{\rm{Inventory}}\,{\rm{units}} \times {\rm{Fixed}}\\\\\,{\rm{manufacturing overhead}}\,\,{\rm{per}}\,{\rm{unit}}\\\\ = 180\,{\rm{units}} \times \$ 560\\\\ = \$ 100,800\\\end{array}$

Compute the fixed manufacturing overhead deferred or (release) from the inventory.

$\begin{array}{c}\\{\rm{Deferred}}\,{\rm{in}}/\left( {{\rm{release}}} \right) = {\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Ending}}}} - {\rm{Fixed}}\,{\rm{Manufacturing}}\\\\\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Beginning}}}}\\\\ = \$ 100,800 - \$ 95,200\\\\ = \$ 5,600\\\end{array}$

Compute the absorption costing NOI for Year 2.

$\begin{array}{c}\\{\rm{Absorption}}\,{\rm{Costing}}\,{\rm{NOI}} = {\rm{Variable}}\,{\rm{Costing}}\,{\rm{NOI}} + {\rm{Fixed}}\,{\rm{manufacturing}}\,{\rm{overhead}}\,\\\\{\rm{from}}\,{\rm{inventory}}\,{\rm{deferred}}\,{\rm{duringthe}}\,{\rm{period}}\\\\ = \$ 1,032,400 + \$ 5,600\\\\ = \$ 1,038,000\\\end{array}$

Compute the absorption costing NOI for Year 3.

Working Notes:

Compute the change in inventory units for Year 3.

$\begin{array}{c}\\{\rm{Change}}\,{\rm{in}}\,{\rm{inventory}} = {\rm{Beginning}}\,{\rm{Inventory}} - {\rm{Ending}}\,{\rm{Inventory}}\\\\ = 180\,{\rm{units}} - 220\,{\rm{units}}\\\\ = - 40\,{\rm{units}}\\\end{array}$

Compute the fixed manufacturing overhead cost for beginning inventory.

$\begin{array}{c}\\{\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Beginning}}}} = {\rm{Beginning}}\,{\rm{Inventory}}\,{\rm{units}} \times {\rm{Fixed}}\\\\\,{\rm{manufacturing overhead}}\,\,{\rm{per}}\,{\rm{unit}}\\\\ = 180\,{\rm{units}} \times \$ 560\\\\ = \$ 100,800\\\end{array}$

Compute the fixed manufacturing overhead cost for the ending inventory.

$\begin{array}{c}\\{\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Ending}}}} = {\rm{Ending}}\,{\rm{Inventory}}\,{\rm{units}} \times {\rm{Fixed}}\\\\\,{\rm{manufacturing overhead}}\,\,{\rm{per}}\,{\rm{unit}}\\\\ = 220\,{\rm{units}} \times \$ 560\\\\ = \$ 123,200\\\end{array}$

Compute the fixed manufacturing overhead deferred or (release) from the inventory.

$\begin{array}{c}\\{\rm{Deferred}}\,{\rm{in}}/\left( {{\rm{release}}} \right) = {\rm{Fixed}}\,{\rm{Manufacturing}}\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Ending}}}} - {\rm{Fixed}}\,{\rm{Manufacturing}}\\\\\,{\rm{Overhea}}{{\rm{d}}_{{\rm{Beginning}}}}\\\\ = \$ 123,200 - \$ 100,800\\\\ = \$ 22,400\\\end{array}$

Compute the absorption costing NOI for Year 3.

$\begin{array}{c}\\{\rm{Absorption}}\,{\rm{Costing}}\,{\rm{NOI}} = {\rm{Variable}}\,{\rm{Costing}}\,{\rm{NOI}} + {\rm{Fixed}}\,{\rm{manufacturing}}\,{\rm{overhead}}\,\\\\{\rm{from}}\,{\rm{inventory}}\,{\rm{deferred}}\,{\rm{duringthe}}\,{\rm{period}}\\\\ = \$ 996,400 + \$ 22,400\\\\ = \$ 1,018,800\\\end{array}$

(2.a)

Determine the increase or decrease in inventory during 2014.

$\begin{array}{c}\\{\rm{Increase}}\,{\rm{or}}\,{\rm{decrease}}\,{\rm{in}}\,{\rm{inventory}} = \frac{{{\rm{Absorption}}\,{\rm{costing}}\,{\rm{NOI}} - {\rm{Variable}}\,{\rm{Costing}}\,{\rm{NOI}}}}{{{\rm{Fixed}}\,{\rm{manufactuing}}\,{\rm{overhead}}\,{\rm{per}}\,{\rm{unit}}}}\\\\ = \frac{\begin{array}{l}\\{\rm{Fixed}}\,{\rm{manufacturing}}\,{\rm{overhead}}\,{\rm{cost}}\\\\\,{\rm{deferred}}\,{\rm{in}}\,{\rm{inventory}}\,\\\end{array}}{{{\rm{Fixed}}\,{\rm{manufactuing}}\,{\rm{overhead}}\,{\rm{per}}\,{\rm{unit}}}}\\\\ = \frac{{\$ 1,012,400 - \$ 984,400}}{{\$ 560\,{\rm{per}}\,{\rm{unit}}}}\\\end{array}$

$\begin{array}{c}\\ = \frac{{\$ 28,000}}{{\$ 560\,{\rm{per}}\,{\rm{unit}}}}\\\\ = 50\,{\rm{units}}\\\end{array}$

Determine the amount of fixed manufacturing cost which is deferred or released from inventory during year 4.

Working Note:

Compute the fixed manufacturing cost which is deferred or released from inventory during year 4.

$\begin{array}{c}\\{\rm{Deferred}}\,{\rm{fixed}}\,{\rm{manufacturing}}\,{\rm{overhead}} = {\rm{Absorption}}\,{\rm{costing}}\,{\rm{net}}\,{\rm{operating}}\,{\rm{income}}\\\\ - {\rm{Variable}}\,{\rm{costing}}\,{\rm{net}}\,{\rm{operating}}\,{\rm{income}}\\\\ = \$ 1,012,400 - \$ 984,400\\\\ = \$ 28,000\\\end{array}$

Ans: Part 1

The absorption costing net operating income of Year 1 is $1,063,600.

Part 1

The absorption costing NOI (net operating income) of Year 2 is $1,038,800.

Part 1

The absorption costing NOI (net operating income) of Year 3 is $1,018,800.

Part 2.a

The inventory units in 2014 will increase by 50 units.

Part 2.b

The fixed manufacturing overhead cost deferred from inventory is $28,000.