Question

Tami Tyler opened Tami’s Creations, Inc., a small manufacturing company, at the beginning of the year. Getting the company through its first quarter of operations placed a considerable strain on Ms. Tyler’s personal finances. The following income statement for the first quarter was prepared by a friend who has just completed a course in managerial accounting at State University.

Ms. Tyler is discouraged over the loss shown for the quarter, particularly because she had planned to use the statement as support for a bank loan. Another friend, a CPA, insists that the company should be using absorption costing rather than variable costing and argues that if absorption costing had been used the company probably would have reported at least some profit for the quarter.

$ 1,144,000 Tami's Creations, Inc. Income Statement For the Quarter Ended March 31 Sales (28,600 units) Variable expenses: Variable cost of goods sold $ 460,460 Variable selling and administrative 194,480 Contribution margin Fixed expenses: Fixed manufacturing overhead 252,800 Fixed selling and administrative 248,260 Net operating loss 654,940 489,060 501,060 $ ( 12,000)

At this point, Ms. Tyler is manufacturing only one product—a swimsuit. Production and cost data relating to the swimsuit for the first quarter follow:

Required:

1. Complete the following:

a. Compute the unit product cost under absorption costing.

b. What is the company’s absorption costing net operating income (loss) for the quarter?

c. Reconcile the variable and absorption costing net operating income (loss) figures.

3. During the second quarter of operations, the company again produced 31,600 units but sold 34,600 units. (Assume no change in total fixed costs.)

a. What is the company’s variable costing net operating income (loss) for the second quarter?

b. What is the company’s absorption costing net operating income (loss) for the second quarter?

c. Reconcile the variable costing and absorption costing net operating incomes for the second quarter.

Answer 1

1 a) Under absorption costing, fixed manufacturing overhead cost is also included in unit product cost.

Fixed manufacturing overhead per unit = Fixed manufacturing overhead/Units produced

= $252,800/31,600 units = $8 per unit

Calculation of unit product cost under absorption costing (Amounts in $)

Direct materials cost per unit	7.10
Direct labor cost per unit	7.30
Variable manufacturing overhead per unit	1.70
Fixed manufacturing overhead per unit	8.00
Unit product cost	24.10

1 b) Absorption Costing Income Statement for First Quarter (Amounts in $)

Sales (28,600 units*$40)		1,144,000
Cost of goods sold (28,600 units*$24.10)		(689,260)
Gross Profit		454,740
Selling and Administrative Expenses:
Variable selling and administrative expenses	(194,480)
Fixed selling and administrative expenses	(248,260)
Total selling and administrative expenses		(442,740)
Net operating income/(loss)		12,000

Therefore company's absorption costing net operating income for the quarter is $12,000.

1 c) Reconciliation of Net Operating income/ (Loss) (Amounts in $)

Net operating income under absorption costing	12,000
Fixed manufacturing overhead deferred in inventory (3,000 units*$8)	(24,000)
Fixed manufacturing overhead released	0
Net operating income/(Loss) under variable costing	(12,000)

3 a) Variable costing income statement for second quarter (Amounts in $)

Sales (34,600 units*$40)		1,384,000
Variable expenses:
Variable cost of goods sold [(7.1+7.3+1.7)*34,600]	557,060
Variable selling and administrative (34,600*6.80)	235,280	792,340
Contribution margin		591,660
Fixed expenses:
Fixed manufacturing overhead	252,800
Fixed selling and administrative	248,260	501,060
Net operating income		90,600

Therefore the company’s variable costing net operating income for the second quarter is $90,600.

3 b) Absorption Costing Income Statement for Second Quarter (Amounts in $)

Sales (34,600 units*$40)		1,384,000
Cost of goods sold (34,600 units*$24.10)		(833,860)
Gross Profit		550,140
Selling and Administrative Expenses:
Variable selling and administrative expenses (34,600*6.80)	(235,280)
Fixed selling and administrative expenses	(248,260)
Total selling and administrative expenses		(483,540)
Net operating income/(loss)		66,600

Therefore company's absorption costing net operating income for the second quarter is $66,600.

3 c) Reconciliation of Net Operating income/ (Loss) (Amounts in $)

Net operating income under absorption costing	66,600
Fixed manufacturing overhead deferred in inventory	0
Fixed manufacturing overhead released from inventory	24,000
Net operating income/(Loss) under variable costing	90,600