Question

Income Statements under Absorption and Variable Costing

Shawnee Motors Inc. assembles and sells MP3 players. The company began operations on August 1 and operated at 100% of capacity during the first month. The following data summarize the results for August:

Sales (13,500 units)				$1,350,000
Production costs (17,000 units):
Direct materials		$629,000
Direct labor		302,600
Variable factory overhead		151,300
Fixed factory overhead		100,300		1,183,200
Selling and administrative expenses:
Variable selling and administrative expenses		$183,400
Fixed selling and administrative expenses		71,000		254,400

If required, round interim per-unit calculations to the nearest cent.

a. Prepare an income statement according to the absorption costing concept.

Shawnee Motors Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales	$
Cost of goods sold
Gross profit	$
Selling and administrative expenses
Income from operations	$

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a. Under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead.

Learning Objective 1.

b. Prepare an income statement according to the variable costing concept.

Shawnee Motors Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		$
Variable cost of goods sold
Manufacturing margin		$
Variable selling and administrative expenses
Contribution margin		$
Fixed costs:
Fixed factory overhead	$
Fixed selling and administrative expenses
Total fixed costs
Income from operations		$

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b. Under variable costing, the cost of goods manufactured includes only variable manufacturing costs.

Learning Objective 1.

c. What is the reason for the difference in the amount of income from operations reported in (a) and (b)?

Under the absorption costing  method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under variable costing , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the absorption costing  income statement will have a higher income from operations than will the variable costing income statement.

Answer 1

a) Under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead. Workings: Shawnee Motors Inc. Absorption Costing Income Statement For the Month Ended August 31 Sales $1,350,000 Cost of goods sold $939,600 [Ref: Workings] Gross profit $410,400 Selling and administrative expenses $254,400 ($183,400 + $71,000] Income from operations $156,000 Direct materials cost Direct labor cost Variable fact. overhead cost Fixed fact. overhead cost Cost of goods manufactured Number of units produced Unit product cost Number of units sold Cost of goods sold $629,000 $302,600 $151,300 $100,300 $1,183,200 17,000 $69.6 ($1183200 / 17000 units] 13,500 $939,600 ($69.6 x 13500 units]

b) Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. Workings: Shawnee Motors Inc. Variable Costing Income Statement For the Month Ended August 31 Sales Variable cost of goods sold Manufacturing margin Variable selling and administrative exps. Contribution margin Fixed costs: Fixed factory overhead $100,300 Fixed selling and administrative exps. $71,000 Total fixed costs Income from operations $1,350,000 $859,950 [Ref: Workings] $490,050 $183,400 $306,650 Direct materials cost $629,000 Direct labor cost $302,600 Variable mfg. overhead cost $151,300 Variable cost of goods manufactured $1,082,900 Number of units produced 17,000 Unit product cost $63.7 ($1082900 / 17000 units] Number of units sold 13,500 Variable cost of goods sold $859,950 ($63.7 x 13500 units] $171,300 $135,350 Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under variable costing , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the absorption costing income statement will have a higher income from operations than will the variable costing income statement. In other words, the only reason for the difference in net operating income (loss) between absorption costing and variable costing is the deferred fixed manufacturing cost to next period through ending inventory under absorption costing. That is, under variable costing, entire fixed manufacturing cost is considered as period cost and so charged to the income statement. However, under the absorption costing, fixed manufacturing cost is considered as product cost and so a portion of it will be deferred to next reporting period through ending inventory. If number of units produced & sold are same, net operating income reported under both methods will be same.