Question

9-25 Variable versus absorption costing. The Zeta Company manufactures trendy, good-looking, moder- ately priced umbrellas. As Zeta's senior financial analyst, you are asked to recommend a method of inven- tory costing. The CFO will use your recommendation to prepare Zeta's 2017 income statement. The following data are for the year ended December 31, 2017: Beginning inventory, January 1, 2017 Ending inventory, December 31, 2017 2017 sales Selling price (to distributor) Variable manufacturing cost per unit, including direct materials Variable operating (marketing) cost per unit sold Fixed manufacturing costs Denominator-level machine-hours Standard production rate Fixed operating (marketing) costs 100,000 units 50,000 units 400,000 units $25 per unit $6 per unit $2 per unit sold $1,625,000 6,500 50 units per machine-hour $1,100,000 Assume standard costs per unit are the same for units in beginning inventory and units produced during the year. Also, assume no price, spending, or efficiency variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs. 1. Prepare income statements under variable and absorption costing for the year ended December 31, 2017 2. What is Zeta's operating income as percentage of revenues under each costing method? 3. Explain the difference in operating income between the two methods 4. Which costing method would you recommend to the CFO? Why?

Answer 1

1 & 2) Income statements under Variable Costing:
			Calculations:
Beginning Inv.	100000
Production	350000
Total units available	450000
Units sold	400000
Ending Inve.	50000
	Amount $
Sales Revenues	10000000		400000*25
Less:Variable costs:
Manuf.	2400000		400000*6
Marketing	800000		400000*2
Total Variable costs	3200000
Contribution	6800000
Less: Fixed Costs
Manuf.	1625000
Marketing	1100000
Total Fixed Costs	2725000
Net Operating Income	4075000
% of Sales Revenues	40.75%
Income statements under Absorption Costing:
Beginning Inv.	100000
Production	350000
Total units available	450000
Units sold	400000
Ending Inve.	50000
	Amount $
Sales Revenues	10000000		400000*25
Less:Manufacturing costs:
variable	2400000		400000*6
fixed	1625000
Closing Stock portion of FMC	-232143		1625000*50000/350000
Total Manufacturing costs	3792857
Gross Profit	6207143
Less: Operating (Market)costs:
variable	800000		400000*2
fixed	1100000
Total Operating (Market)Costs	1900000
Net Operating Income	4307143
% of Sales Revenues	43.07%
3) Reconciliation Net Operating Income of both costing methods:
	Amount $
Net Income as per Absorption Costing=	4307143
less: Fixed Manuf. Cost portion of Cl. Inv.	-232143
Net Income as per Variable Costing	4075000
4) CFO is recommended to follow the Absorption costing method
for calculation Net Operating Income because it tallies the
Revenues with its actual costs and forward the excess fixed
costs to next period with the Closing Inventory.