Question

1. Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.

Operating Income
Original Production Level-Absorption	Original Production Level-Variable	Additional 10,000 Units-Absorption	Additional 10,000 Units-Variable
$310,000	$250,000	$	$

2. What is the change in operating income from producing 10,000 additional units under absorption costing?

$

3. What is the change in operating income from producing 10,000 additional units under variable costing?

$

4. What would be your recommendation to the production manager?

a. Do not produce the extra 10,000 units. The increase in operating income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.

b. Produce the extra 10,000 units. Operating income will be increased, and the production manager will receive praise for creating higher profits.

c. Do not produce the extra 10,000 units. Operating income does not change under absorption costing when the additional units are produced.

d. Produce the extra 10,000 units. It's always a good idea to have extra units on hand and keep the factory operating at capacity, even if all the units are not sold.

Absorption Statement

Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goods sold.

Saxon, Inc. Absorption Costing Income Statement For the Year Ended December 31
Sales		$1,200,000
Cost of goods sold:
Cost of goods manufactured	$840,000
Ending inventory	(210,000)
Total cost of goods sold		(630,000)
Gross profit		$570,000
Selling and administrative expenses		(260,000)
Operating income		$310,000

Variable Statement

Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statement includes a computation of manufacturing margin.

Saxon, Inc. Variable Costing Income Statement For the Year Ended December 31
Sales		$1,200,000
Variable cost of goods sold:
Variable cost of goods manufactured	$600,000
Ending inventory	(150,000)
Total variable cost of goods sold		(450,000)
Manufacturing margin		$750,000
Variable selling and administrative expenses		(195,000)
Contribution margin		$555,000
Fixed costs:
Fixed manufacturing costs	$240,000
Fixed selling and administrative expenses	65,000
Total fixed costs		(305,000)
Operating income		$250,000

Method Comparison

Review the income statements on the Absorption Statement and Variable Statement, then complete the following table. The company’s sales price per unit is $80, and the number of units in ending inventory is 5,000. There was no beginning inventory.

Item	Amount
Number of units sold	15,000
Variable sales and administrative cost per unit	$13
Number of units manufactured	20,000
Variable cost of goods manufactured per unit	$30
Fixed manufacturing cost per unit	$12

Answer 1

Working Notes:-

Calculation of Closing Stock Particulars Units A.Beginning Inventory B.Production (20,000 + 10,000) 30,000.00 C.Sales 15,000.00 Closing A +B-C 15,000.00

Calculation of unit Product Cost Particulars Calculation Absorption Costing Variable Costing 30.00 $ 30.00 Variable Costs: Manufacturing Cost per unit produced Fixed Costs Manufacturing Cost per unit produced Unit Product Cost Manf. Costs / Units produced = $240,000 / (20,000+10,000) 8.00 38.00 $ 30.00

Cost of goods Sold Calculation Particulars Calculation Absorption Costing Variable Costing A. Opening Stock Previous Closing B.Cost of goods manufactured No. of production x Unit product cost 30,000 x $38 30,000 x $30 $ 11,40,000.00 $ 9,00,000.00 C.Closing Inventory No. of units x Unit product cost 15,000 x $38 15,000 x $30 $ 5,70,000.00 $ 4,50,000.00 Cost of Goods Sold A+B-C 5,70,000.00 S 4,50,000.00

Saxon, Inc. Absorption Costing Income Statement (Additional 10,000 units) For the Year Ended December 31 12,00,000.00 $ S 11,40,000.00 -5,70,000.00 Sales Cost of goods sold: Cost of goods manufactured Ending inventory Total cost of goods sold Gross profit Selling and administrative expenses Operating income 5,70,000.00 6,30,000.00 -2,60,000.00 3,70,000.00

Saxon, Inc. Variable Costing Income Statement (Additional 10,000 units) 12,00,000.00 For the Year Ended December 31 Sales $ Variable cost of goods sold: Variable cost of goods 9,00,000.00 manufactured Ending inventory $ 4,50,000.00 Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs $ 2,40,000.00 Fixed selling and administrative 65,000.00 expenses Total fixed costs Operating income 4,50,000.00 7,50,000.00 -1,95,000.00 5,55,000.00 -3,05,000.00 2,50,000.00

Answers:-

1.

Operating Income
Original Production Level-Absorption	Original Production Level-Variable	Additional 10,000 Units-Absorption	Additional 10,000 Units-Variable
$310,000	$250,000	$370,000	$250,000

2. What is the change in operating income from producing 10,000 additional units under absorption costing?

=$370,000 - $310,000 = $60,000

3. What is the change in operating income from producing 10,000 additional units under variable costing?

=$250,000 - $250,000 = $0

4. What would be your recommendation to the production manager?

a. Do not produce the extra 10,000 units. The increase in operating income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.