Question

Problem 7-23 Absorption and Variable Costing; Production Constant, Sales Fluctuate [LO7-1, LO7-2, LO7-3]

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.

Tami’s Creations, Inc. Income Statement For the Quarter Ended March 31
Sales (28,100 units)				$	1,124,000
Variable expenses:
Variable cost of goods sold	$	415,880
Variable selling and administrative		193,890			609,770
Contribution margin					514,230
Fixed expenses:
Fixed manufacturing overhead		297,900
Fixed selling and administrative		238,830			536,730
Net operating loss				$	( 22,500)

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.

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:

Units produced	33,100
Units sold	28,100
Variable costs per unit:
Direct materials		$	7.20
Direct labor		$	6.00
Variable manufacturing overhead		$	1.60
Variable selling and administrative		$	6.90

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 33,100 units but sold 38,100 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

1A) Calculation of Unit product cost under Absorption costing

	Unit product cost
Direct materials	$7.20
Direct labor	6.00
Variable manufacturing overhead	1.60
Fixed manufacturing overhead ($297900/33100)	9.00
Unit product cost	$23.80

1B) Calculation of Net operating income under Absorption costing

Tami's Creation, Inc.
Absorption Costing Income Statement
Sales	$1124000
Less: Cost of goods sold (28100*23.80)	-668780
Gross profit	455220
Less: Selling & administrative expenses (28100*$6.90+238830)	-432720
Net operating income	$22500

1C) Reconcile the variable and absorption costing net operating income (loss) figures.

Net operating income(loss) as per Variable Costing	$-22500
Add: Fixed manufacturing cost deferred in inventory (5000*$9)	45000
Net operating income as per Absorption Costing	$22500

3A) Calculation of Net operating income under Variable costing for the second quarter.

Tami's Creation, Inc.
Variable Costing Income Statement
Sales ($1124000/28100*38100)		$1524000
Less: Variable costs:
Direct materials (38100*$7.20)	274320
Direct labor (38100*$6.00)	228600
Variable manufacturing overhead (38100*$1.60)	60960
Variable selling & administrative expenses (38100*$6.90)	262890	-826770
Contribution margin		697230
Less: Fixed expenses
Fixed manufacturing expenses	297900
Fixed selling & administrative expenses	238830	-536730
Net operating Income		$160500

3B) Calculation of Net operating income under Absorption costing for the second quarter.

Tami's Creation, Inc.
Absorption Costing Income Statement
Sales ($1124000/28100*38100)	$1524000
Less: Cost of goods sold (38100*$23.80)	-906780
Gross profit	617220
Less: Selling & administrative expenses (38100*$6.90+238830)	-501720
Net operating income	$115500

3C) Reconcile of Variable Costing and Absorption Costing Net Operating Incomes for the second quarter

Net operating income(loss) as per Variable Costing	$160500
Less: Fixed manufacturing cost released from inventory (5000*$9)	-45000
Net operating income as per Absorption Costing	$115500