Question

Income Statements under Absorption Costing and Variable Costing

Fresno Industries Inc. manufactures and sells high-quality camping tents. The company began operations on January 1 and operated at 100% of capacity (58,300 units) during the first month, creating an ending inventory of 5,300 units. During February, the company produced 53,000 units during the month but sold 58,300 units at $115 per unit. The February manufacturing costs and selling and administrative expenses were as follows:

	Number of Units		Unit Cost		Total Cost
Manufacturing costs in February 1 beginning inventory:
Variable	5,300		$46.00		$243,800
Fixed	5,300		17.00		90,100
Total			$63.00		$333,900
Manufacturing costs in February:
Variable	53,000		$46.00		$2,438,000
Fixed	53,000		18.70		991,100
Total			$64.70		$3,429,100
Selling and administrative expenses in February:
Variable	58,300		$22.10		$1,288,430
Fixed	58,300		7.00		408,100
Total			$29.10		$1,696,530

a. Prepare an income statement according to the absorption costing concept for the month ending February 28.

Fresno Industries Inc.
Absorption Costing Income Statement
For the Month Ended February 28
Sales		$
Cost of goods sold:
	$
		$
		$

b. Prepare an income statement according to the variable costing concept for the month ending February 28.

Fresno Industries Inc.
Variable Costing Income Statement
For the Month Ended February 28
		$
		$
		$
Fixed costs:
	$
		$

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

Under the   method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under  , 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 decreases, the   income statement will have a lower operating income.

Answer 1

a. Absorption Costing

Sales		$      67,04,500
Cost of Goods Sold
Beginning Inventory	$      3,33,900
Manufactured	$    34,29,100
Total cost of goods sold		$      37,63,000
Gross Profit		$      29,41,500
Selling and administrative expenses		$      16,96,530
Net Operating Income		$      12,44,970

b.

Variable Costing
Sales		$      67,04,500
Variable Expenses
Cost of Goods Sold	$    26,81,800
Selling and administrative expenses	$    12,88,430
Total Variable Expenses		$      39,70,230
Contribution Margin		$      27,34,270
Fixed Expenses
Manufacturing Costs	$      9,91,100
Selling and administrative expenses	$      4,08,100
Total Variable Expenses		$      13,99,200
Net Operating Income		$      13,35,070

c.

Under the Absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under Variable costing method, 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 decreases, the absorption costing income statement will have a lower operating income.