Question

Income statements under absorption and variable costing

Gallatin County Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1 and operated at 100% of capacity during the first month. The following data summarize the results for July:

Sales (3,500 units)				$2,450,000
Production costs (4,000 units):
Direct materials		$1,204,000
Direct labor		517,600
Variable factory overhead		84,400
Fixed factory overhead		132,400		1,938,400
Selling and administrative expenses:
Variable selling and administrative expenses		$60,100
Fixed selling and administrative expenses		25,200		85,300

This information has been collected in the Microsoft Excel Online file. Open the spreadsheet, perform the required analysis, and input your answers in the questions below.

Open spreadsheet

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

Gallatin County Motors Inc.
Absorption Costing Income Statement
For the Month Ended July 31
		$
		$
		$

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

Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31
					$
					$
					$
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 increases, the   income statement will have a higher Operating income than will the variable costing income statement.

Answer 1

Answer-a)-

GALLATIN COUNTY MOTORS INC.
Contribution Margin statement (Using absorption costing approach)
Particulars			Amount
			$
Sales (a)			2450000
Less:- Cost of goods sold (b)
Opening inventory
Add:- Cost of goods manufactured		1938400
Direct materials		1204000
Direct labor		517600
Variable factory overhead		84400
Fixed factory overhead		132400
Cost of goods available for sale		1938400
Less:- Closing inventory	500 units*$484.60 per unit	242300	1696100
Gross margin C= a-b			753900
Less:-Variable selling & administrative exp.			60100
Less:- Fixed costs
Selling & administrative exp.			25200
Net Income			668600

Explanation- Unit product cost under Absorption costing:-Direct materials + Direct Labor+ Variable manufacturing overhead + fixed manufacturing overhead

=($1204000+$517600+$84400+$132400)/4000 units

= $484.60 per unit

b)-

GALLATIN COUNTY MOTORS INC.
Contribution Margin statement (Using variable costing approach)
Particulars			Amount
			$
Sales (a)			2450000
Less:- Variable cost of goods sold (b)
Opening inventory
Add:- Variable cost of goods manufatured		1806000
Direct materials		1204000
Direct labor		517600
Variable factory overhead		84400
Variable cost of goods available for sale		1806000
Less:- Closing inventory	500 units*$451.50 per unit	225750	1580250
Gross contribution margin C= a-b			869750
Less:-Variable selling & administrative exp.			60100
Contribution margin			809650
Less:- Fixed costs
Manufacturing overhead			132400
Selling & administrative exp.			25200
Net Income			652050

Explanation-Unit product cost under Variable costing:-Direct materials + Direct Labor+ Variable manufacturing overhead

=($1204000+$517600+$84400)/4000 units

= $451.50 per unit

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 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 Operating income than will the variable costing income statement