Question

1. Inventory Valuation under Absorption Costing and Variable Costing

At the end of the first year of operations, 6,700 units remained in the finished goods inventory. The unit manufacturing costs during the year were as follows:

Direct materials	$38.30
Direct labor	13.80
Fixed factory overhead	5.30
Variable factory overhead	4.70

Determine the cost of the finished goods inventory reported on the balance sheet under (a) the absorption costing concept and (b) the variable costing concept.

Absorption costing	$
Variable costing	$

2. Income Statements under Absorption Costing 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 (11,000 units)				$1,540,000
Production costs (14,000 units):
Direct materials		$725,200
Direct labor		348,600
Variable factory overhead		173,600
Fixed factory overhead		116,200		1,363,600
Selling and administrative expenses:
Variable selling and administrative expenses		$211,400
Fixed selling and administrative expenses		81,800		293,200

If required, round interim per-unit calculations to the nearest cent.

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

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

Answer 1

Answer-1)- Cost of finished goods inventory under absorption costing method = 6700 units*$62.10 per unit

= $416070

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

=$38.30+$13.80+$4.70+$5.30

= $62.10 per unit

Cost of finished goods inventory under variable costing method = 6700 units*$56.80 per unit

= $380560

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

=$38.30+$13.80+$4.70

= $56.8 per unit

Answer-2-a)-

GALLATIN MOTORS INC.
Income statement (Using absorption costing approach)
Particulars			Amount
			$
Sales (a)			1540000
Less:- Cost of goods sold (b)
Opening inventory
Add:- Cost of goods manufactured		1363600
Direct materials		725200
Direct labor		348600
Variable manufacturing overhead		173600
Fixed manufacturing overhead		116200
Variable cost of goods available for sale		1363600
Less:- Closing inventory	3000 units*$97.4 per unit	292200	1071400
Gross margin C= a-b			468600
Less:-Variable selling & administrative exp.			211400
			257200
Less:- Fixed costs
Selling & administrative exp.			81800
Net Income			175400

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

=($725200+$348600+$173600+$116200)/14000 units

= $97.4 per unit

b)-

GALLATIN MOTORS INC.
Income statement (Using variable costing approach)
Particulars			Amount
			$
Sales (a)			1540000
Less:- Variable cost of goods sold (b)
Opening inventory		NIL
Add:- Variable cost of goods manufactured		1247400
Direct materials		725200
Direct labor		348600
Variable manufacturing overhead		173600
Variable cost of goods available for sale		1247400
Less:- Closing inventory	3000 units*$89.1 per unit	267300	980100
Gross contribution margin C= a-b			559900
Less:-Variable selling & administrative exp.			211400
Contribution margin			348500
Less:- Fixed costs
Manufacturing overhead			116200
Selling & administrative exp.			81800
Net Income			150500

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

=($725200+$348600+$173600)/14000 units

= $89.1 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.