Question

1. WC ne botenent will have a Higher operating income? By how MULLA P6-66A Absorption and variable costing income statements (Learning Objective 6) Mario's Foods produces frozen meals, which it sells for $8 each. The company uses the IF inventory costing method, and it computes a new monthly fixed manufacturing overhead rate based on the actual number of meals produced that month. All costs and production levels are exactly as planned. The following data are from the company's first two months in business February Sales .............. Production ................ Variable manufacturing expense per meal ............. Sales commission expense per meal ........ Total fixed manufacturing overhead ....................... Total fixed marketing and administrative expenses..... January 1,400 meals 2,000 meals $ 4 $ 2 $ 700 $ 500 1,800 meals 1,400 meals $ 4 $ 2 $ 700 $ 500 Requirements 1. Compute the product cost per meal produced under absorption costing and under variable costing. Do this first for January and then for February. 2. Prepare separate monthly income statements for January and for February, using the following: a. Absorption costing b. Variable costing 3. Is operating income higher under absorption costing or variable costing in January? In February? Explain the pattern of differences in operating income based on absorption costing versus variable costing.

Answer 1

Note that absorption costing includes fixed manufacturing overhead as part of product cost while variable costing excludes the fixed manufacturing overhead as it is considered as period cost.

Requirement 1

January - Absorption costing

• Product cost per meal = Variable manufacturing expense per meal + fixed manufacturing overhead per meal
• Product cost per meal = $4 + ($700 / 2,000 meals)
• Product cost per meal = $4 + $0.35
• Product cost per meal = $4.35

January - Variable costing

• Product cost per meal = variable manufacturing expense per meal
• Product cost per meal = $4

February - Absorption costing

• Product cost per meal = Variable manufacturing expense per meal + fixed manufacturing overhead per meal
• Product cost per meal = $4 + ($700 / 1,400 meals)
• Product cost per meal = $4 + $0.50
• Product cost per meal = $4.50

February - Variable costing

• Product cost per meal = variable manufacturing expense per meal
• Product cost per meal = $4

Requirement 2

January - Absorption costing Income statement
Sales (1,400 meals x $8)	$11,200
Less: cost of goods sold (1,400 meals x $4.35)	($6,090)
Gross margin	$5,110
Less: operating expense - sales commission (1,400 meals x 2)	($2,800)
Less: operating expense - fixed marketing and admin. expense	($500)
Net income	$1,810
January - Variable costing Income statement
Sales (1,400 meals x $8)	$11,200
Less: variable cost (1,400 meals x $4)	($5,600)
Less: variable sales commission (1,400 meals x 2)	($2,800)
Contribution margin	$2,800
Less: fixed manufacturing overhead	($700)
Less: fixed marketing and admin. expense	($500)
Net income	$1,600

February - Absorption costing Income statement
Sales (1,800 meals x $8)	$14,400
Less: cost of goods sold (600 meals x $4.35)	($2,610)
Less: cost of goods sold (1,200 meals x $4.50)	($5,400)
Gross margin	$6,390
Less: operating expense - sales commission (1,800 meals x 2)	($3,600)
Less: operating expense - fixed marketing and admin. expense	($500)
Net income	$2,290
February - Variable costing Income statement
Sales (1,800 meals x $8)	$14,400
Less: variable cost (1,800 meals x $4)	($7,200)
Less: variable sales commission (1,800 meals x 2)	($3,600)
Contribution margin	$3,600
Less: fixed manufacturing overhead	($700)
Less: fixed marketing and admin. expense	($500)
Net income	$2,400

Requirement 3

For January, the absorption income statement is higher than the variable costing income statement by $210. This is due to the recognition of fixed manufacturing overhead as part of product cost under absorption costing. Thus, as part of product cost, portion of the fixed manufacturing overhead is recognized as part of the cost of the ending inventory. Under variable costing the fixed manufacturing overhead is expensed outright.

For February, the absorption income statement is lower than the variable costing income statement by $110.