Question

Problem 2: Felix and Oscar Industries makes artificial Christmas trees. The unit costs for producing a tree are: Direct materials $50 Direct Labor $30 Variable Overhead $30 Fixed Overhead $10 The company incurs $2 per tree in variable selling and administrative costs and $8,000 in fixed marketing costs. At the beginning of 2021 the company had 1,800 trees in the beginning finished goods inventory. The company produced 4,000 more trees during the year. Sales totaled 3,000 trees at a price of $200 per tree. Required: a. Based on absorption costing, what was the company's operating income for 2021? b. Based on variable costing, what was the company's operating income for 2021? C. Assume that in 2022 the company produced 4,000 trees and sold 5,000. Based on absorption costing, what was the operating income for 2022? Based on variable costing. what was the operating income for 2022? d. For both 2021 and 2022, explain why the operating income based on absorption costing differed from the operating income based on variable costing.

Answer 1

Direct materials per unit	$50
Direct labor per unit	$30
Variable overhead per unit	$30
Variable manufacturing overhead per unit	$110

a) Absorption Costing:
Felix and Oscar Industries
Income Statement
Sales Revenue (3,000 trees * $200 per tree)		$600,000
Less: Cost of Goods Sold:
Variable manufacturing overheads (3,000 trees * $110 per tree)	($330,000)
Fixed manufacturing overhead (3,000 trees * $10 per tree)	($30,000)	($360,000)
Gross Margin		$240,000
Less: Operating Expenses:
Variable selling and administrative costs (3,000 trees * $2)	($6,000)
Fixed marketing costs	($8,000)	($14,000)
Net Operating Income		$226,000
b) Variable Costing:
Felix and Oscar Industries
Income Statement
Sales Revenue (3,000 trees * $200 per tree)		$600,000
Less: Variable Costs:
Variable manufacturing overheads (3,000 trees * $110 per tree)	($330,000)
Variable selling and administrative costs (3,000 trees * $2)	($6,000)	($336,000)
Contribution Margin		$264,000
Less: Fixed Costs:
Fixed manufacturing overheads (4,000 trees * $10)	($40,000)
Fixed marketing costs	($8,000)	($48,000)
Net Operating Income		$216,000
c) Absorption Costing:
Felix and Oscar Industries
Income Statement
Sales Revenue (5,000 trees * $200 per tree)		$1,000,000
Less: Cost of Goods Sold:
Variable manufacturing overheads (5,000 trees * $110 per tree)	($550,000)
Fixed manufacturing overhead (5,000 trees * $10 per tree)	($50,000)	($600,000)
Gross Margin		$400,000
Less: Operating Expenses:
Variable selling and administrative costs (5,000 trees * $2)	($10,000)
Fixed marketing costs	($8,000)	($18,000)
Net Operating Income		$382,000
c-1) Variable Costing:
Felix and Oscar Industries
Income Statement
Sales Revenue (5,000 trees * $200 per tree)		$1,000,000
Less: Variable Costs:
Variable manufacturing overheads (5,000 trees * $110 per tree)	($550,000)
Variable selling and administrative costs (5,000 trees * $2)	($10,000)	($560,000)
Contribution Margin		$440,000
Less: Fixed Costs:
Fixed manufacturing overheads (4,000 trees * $10)	($40,000)
Fixed marketing costs	($8,000)	($48,000)
Net Operating Income		$392,000
d) The main reason for differences in operating income between absorption costing and variable costing is that the fixed manufacturing overheads are taken based on the number of units sold under absorption costing whereas the fixed manufacturing overheads are taken based on the number of units produced under variable costing. Hence, the fixed manufacturing overheads are there in the ending inventory in the absorption costing but not in the variable costing. Therefore, the difference is shown in the operating income.