Question

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:

1	Sales (31,000 units)		$7,750,000.00
2	Production costs (38,000 units):
3	Direct materials	$3,040,000.00
4	Direct labor	1,710,000.00
5	Variable factory overhead	950,000.00
6	Fixed factory overhead	570,000.00	6,270,000.00
7	Selling and administrative expenses:
8	Variable selling and administrative expenses	$1,120,000.00
9	Fixed selling and administrative expenses	200,000.00	1,320,000.00

	Required:
a.	Prepare an income statement according to the absorption costing concept.*
b.	Prepare an income statement according to the variable costing concept.*
c.	What is the reason for the difference in the amount of Operating income reported in (a) and (b)? * Be sure to complete the statement heading. Refer to the list of Labels and Amount Descriptions provided for the exact wording of the answer choices for text entries. A colon (:) will automatically appear if it is required. Enter amounts as positive numbers unless the amount is a calculation that results in a negative amount. For example: Net loss should be negative. Expenses should be positive.

Answer 1

Answer -

1. Answer -

Gallatin County Motors Inc.
Absorption Costing Income Statement
For the Month Ended July 31
Sales	$7,750,000
Cost of goods sold	$5,115,000
Gross profit	$2,635,000
Selling and administrative expenses	$1,320,000
Operating income	$1,315,000

Calculation:

Cost of goods sold:

= [(Direct materials + Direct labor + Variable factory overhead + Fixed factory overhead) / 38000 units] * 31000 units

= [($3040000 + $1710000 + $950000 + $570000) / 38000 units] * 31000 units

= $5115000

Gross profit:

= Sales - Cost of goods sold

= $7750000 - $5115000

= $2635000

Selling and administrative expenses:

= Variable selling and administrative expenses + Fixed selling and administrative expenses

= $1120000 + $200000

= $1320000

Operating income:

= Gross profit - Selling and administrative expenses

= $2635000 - $1320000

= $1315000

2. Answer -

Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31
Sales		$7,750,000
Variable cost of goods sold		$4,650,000
Manufacturing margin		$3,100,000
Variable selling and administrative expenses		$1,120,000
Contribution margin		$1,980,000
Fixed costs:
Fixed factory overhead	$570,000
Fixed selling and administrative expenses	$200,000
Total fixed costs		$770,000
Operating income		$1,210,000

Calculation:

Variable cost of goods sold:

= [(Direct materials + Direct labor + Variable factory overhead) / 38000 units] * 31000 units

= [($3040000 + $1710000 + $950000) / 38000 units] * 31000 units

= $4650000

Manufacturing margin:

= Sales - Variable cost of goods sold

= $7750000 - $4650000

= $3100000

Contribution margin:

= Manufacturing margin - Variable selling and administrative

= $3100000 - $1120000

= $1980000

Total fixed costs:

= Fixed factory overhead + Fixed selling and administrative

= $570000 + $200000

= $770000

Operating income:

= Contribution margin - Total fixed costs

= $1980000 - $770000

= $1210000

3. Answer -

In absorption costing method, the cost of goods sold includes all direct costs (direct materials, direct labor), variable overhead and also fixed factory overhead as a production costs (here, fixed costs does change with production level).

In variable costing, contribution margin computed by deducting all variable costs and direct costs from sales revenue and all fixed costs are computed separately and deducted from contribution margin to obtaining operating income. Here, fixed factory overhead does not change with production level.

Therefore, increase in inventory, shows higher operating income according to absorption costing than the variable costing.