Question

Louie's Meals produces frozen​ meals, which it sells for $8 each. The company uses the FIFO 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:

Requirement 1. Compute the product cost per meal produced under absorption costing and under variable costing. Do this first for January and then for February January February Absorption Variable Absorption Variable costing costing costing costing Total product cost 4.00 4.001 4.00 4.00 Requirement 2a. Prepare separate monthly income statements for January and for February, using absorption costing. Louie's Meals Income Statement (Absorption Costing) Month Ended January 31 February 28 11200 Sales revenue Less: Cost of goods sold Gross profit 13600 1740 Less: Operating expenses Requirement 2b. Prepare Louie's Meals January and February income statements using variable costing. Louie's Meals Contribution Margin Income Statement (Variable Costing) Month Ended January 31 February 28 Less: Less: Requirement 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. In January, absorption costing operating income variable costing income. This is because units produced were units sold. Absorption costing defers some of costs in the units of ending inventory. These costs will not be until those units are sold. Deferring these costs to the future January's absorption costing income. In February, absorption costing operating income variable costing operating income. This is because units produced were units sold for the month As inventory as was the case in this February. January's costs that absorption costing assigned to that inventory are expensed in This V February's absorption costing income.

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Data Table

	January		February
Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	1,400	meals	1,700	meals
Production. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	2,000	meals	1,400	meals
Variable manufacturing expense per meal. . . . . . . . . . . .	$4		$4
Sales commission expense per meal. . . . . . . . . . . . . . . .	$2		$2
Total fixed manufacturing overhead. . . . . . . . . . . . . . .	$700		$700
Total fixed marketing and administrative expenses. . . . .	$400		$400

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

1. 
   Calculation of Product Cost January February Absorption Variable Absorption Variable Total Product Cost $4.35 $4.00 $4.5 $4.00 PRODUCT COST AS PER VARIABLE COSTING As per Variable Costing, product cost includes only variable Manufacturing Expenses. Fixed manufacturing Expenses and Variable Non-Manufacturing expenses are not included in the Product Cost. So, Product cost per unit as per Variable Costing Method = Variable Manufacturing Expenses per Unit = $4 (Given) PRODUCT COST AS PER ABSORPTION COSTING As per Absorption costing Product cost Includes all Manufacturing Expenses. That is it includes both Fixed and Variable Manufacturing Expenses in the Product Cost. Product Cost doesn't include non Manufacturing Expenses. Particulars January February Variable Manufacturing Expense (Given) Fixed Manufacturing Expenses 0.5 (Working Note) Total Product Cost 4.35 4.50 Working Note: Calculation of Fixed Manufacturing Cost per unit Particulars January February Fixed Manufacturing Expenses 700 Total Units Produced 2000 1400 Fixed manf Expense per unit 0.50 4 4 0.35 700 0.35
   
   2a Louie's Meals Income Statement(Absorption Costing) Janauary February Sales Revenue 11200 13600 Less: Cost of Goods Sold 6090 7560 GROSS PROFIT 5110 6040 Less: Operating Expenses 3200 3800 NET INCOME 1910 2240 (Working Note:1) (Working Note:2) (Working Note:3) (Given) (Given) WORKING NOTE 1:Calculation of Sales Revenue January February Total Sales (in Unit) 1400 1700 Sale Price per Unit 8 8 Sales Revenue 11200 13600 WORKING NOTE 2:Calculation of Total Costs of Goods Sold January February Sale from Opening Inventory 0 600 Product cost opening Inventory 0 4.35 Cost of Opening Inventory Sold 0 2610 Sales from Production 1400 1100 Product Cost per Unit 4.35 4.5 Cost of Units produced and Sold 6090 4950 Total Cost of Goods Sold 6090 7560 (Given) (Calculated above) (Given) (Calculated above)
   
   WORKING NOTE 3:Calculation of Operating Expenses January February Sales Comission 2800 3400 =1,400 x $2 =$1,700 x $2 Fixed Manf and Admin Exp 400 400 Operating Expenses 3200 3800
   
   2b (Working Note:1) Louie's Meals Contribution Margin Income Statement (Variable Costing) Janauary February Sales Revenue 11200 13600 Less: Variable Costs Cost of Goods Sold 5600 6800 Sales Comission 2800 3400 Contribution Margin 2800 3400 Less: Fixed Costs Manufacturing Expenses 700 700 Marketing and Admin 400 400 NET INCOME 1700 2300 (Working Note:5) (Working Note:6) (Given) (Given) (Given) (Given) WORKING NOTE 5:Calculation of Cost of Goods Sold January February Total Sales (In Units) 1400 1700 Variable Product Cost 4 4 Total Sales Comission 5600 6800 WORKING NOTE 6:Calculation of Sales Comission January February Total Sales (In Units) 1400 1700 Sales Comission per unit 2 Total Sales Comission 2800 3400 (Given) (Given) 2
   
   3 In January, absorption costing operating income Less than Variable costing income. This is because units produced were Greater than Units sold. Absorption Costing defers some of january's, Fixed Manufacturing overhead cost in the units of ending inventory. These costs will not be Expensed untill those units are sold. Deffering these Fixed Manufacturing Cost to Future Sales January absorption. In February Absorption costing income Exceeds Variable costing income. This is because units produced were less than units sold in month. As Inventory Decreases. As was the case in the February. Janaurys Fixed Manufacturing Expenses that absorption costing assigned to that inventory are Expensed in February. This increases February's Absorption Income.
   
2. The main reason for the differences of net profit under both the methods is Difference in treatement of fixed manufacturing overhead.
3. Under variable costing fixed manufacturing overhead is treated as periodic cost as expenses of in same period during which they are incurred. But under absorption foxed manufacturing coats are treated as Product costs are not expensed off in period they are incurred but are expensed in the period in which goods produced are sold.

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