Question

Dance Creations manufactures authentic Hawaiian hula skirts that are purchased for traditional Hawaiian celebrations, costume parties, and other functions. During its first year of business, the company incurred the following costs:

Variable Cost per Hula Skirt
Direct materials	$	10.50
Direct labor		4.30
Variable manufacturing overhead		1.45
Variable selling and administrative expenses		0.40
Fixed Cost per Month
Fixed manufacturing overhead	$	20,240
Fixed selling and administrative expenses		5,850

Dance Creations charges $35 for each skirt that it sells. During the first month of operation, it made 1,840 skirts and sold 1,720.

Required:
1. Assuming Dance Creations uses variable costing, calculate the variable manufacturing cost per unit for last month.
2. Complete a variable costing income statement for the last month.
3. Assuming Dance Creations uses full absorption costing, calculate the full manufacturing cost per unit for the last month.
4. Complete a full absorption costing income statement.
6. Suppose next month Dance Creations expects to produce 1,840 hula skirts and sell 1,940. Without recreating the new income statements, calculate the difference in profit between variable costing and full absorption costing. Which would be higher?

Answer 1

Answer

1 direct material, direct labour and variable manufacturing overhead are included in variable manufacturing cost.

Variable manufacturing cost per unit

= 10.50 + 4.30 + 1.45 = $16.25

$16.25 is variable manufacturing cost per unit.

2 variable costing income statement for last month

Particulars	$
Sales (1,720 × 35)	60,200
Less variable costs:
Direct material (1,720 × 10.50)	18,060
Variable manufacturing overhead (1,720 × 1.45)	2,494
Direct labour (1,720 × 4.30)	7,396
Variable administrative and selling expense (1,720 × 0.40)	688
Contribution margin	31,562
Less fixed selling and administrative expenses	5,850
Fixed manufacturing overhead	20,240
Operation income	5,472

The above are the detailed presentation of variable cost income statement for last month.

3 fixed manufacturing overhead, variable manufacturing cost, Direct material and direct labour are included in full manufacturing cost under absorption costing system.

Fixed manufacturing overhead per unit

= 20,240 / 1,840 = $11

Full manufacturing cost per unit

= 10.50 + 4.30 + 1.45 + 11 = $27.25

Full manufacturing cost is $27.25.

4 Absorption costing income statement

Particulars	$
Sales (1,720 × 35)	60,200
Less cost of goods sold
Variable manufacturing overhead (1,720 × 1.45)	2,494
Direct material (1,720 × 10.50)	18,060
Fixed manufacturing overhead (1720 × 11)	18,920
Direct labour (1,720 × 4.30)	7,396
Gross profit	13,330
Less variable selling and administrative expenses (1,720 × 0.40)	688
Fixed selling and administrative expenses	5,850
Operating income	6,792

5 Reconciliation factor = (opening inventory - ending inventory) × fixed manufacturing overhead per unit

Opening inventory = 1,840 - 1,720 = 120 units

Ending inventory = (1,840 + 120) - 1,940  = 20 units

Reconciliation factor

= (120 - 20) × 11 = $1,100

Difference in operating between variable costing and absorption costing income statement is $1,100.

Variable costing operating income is higher ,because the fixed manufacturing overhead is low in variable costing compared to Absorption.

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