Question

P6.7A (LO 5), AN Writing Jackson Company produces plastic that is used for injection-molding applications such as gears for small motors. In 2019, the first year of operations, Jackson produced 4,000 tons of plastic and sold 3,500 tons. In 2020, the production and sales results were exactly reversed. In each year, the selling price per ton was $2,000, variable manufacturing costs were 15% of the sales price of units produced, variable selling expenses were 10% of the selling price of units sold, fixed manufacturing costs were $2,800,000, and fixed administrative expenses were $500,000.

Instructions

a. Prepare income statements for each year using variable costing. (Use the format from Illustration 6A.5.)

b. Prepare income statements for each year using absorption costing. (Use the format from Illustration 6A.4.)

c. Reconcile the differences each year in net income under the two costing approaches.

d. Comment on the effects of production and sales on net income under the two costing approaches.

Answer 1

a) Under variable costing (marginal costing), unit product cost shall consider only variable mfg. costs incurred to produce the number of goods. Therefore, 2019 2020 Units in beginning inventory 0 500 Number of units produced 4,000 3,500 Number of units available for sale 4,000 4,000 Number of units sold 3,500 4,000 Units in ending inventory 500 0 AN Writing Jackson Company Variable Costing Income Statement 2019 2020 Sales Revenue $7,000,000 $8,000,000 (3500 units x $2000; 4000 units x $2000] Variable Cost of Goods Sold $1,050,000 $1,200,000 [3500 units x $300; 4000 units x $300] Manufacturing margin $5,950,000 $6,800,000 (Sales - Variable Cost of Goods Sold] Variable Selling and Admin. Expenses $700,000 $800,000 (3500 units x $200; 4000 units x $200] Contribution Margin $5,250,000 $6,000,000 Fixed Expenses: Fixed Manufacturing costs $2,800,000 $2,800,000 [Fully charged as expense] Fixed Selling and Admin. Expenses $500,000 $500,000 [Fully charged as expense) Total Fixed Expenses $3,300,000 $3,300,000 Net Operating Income $1,950,000 $2,700,000 (Contribution margin - Total Fixed Expenses]

b) Under absorption costing, unit cost of goods manufactured shall consider both variable and fixed manufacturing costs incurred to produce the number goods. Unit cost under absorption costing is calculated under FIFO assumption. That is, units produced first are sold first. Closing inventory consists of cost of goods produced in recent year. Therefore, 2019 2020 Variable manufacturing costs $1,200,000 $1,050,000 [4000 units x $300; 3500 units x $300] Fixed manufacturing costs $2,800,000 $2,800,000 Total manufacturing costs $4,000,000 $3,850,000 Number of units produced 4,000 3,500 Unit product cost $1,000.00 $1,100.00 [$4000000/4000=$1000; $3850000/3500=$1100] Units sold from current production 3,500 3,500 Cost of goods sold from current production $3,500,000 $3,850,000 ($1000 x 3500 units; $1100 x 3500 units] Add: Cost of beginning inventory sold $0 $500,000 (500 units x $1000] Total cost of goods sold $3,500,000 $4,350,000

AN Writing Jackson Company Absorption Costing Income Statement 2019 2020 Sales Revenue $7,000,000 $8,000,000 [3500 units x $2000; 4000 units x $2000] Cost of Goods Sold $3,500,000 $4,350,000 [As calculated above] Gross Profit $3,500,000 $3,650,000 (Sales Revenue - Cost of Goods Sold] Less: Selling & Administrative Expenses $1,200,000 $1,300,000 [$700000 + $500000; $800000 + $500000] Operating Income $2,300,000 $2,350,000 c) Reconciliation between net operating income under Variable and Absorption Costing: Net operating income - Absorption costing Fixed Fixed mfg. cost deferred in ending inventory Fixed Fixed mfg. cost released in beginning inventory Net operating income - Variable costing 2019 2020 $2,300,000 $2,350,000 -$350,000 [500 units x ($2800000 / 4000 units)] $350,000 (Ref: Previous line] $1,950,000 $2,700,000

d) The only reason for the difference in net operating income (loss) between absorption costing and variable costing is the deferred fixed mfg. overhead cost to next period through ending inventory under absorption costing. That is, under variable costing, entire fixed manufacturing overhead cost is considered as period cost and so charged to income statement. However, under the absorption costing, fixed mfg. overhead cost is considered as product cost and so a portion of it will be deferred to next reporting period through ending inventory. If number of units produced and sold are same, net operating income reported under both methods will be same. If number of units produced is higher than number of units sold, operating income reported under variable costing will be less than operating income reported under absorption costing. If number of units produced is less than number of units sold, operating income reported under variable costing will be higher than operating income reported under absorption costing.