Question

Navaroli Company began operations in January 5, 2018. Cost and sales information for its first two calendar years of operations are summarized below:

Manufacturing costs                                                                       Production and sales data

Direct Materials                                $80 per unit                        Units produced, 2018     200,000 units

Direct Labor                                        $120 per unit                     Units sold, 2018                                 140,000 units

Factory Overhead costs:                                                                2018 ending inventory    60,000 units

                Variable                               $30 per unit                        Units produced, 2019     80,000 units

                Fixed per year                    $14,000,000                        Units sold, 2019                                 140,000 units

Selling & Administrative costs:                                                   2019 ending inventory               0 units

                Variable                               $10 per unit                        Sales price per unit          $600 per unit

                Fixed per year                    $8,000,000

1. Prepare an income statement for 2018 under absorption costing
2. Prepare an income statement for 2018 under variable costing
3. Explain the difference in reported income under the two costing methods
4. Prepare an income statement for 2019 under absorption costing
5. Prepare an income statement for 2019 under variable costing
6. Prepare a schedule to convert variable costing income to absorption costing for each year

Answer 1

Working note: Product Cost Direct Material Direct Labor Variable manufacturing overhead Fixed manufacturing overhead Total Product Cost per Unit 2018 $80 $1201 $300 $70 2019 $80 $120 $30 $100 $330 $300 Fixed manufacturing overhead Total production units Fixed manufacturing overhead per unit 2018 $14,000,000 200,000 $701 2019 $14,000,000 140,000 $1001 $84,000,000 1) Navaroli Company Income Statement-Absorption Costing For the Year Ended 2018 Sales Less :Cost of Goods Sold Beginning Inventory - Finished Goods $0 Cost of goods manufactured Direct Material $16,000,000 Direct Labor $24,000,000 Variable Manufacturing overhead $6,000,000 Fixed Manufacturing overhead $14,000,000 Cost of Goods available for Sale $60,000,000 Less: Closing stock (60,000 * $300) $18,000,000 Gross profit Less: Operating expenses Variable selling and administrative expenses $1,400,000 Fixed selling and administrative expenses $8,000,000 Net Operating Income $42,000,000 $42,000,000 $9,400,000 $32,600,000 Product Cost- Variable Costing Direct Material Direct Labor Variable manufacturing overhead Total Product Cost per Unit $80 $120 $30 $230 2) Navaroli Company Income Statement-Variable Costing For the Year Ended 2018 Sales $84,000,000 Less : Variable Cost of Goods Sold Beginning Inventory - Finished Goods SO Variable Cost of goods manufactured Direct Material $16,000,000 Direct Labor $24,000,000 Variable Manufacturing overhead $6,000,000 Variable Cost of Goods available for Sale $46,000,000 Less: Closing stock (valued at $230 per unit) $13,800,000 $32,200,000 Variable selling and administrative expense $1,400,000 Contribution Margin $50,400,000 Less: Fixed Cost Manufacturing overheads $14,000,000 Selling and administrative expenses $8,000,000 $22,000,000 Net Operating Income $28,400,000 3) In Absorption costing Closing stock will have portion of fixed manufacturing overhead in it Hence Operating Income will be higher in year 1 In Variable Costing the fixed manufacturing cost is treated as period cost and charged to the period incurred Hence operating income reported under variable costing is lower than absorption costing $84,000,000 4) Navaroli Company Income Statement-Absorption Costing For the Year Ended 2019 Sales Less Cost of Goods Sold Beginning Inventory - Finished Goods $18,000,000 Cost of goods manufactured Direct Material $6,400,000 Direct Labor $9,600,000 Variable Manufacturing overhead $2,400,000 Fixed Manufacturing overhead $14,000,000 Cost of Goods available for Sale $50,400,000 Less: Closing stock $0 Gross profit Less: Operating expenses Variable selling and administrative expenses $1,400,000 Fixed selling and administrative expenses $8,000,000 Net Operating Income $50,400,000 $33,600,000 $9,400,000 $24,200,000 $84,000,000 5) Navaroli Company Income Statement-Absorption Costing For the Year Ended 2019 Sales Less : Variable Cost of Goods Sold Beginning Inventory - Finished Goods $13,800,000 Variable Cost of goods manufactured Direct Material $6,400,000 Direct Labor $9,600,000 Variable Manufacturing overhead $2,400,000 Variable Cost of Goods available for Sale $32,200,000 Less: Closing stock $0 Variable selling and administrative expense Contribution Margin Less: Fixed Cost Manufacturing overheads $14,000,000 Selling and administrative expenses $8,000,000 Net Operating Income $32,200,000 $1,400,000 $50,400,000 $22,000,000 $28,400,000 2018 6) Schedule to convert Variable costing income to Absorption costing income 2019 Operating Income as per Variable Costing $28,400,000 $28,400,000 Add: Fixed overhead included in closing stock $4,200,000 60,000*$70 Less: Fixed overhead included in opening stock -$4,200,000 60,000 $70 Operating Income as per Absorption costing $32,600,000 $24,200,000