Question

Question 1

Maya Limited manufactures a specialised storage accessory for automobiles called ‘the Storax’, which is a type of pocket which can be easily fixed in the boot of any vehicle. The company has been in operation for two years and, now that the production process has been established and refined, the directors have decided to focus on the income and costs arising from activities. The managing director has recently read an article about product costing and, in particular, absorption and variable costing and is keen to understand how this would affect company profits.

The following information is available for the months of July and August:

July August

Production (units) 13 000 15 000
Sales (units) 12 000 16 000
Direct materials    $29 250 $33 750
Direct labour $19 500 $22 500
Variable production overheads $7 800 $9 000
Total selling and administrative expenses $45 200 $57 600

Additional information:

1.For Ludo Limited normal production capacity is 15 000 units per month.

2.Fixed production overheads are $29 400 per month.

3. The company sells ‘the Storax’ for $20 each.

4. Total selling and administrative expenses includes a fixed and variable element. The variable portion is $ 1.55 per unit and is based on units sold.

5. At 30 June the company had no ‘Storax’ accessories in its warehouse.

REQUIREMENT:

REQUIRED:
1.1	Prepare profit statements for Mayana Limited for the months of July and August using Absorption costing.
1.2	Reconcile the profit between Absorption costing and Variable costing.
1.3	Provide a brief explanation of the effect on profit of using each of the methods at (b) above

Answer 1

Working notes: Production volume variance Normal volume Fixed manufacturing overhead Fixed manufacturing overhead per unit Actual volume July 15,000 $29,400 $1.96 13,000 August 15,000 $29,400 $1.96 6 15,000 a $25,480 $29,400 Manufacturing overhead applied Monthly fixed manufacturing overhead (Under Over applied Comments $29,400 a*b $29,400 $0 None -$3,920 Unfavourable 1.1 Maya Limited Income Statement-Absorption Costing July August $240,000 $320,000 $0 $6,310 Sales Less Cost of Goods Sold Beginning Inventory - Finished Goods Cost of goods manufactured Direct Material Direct Labor Variable Manufacturing overhead Fixed Manufacturing overhead Cost of Goods available for Sale Less: Closing stock ($82,030/13,000*1,000) Unadjusted Cost of goods sold Production volume variance Gross profit Less: Operating expenses Selling and administrative expenses Net Operating Income $29,250 $19,500 $7,800 $25,480 $82,030 $6,310 $75,720 $3,920 $33,750 $22,500 $9,000 $29,400 $100,960 $0 $100,960 $0 $79,640 $160,360 $100,960 $219,040 $0 $45,200 $115,160 $57,600 $161,440 August $161,440 1.2 Reconciliation of Operating Income Variable Costing and Absorption Costing July Operating Income as per Absorption Costing $115,160 Less: Fixed overhead included in closing stock Closing stock as per Absorption costing $6,310 Closing stock as per Variable costing $4,350 -$1,960 Add: Fixed overhead included in opening stock Opening stock as per Absorption costing Opening stock as per Variable costing $6,310 $4,350 $1,960 Operating Income as per Variable costing $113,200 $163,400 1.3 Explanation: In Absorption costing Closing stock will have portion of fixed manufacturing overhead in it Hence Operating Income will be higher in July 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 In August the fixed manufacturing overhead is released from opening stock in Absorption costing which increases the cost of goods sold. Hence profit reported under Variable costing is higher since there is no closing stock Working notes: August $320,000 $4,350 Maya Limited Income Statement- Variable Costing July Sales $240,000 Less : Variable Cost of Goods Sold Beginning Inventory - Finished Goods $0 Variable Cost of goods manufactured Direct Material $29,250 Direct Labor $19,500 Variable Manufacturing overhead $7,800 Variable Cost of Goods available for Sale $56,550 Less: Closing stock ($56,550/13,000*1,000) $4,350 Variable cost of goods sold $52,200 Variable selling and administrative expenses $18,600 Contribution Margin $169,200 Less: Fixed Cost Fixed Manufacturing overhead $29,400 Fixed Selling and administrative expenses $26,600 $56,000 Net Operating Income $113,200 $33,750 $22,500 $9,000 $69,600 $0 $69,600 $24,800 $1.55 per unit sold $225,600 $29,400 $32,800 $62,200 $163,400