Question

near the very end of the fiscal year, the production manager noted that if Net Income increases by $200 they will get a big bonus. How can the production manager increase Net income using Absorption costing even though no additional units will be produced?'

	Prior Year (Budget and Actual)	Current Year (Budget and Actual)
Beginning Inventory (Units)	0	?
Sales (Units)	600,000	575,000
Manufactured (Units)	600,000	640,000
Selling Price ($/unit)	9.90	10.00
Variable Manufacturing Cost ($/unit)	4.80	5.00
Total Fixed Manufacturing Costs ($)	1,560,000	1,600,000
Variable Selling Cost ($/unit)	1.00	1.00
Total Fixed SG&A Costs ($)	351,000	358,000

Other information:

• The manufacturer uses FIFO.
• All Variable costs are direct costs

Answer 1

Answer

Particulars	Calculation	Prior Year
Sales	600,000 units x $ 9.90	5,940,000
Cost of goods sold
Variable Manufacturing cost	600,000 units x$ 4.80	2,880,000
Fixed manufacturing cost		1,560,000
Cost of goods sold		1,500,000
Less: Variable Selling Cost	600,000 units x$ 1.00	600,000
Fixed SG&A Cost		351,000
Net Income		549,000

Income statement of current year under Absorption Costing and Variable Costing

Particulars	Calculation	Absorption Costing
Sales	(575,000 units x $ 10.00)	5,750,000
Cost of goods sold
Variable Manufacturing cost	(640,000 units x $ 5.00)	3,200,000
Fixed manufacturing cost		1,600,000
Cost of goods available for sale		4,800,000
Less: Closing Inventory	65,000 units x $ 4,800,000                              640,000	(487,500)
Cost of goods sold		4,312,500
Gross Profit		462,500
Less: Variable Selling Cost	575,000 units x$ 1.00	575,000
Fixed SG&A Cost		358,000
Net Income		504,500

Income statement of current year under Variable Costing:

Particulars	Calculation	Variable Costing
Sales	(575,000 units x $ 10.00)	5,750,000
Cost of goods sold
Variable Manufacturing cost	(640,000 units x $ 5.00)	3,200,000
Variable cost of goods available for sale		3,200,000
Less: Closing Inventory	65,000 units x $ 5.00	(325,000)
Gross Contribution Margin		2,875,000
Less: Variable Selling Cost	575,000 units x$ 1.00	575,000
Contribution Margin		2,300,000
Less: Fixed Expenses
Fixed manufacturing cost		1,600,000
Fixed SG&A Cost		358,000
Net Income		342,000

As can be seen in the question above, net income under absorption costing is $ 504,500 while profit under variable costing is $ 342,000. This is because, under Absorption costing, Inventory is valued at variable and fixed manufacturing cost both but under variable costing; only variable cost is taken into consideration for valuation of inventory.

Hence, this shows that the production manager can increase Net income using Absorption costing.