Question

Solo limited makes and sells a single product .The following data relates to period 1 to 4.

Variable cost per unit          30

Selling price per unit            55

Fixed cost per period           6000

Normal activity is 500 units and production and sales for the four periods are as follows;

Periods            1          2         3         4 

Sales              500      400     550       450

Production   500        500     450       500

1. Prepare operating statements for each of the periods 1 to 4 based on marginal costing principles.

2. Prepare operating statements for each of the periods 1 to 4 based on absorption costing principles.

3. Comment briefly on the results obtained in each period and in total by the two systems.
   

Answer 1

A) Operating statement for the period 1 to 4 based on marginal costing principle:

	Period 1	Period 2	Period 3	Period 4
Sales revenue [$ 55 per unit]	27,500	22,000	30,250	24,750
Less: Total variable costs [$ 30 per unit]	15,000	12,000	16,500	13,500
Contribution margin [$ 25 per unit]	12,500	10,000	13,750	11,250
Less: Fixed costs	6,000	6,000	6,000	6,000
Net operating income	6,500	4,000	7,750	5,250

B) Operating statement for the period 1 to 4 based on absorption costing principle:

	Period 1	Period 2	Period 3	Period 4
Sales revenue [$ 55 per unit]	27,500	22,000	30,250	24,750
Expenses:
Variable cost of production [$ 30 per unit]	15,000	15,000	13,500	15,000
Fixed costs of production	6,000	6,000	6,000	6,000
Total cost of production	21,000	21,000	19,500	21,000
Add: Beg inventory of finished goods	0	0	4,200	0
Less: End inventory of finished goods	0	(4,200)	0	(2,100)
Cost of goods sold	21,000	16,800	23,700	18,900
Net operating income [Net sales revenue - Cost of goods sold]	6,500	5,200	6,550	5,850

B) As per marginal costing principle, fixed manufacturing expenses is treated as a period cost and thus, the whole amount of fixed manufacturing expenses is to be subtracted while calculating net operating income.

On the other hand, as per absorption costing principle, fixed manufacturing expenses is treated as a product cost, thus, proportionate fixed manufacturing expenses associated to the units sold is only should be subtracted while calculating net operating income.

Reconciliation of Net operating income under marginal costing to net operating income under absorption costing:

	Period 1	Period 2	Period 3	Period 4
Net operating income under marginal costing	6,500	4,000	7,750	5,250
Add: Fixed manufacturing overhead deferred in ending inventory of finished goods	0	1,200	0	600
Less: Fixed manufacturing overhead deferred in beginning inventory of finished goods	0	0	(1,200)	0
Net operating income under absorption costing	6.500	5,200	6,550	5,850

Note: In period 2, Fixed manufacturing overhead deferred in ending inventory of finished goods = [6,000/500] X 100 = 1,200

In period 3, Fixed manufacturing overhead deferred in beginning inventory of finished goods = fixed manufacturing overhead deferred in ending inventory of finished goods, period 2 = 1,200 (calculated above)

In period 4, Fixed manufacturing overhead deferred in ending inventory of finished goods = [6,000/500] X 50 = 600.