Question

Easton Pump Company's planned production for the year just ended was 19,000 units. This production level was achieved, and 21,800 units were sold. Other data follow: Direct material used Direct labor incurred Fixed manufacturing overhead Variable manufacturing overhead Fixed selling and administrative expenses Variable selling and administrative expenses Finished-goods inventory, January 1 $573,800 296,400 408,500 193,800 351,500 114,950 3,700 units The cost per unit remained the same in the current year as in the previous year. There were no work-in-process inventories at the beginning or end of the year Required: 1. What would be Easton Pump Company's finished-goods inventory cost on December 31 under the variable-costing method? (Do not round intermediate calculations.) 2-a. Which costing method, absorption or variable costing, would show a higher operating income for the year? 2-b. By what amount? (Do not round intermediate calculations.) 1. Finished-goods inventory cost Higher operating income method Variable costing Difference in reported income

Answer 1

In the variable costing, only variable costs are considered as product costs and are attributed to the products and all the fixed costs are treated as period costs and are directly charged to income of the year during which the fixed costs are incurred.

Therefore the cost / unit of product is computed as under:

Particulars	Computation	Amount ($)
Material Cost	=> $573,800 / 19,000 units	30.20
Labour Cost	=> $296,400 / 19,000 units	15.60
Variable FOH	=> $193,500 / 19,000 units	10.18
Varaible SOH	=> $114,950 / 19,000 units	6.05
Total Cost / unit		62.03

Closing Inventory => Opening Stock + Production - Sales

= 3,700 units + 19,000 units - 21,800 units

= 900 units

Value of closing stock => 900 units * $62.03 = $55,830.60

2. In the given situation, since the inventory level has decreased when compared to previous year, the variable costing method gives more profit. This is because in case of absorption costing, the cost of opening stock includes the absorbed fixed costs which increases the cost and on the other hand the fixed costs absorbed by the closing stock is not enough to off set the increase in cost owing to lesser quantity and thereby end up giving lesser profits.

3. Value per unit in absorption costing = Total variable cost p.u. + (fixed costs) / production

= $62.034 + (408,500 + 351,500) / 19,000

= $102.034

Excess of cost of opening stock over closing stock under absorption costing

=> (3,700 - 900) * $102.034 = $ 285,695

Excess of cost of opening stock over closing stock under variable costing

=> (3,700 - 900) * $62.034 = $ 173,695

Difference in cost => Difference in profits = $285,695 - $173,695

= $112,000

Therefore variable costing gives $112,000 more operating income than absorption costing