Question

Question 5: Variable costing (20 marks in total)

Slumberworld Pty Ltd's planned production for the current year was 15,000 units. This production level was achieved, but only 13,500 units were sold at $60 each. Other data are as follows:

	$
Direct material used	120,000
Direct labour cost incurred	60,000
Fixed manufacturing overhead (actual and planned)	75,000
Variable manufacturing overhead (actual and planned)	36,000
Fixed selling and administrative expenses	90,000
Variable selling and administrative expenses	13,500
Finished goods inventory, 1 January	None

The company uses normal costing. There were no work in process inventories at the beginning or end of the year.

Required

1. Prepare an income statement for Slumberworld for the current year using:
   1. absorption costing
   2. variable costing
2. Which costing method, absorption costing or variable costing, shows a higher operating profit? Why?
3. What would be Slumberworld's finished goods inventory cost on 31 December, under:
   1. absorption costing
   2. variable costing
4. Which costing method, variable or absorption, would you recommend to Slumberworld's management? Why?

Answer 1

	Absorption Costing	Variable Costing
Direct materials	$          8.00	$         8.00
Direct labor	$          4.00	$         4.00
Variable manufacturing overhead	$          2.40	$         2.40
Fixed manufacturing overhead (actual and planned)	$          5.00
Unit Product cost	$        19.40	$       14.40
a)
Slumberworld
Absorption Income Statement
Units	13500
Sales (@ $60 per unit)	8,10,000
Cost of goods sold (@ $19.40 per unit)	2,61,900
Gross margin	5,48,100
Fixed selling and administrative expenses	90,000
Variable selling and administrative expenses	13,500
Net operating income	4,44,600
Slumberworld
Variable Income Statement
Units	13500
Sales (@ $60 per unit)	8,10,000
Cost of goods sold (@ $19.40 per unit)	1,94,400
Variable selling and administrative expenses	13,500
Contribution margin	6,02,100
Fixed selling and administrative expenses	90,000
Fixed manufacturing overhead (actual and planned)	75,000
Net operating income	4,37,100
b)
Absorbtion costing has higher operating Income
c) What would be Slumberworld's finished goods inventory cost on 31 December, under:
absorption costing = 1500 units x 19.40	$ 29,100.00
variable costing = 1500 units x 14.40	$ 21,600.00
d)
Absorption costing is better option because fixed manufacturing overhead costs are expensed when the product is sold.