Question

Problem Two Straightforward Problem on Absorption versus Variable Costing (LO 2, 3, 4, 6) Cow Dippers, Inc. produces non-fat frozen yogourt. The product is sold at wholesale in 10-litre commercial containers, which have the following price and variable costs. Sales price $30 Direct material 10 Direct labour 4 Variable overhead Budgeted fixed overhead in 20x4, the company's first year of operations, was $600,000. Actual production was 150,000 10-litre containers, of which 125,000 were sold. Cow Dippers, Inc. incurred the following selling and administrative expenses. Fixed $100,000 for the year Variable$2 per container sold Required: 1. Compute the product cost per container of frozen yogurt under (a) variable costing and (b) absorption costing. 2. Prepare income statements for 20x4 using (a) absorption costing and (b) variable costing 3. Reconcile the income reported under the two methods by listing the two key places where the income statements differ. 4. Reconcile the income reported under the two methods using the shortcut method

Answer 1

1. Per Container Product Cost under

	Variable Costing	Absorption Costing
Direct Material	$                       10.00	$                        10.00
Direct Labour	$                         4.00	$                          4.00
Variable Overhead	$                         6.00	$                          6.00
*Fixed Overhead ($600,000/$150,000)	$                              -	$                          4.00
	$                       20.00	$                        24.00

*Fixed Overhead per unit = Total Fixed Overhead / Annual production

2.

a) Absorption Costing Income Statement

Particulars	Amount ($)
Revenue (a)	3,750,000 (125,000 * 30)
Less: Cost of Goods Sold (b)	3,000,000(125,000 * 24)
Gross Margin (c= a-b)	750,000
Less : Selling and Administrative Expenses:
Variable (d)	250,000 (125,000 * 2)
Fixed (e)	100,000
Net Profit (f = c- d-e)	400,000

b)Variable Costing Income Statement

Particulars	Amount ($)
Revenue (a)	3,750,000 (125,000 * 30)
Less: Variable product cost (b)	2,500,000(125,000 * 20)
Less: Variable Selling and Administrative Expenses ©	250,000 (125,000 * 2)
Contribution Margin (d = a-b-c)	1,000,000
Less: Fixed Manufacturing Overhead (e)	600,000
Less : Fixed Selling and Administrative Expenses (f)	100,000
Net Profit (g = d-e-f)	300,000

3. Reconciliation of Income under two methods

Particulars	Amount
Cost of goods sold under absorption costing	$3,000,000
Variable cost of goods sold	$2,500,000
Difference in cost of goods sold	$500,000
Fixed manufacturing overhead as period expense under variable costing	$600,000
Total differences between the two methods	($100,000)
Net profit under variable costing	$300,000
Net profit under absorption costing	$400,000
Difference in net profit	($100,000)

4. Reconciliation of Income under two methods by shortcut method

Change in inventory in units x predetermined fixed overhead rate per unit:

(150,000 - 125,000) units * $ 4 (calculated as above)

25000 units * $ 4 = $ 100,000