Question

The vice president of sales at Wildlife Corporation has received the income statement for January 2009. This statement, which was prepared on the basis of variable costing, is reproduced below. The firm has just adopted a variable costing system for internal reporting. Wildlife Corporation Income Statement For the Month of January 2009 $2,400,000 1,200,000 $1,200,000 Sales revenues Variable cost of goods sold Contribution margin Fixed costs Manufacturing Selling and administrative Operating income S600,000 400,000 1,000,000 $ 200,000 The controller attached the following notes to the statements. • Unit sales price for January averaged $24 Unit manufacturing costs for the month were: Variable costs Fixed costs Total costs The unit rate for fixed manufacturing costs is based on monthly production of 150,000 units. Production for January was 50,000 units above sales. Inventory on January 30 was 50,000 units.

Answer 1

Requirement 1

Absorption costing means that all the manufacturing costs have been absorbed the units produced..

a)                     Income Statement

                        For the month of September

using Absorption costing

Particulars	Amount ($)
Sales Revenue	2,400,000
Less: Cost of goods sold
Cost of goods manufactured (150,000*$16) 2,400,000
Less: Closing Inventory (50,000*$16) (800,000)	(1,600,000)
Gross Profit	800,000
Less: Fixed Selling and Administrative costs	(400,000)
Operating Income	400,000

b) Reconciliation of Difference in operating Income

Operating income as per variable costing	$ 200,000
Add: Fixed cost component in Closing Inventory as per Absorption costing (50,000*$4)	$ 200,000
Operating Income as per Absorption costing	$ 400,000

All fixed costs are considered as period costs under variable costing method. They are not included in valuation of inventory unlike absorption costing where it is allocated. In absorption costing, fixed cost is allocated to inventories along with variable costs on per unit basis.

Requirement 2

The Income statement of the company should be prepared as per variable costing due to following reasons: -

• The variable costing statement provides a very clear view of the company's profit by considering fixed costs as period costs which is a correct treatment of Fixed costs.
• Profit under Absorption costing is higher than variable costing when closing stock is higher than opening stock.

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