Question

Prepare an income statement using Absorption Cost and other using Variable costs.

D's company produce donuts.

The variable cost of making each box of donuts is $ 0.40.
The Fixed Production Costs are $ 65,000.
Administrative and variable sales expenses are $ 0.20 per box.
The administrative and sales Fixed Costs are $ 55,000.

During 2018 the company produces 500,000 and sells 450,000 boxes of donuts to $ 1. The company has the capacity to produce 600,000 boxes of donuts. The company uses a calendar year and this is its first year of operations.

1. Prepare the Income Statement for full costs (absorption cost) and for variable costs. There is no tax rate.

2. A school wishes to raise funds for the graduating class. They extend an offer to buy 5,000 boxes per month for 10 months at $ 0.60. If the company accepts, this sale will not affect normal sales. The company must incur all variable costs, but not fixed costs. Determine if you accept the offer or reject it. Present your computations.

Answer 1

Solution

1. Absorption Costing Income Statement

Absorption Costing Income Statement
For the Year Ended December 31, 2018
Sales Revenue		$450,000
Less: Cost of goods sold:
cost of goods available for sale	$265,000
Less: ending inventory	$26,500	$238,500
Gross Margin		$211,500
Selling and administration costs
Variable	$90,000
Fixed	$55,000	$145,000
Net Operating Income		$66,500

Computations:

Sales revenue = $1 x 450,000 units = $450,000

Cost of goods available for sale –

Variable = $0.40 x 500,000 = $200,000

Fixed = $65,000

Total cost of goods available for sale, 500,000 units = $265,000

Cost of goods available for sale per unit = 265,000/500,000 = $0.53

Ending inventory = (500,000 – 450,000) x $0.53 = $26,500

Variable selling and administration costs = $0.20 x 450,000 units = $90,000

Variable costing income statement:

Variable Costing Income statement
For the Year Ended December 31, 2018
Sales Revenue		$450,000
variable cost of production	$200,000
Less: ending inventory	$20,000	$180,000
Gross margin		$270,000
Less: variable selling and administration cost		$90,000
Contribution margin		$180,000
Less: fixed costs
fixed manufacturing cost	$65,000
Fixed selling and administration costs	$55,000	$120,000
Net Income		$60,000

2. Accept or Reject the offer –

Offer price = $0.60

Variable costs –

Cost to make   $0.40

Selling cost      $0.20

Total                $0.60

Contribution margin = $0.60 - $0.60 = 0

Hence, the contribution margin from sale of 5,000 boxes = 5,000 x $0 = 0

The acceptance of special offer would result in no increase in the company’s profitable income.

The company however, has additional capacity to meet the special order without affecting the regular sales requirement, hence its fixed costs are not affected.

The company can accept the special order at any price above $0.60. A price equal to $0.60 or below $0.60 per unit is not profitable to the company.

Hence, Reject the offer.