Question

Tami Tyler opened Tami’s Creations, Inc., a small manufacturing company, at the beginning of the year. Getting the company through its first quarter of operations placed a considerable strain on Ms. Tyler’s personal finances. The following income statement for the first quarter was prepared by a friend who has just completed a course in managerial accounting at State University.

Tami’s Creations, Inc. Income Statement For the Quarter Ended March 31
Sales (28,400 units)				$	1,136,000
Variable expenses:
Variable cost of goods sold	$	451,560
Variable selling and administrative		193,120			644,680
Contribution margin					491,320
Fixed expenses:
Fixed manufacturing overhead		251,200
Fixed selling and administrative		252,120			503,320
Net operating loss				$	( 12,000)

Ms. Tyler is discouraged over the loss shown for the quarter, particularly because she had planned to use the statement as support for a bank loan. Another friend, a CPA, insists that the company should be using absorption costing rather than variable costing and argues that if absorption costing had been used the company probably would have reported at least some profit for the quarter.

At this point, Ms. Tyler is manufacturing only one product—a swimsuit. Production and cost data relating to the swimsuit for the first quarter follow:

Units produced	31,400
Units sold	28,400
Variable costs per unit:
Direct materials		$	7.20
Direct labor		$	7.00
Variable manufacturing overhead		$	1.70
Variable selling and administrative		$	6.80

Required:

1. Complete the following:

a. Compute the unit product cost under absorption costing.

b. What is the company’s absorption costing net operating income (loss) for the quarter?

c. Reconcile the variable and absorption costing net operating income (loss) figures.

3. During the second quarter of operations, the company again produced 31,400 units but sold 34,400 units. (Assume no change in total fixed costs.)

a. What is the company’s variable costing net operating income (loss) for the second quarter?

b. What is the company’s absorption costing net operating income (loss) for the second quarter?

c. Reconcile the variable costing and absorption costing net operating incomes for the second quarter.

	Tami’s Creations, Inc. Variable Costing Income Statement Sales $1,376,000 Variable expenses: Variable cost of goods sold 488,480 Variable selling and administrative 292,400 780,880 Contribution margin 595,120 Fixed expenses: Fixed manufacturing overhead 251,200 Fixed selling and administrative 252,120 503,320 Net operating income (loss) $91,800

Answer 1

1. a.

Under absorption costing the unit product cost include, all the cost associated with the production, including direct materials, direct labor, variable and fixed manufacturing overhead.

Fixed manufacturing overhead per unit = Total Fixed manufacturing overhead / Units produced = $251,200 / 31,400 = $8 per unit

b. Company’s absorption costing net operating income (loss) for the quarter was $12,000.

Units produced = 31,400

Units sold = 28,400

Ending inventory = Units produced - Units sold = 31,400 - 28,400 = 3,000

Unit product cost = $23.90 per unit

Cost of goods sold = Units sold × Unit product cost = 28,400 × $23.90 = $678,760

Variable selling and administrative overhead = Units sold × Variable selling and administrative overhead per unit = 28,400 × $6.80 = $193,120

Selling and administrative expenses = Variable + Fixed = $193,120 + $252,120 = $445,240

c.

Fixed manufacturing overhead deferred in ending inventory = Ending inventory × Fixed manufacturing overhead per unit = 3,000 × $8 = $24,000

Under variable costing, the full amount of fixed manufacturing overhead is charged and expensed as a period cost during the year. But in absorption costing, the fixed manufacturing overhead per unit is charged as a product cost and expensed as cost of goods sold. Therefore, the fixed manufacturing cost of unsold goods is deferred in ending inventory. Therefore, net operating income under absorption is higher than the net operating income under variable costing.

3.

a. Net operating income under variable costing for the second quarter was $91,800 (Given)

b. Net operating income under absorption costing for the second quarter was $67,800

Units produced = 31,400

Units sold = 34,400

Sales = 34,400 × $40 = $1,376,000

Cost of goods sold = Units sold × Unit product cost = 34,400 × $23.90 = $822,160

Variable selling and administrative overhead = Units sold × Variable selling and administrative overhead per unit = 34,400 × $6.80 = $233,920

Selling and administrative expenses = Variable + Fixed = $233,920 + $252,120 = $486,040

c.

Here, the goods sold during the year is more than the goods produced. Therefore, the cost of fixed manufacturing overhead deferred in ending inventory is adjusted in the second quarter net operating income under absorption costing. Therefore, net operating income under absorption is lower than the net operating income under variable costing.