Question

Fly Boy Company manufacturers fishing rods with a Variable manufacturing cost of $35. Budgeted (and actual) fixed man. overhead for the most recent year was $400,000. Budgeted(and actual) production was 25,000 units and sales were 20,000 units. Which of following statements was true.

Operating income is higher under absorption by $80000

Operating income is lower under absorption by $80000

Operating income is higher under absorption by $100000

Operating income is Lower under absorption by $100000

Operating income is the same under both variable and absorpton

Answer 1

(A) Variable Manufacturing Overhead	=	$                 35
(B) Budgeted Manufacturing Overhead	=	$      4,00,000
(C) Budgeted Production units	=	25,000
Budgeted Overhead Rate (B/C)	=	16
Actual Production units	=	25,000
Allocated Fixed Overhead	=	Actual Production units X Absorption Rate
	=	25000 * 16
	=	$      4,00,000

Under Absorption Costing,

Product Cost = Direct Material + Direct Labour + Variable Manufacturing Cost + Fixed manufacturing Cost

= 35 + 16 = $ 51 per unit

Under Variable Costing

Product Cost = Direct Material + Direct Labour + Variable Manufacturing Cost

= $ 35 per unit

Hence under variable costing product cost per unit will be $ 16 less than absorption costing.

Now, Increase in Margin under variable costing = 51 - 35 = $ 16 * 20000 (units sold)

= $ 320,000

Less: Fixed overhead = $ 400,000

Hence, Operating Income will be higher in case of absorption costing by $ 80,000 (400,000 - 320000)

therefore Option A is correct.