Question

Income Statements under Absorption and Variable Costing

Shawnee Motors Inc. assembles and sells MP3 players. The company began operations on August 1 and operated at 100% of capacity during the first month. The following data summarize the results for August:

Sales (8,000 units)				$1,120,000
Production costs (10,000 units):
Direct materials		$518,000
Direct labor		249,000
Variable factory overhead		124,000
Fixed factory overhead		83,000		974,000
Selling and administrative expenses:
Variable selling and administrative expenses		$151,000
Fixed selling and administrative expenses		58,400		209,400

If required, round interim per-unit calculations to the nearest cent.

a. Prepare an income statement according to the absorption costing concept.

Shawnee Motors Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales	$
Cost of goods sold
Gross profit	$
Selling and administrative expenses
Income from operations	$

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a. Under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead.

Learning Objective 1.

b. Prepare an income statement according to the variable costing concept.

Shawnee Motors Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		$
Variable cost of goods sold
Manufacturing margin		$
Variable selling and administrative expenses
Contribution margin		$
Fixed costs:
Fixed factory overhead	$
Fixed selling and administrative expenses
Total fixed costs
Income from operations		$

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b. Under variable costing, the cost of goods manufactured includes only variable manufacturing costs.

Learning Objective 1.

c. What is the reason for the difference in the amount of income from operations reported in (a) and (b)?

Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under variable costing , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the absorption costing income statement will have a higher income from operations than will the variable costing income statement.

Answer 1

(a)

Income statement (Absorption costing)

Sales	1,120,000
Production costs:
Direct materials	518,000
Direct labor	249,000
Variable manufacturing overheads	124,000
Fixed manufacturing overheads	83,000
Cost of goods produced	974,000
- Closing stock of finished goods (974,000/10,000) x 2,000	- 194,800
Cost of goods sold	779,200
Gross profit	340,800
- Variable Selling and administrative overheads	-151,000
- Fixed Selling and administrative overheads	- 58,400
Income from operations	131,400

(b)

Income statement (Variable costing)

Sales (A)	1,120,000
Variable Production costs:
Direct materials	518,000
Direct labor	249,000
Variable manufacturing overheads	124,000
Cost of goods produced	891,000
- Closing stock of finished goods (891,000/10,000) x 2,000	- 178,200
Variable cost of goods sold(B)	712,800
Manufacturing margin (A -B)	407,200
- Variable Selling and administrative overheads	- 151,000
Contribution margin	256,200
- Fixed factory overheads	- 83,000
- Fixed Selling and administrative overheads	- 58,400
Income from operations	114,800

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