Question

Dance Creations manufactures authentic Hawaiian hula skirts that are purchased for traditional Hawaiian celebrations, costume parties, and other functions. During its first year of business, the company incurred the following costs:

Variable Cost per Hula Skirt
Direct materials	$	9.85
Direct labor		3.65
Variable manufacturing overhead		1.30
Variable selling and administrative expenses		0.70
Fixed Cost per Month
Fixed manufacturing overhead	$	16,125
Fixed selling and administrative expenses		5,200

Dance Creations charges $32 for each skirt that it sells. During the first month of operation, it made 1,600 skirts and sold 1,460.

Required:
1. Assuming Dance Creations uses variable costing, calculate the variable manufacturing cost per unit for last month.
2. Complete a variable costing income statement for the last month.
3. Assuming Dance Creations uses full absorption costing, calculate the full manufacturing cost per unit for the last month.
4. Complete a full absorption costing income statement.
6. Suppose next month Dance Creations expects to produce 1,600 hula skirts and sell 1,700. Without recreating the new income statements, calculate the difference in profit between variable costing and full absorption costing. Which would be higher?

Answer 1

Question 1

Manufacturing Cost per Unit using Variable Costing

Particulars	Amount
Direct Materials Cost per Unit	9.85
Add:Direct Labour Cost per Unit	3.65
Add: Variable Manufacturing Overhead per Unit	1.30
Variable Manufacturing Cost per Unit	14.80

Question 2

Variable Costing Income Statement

Particulars	Amount	Amount
Sales Revenue		46,720
Less: Variable Costs
Variable Manufacturing Cost	21,608
Variable Selling and Administrative Costs	1,022
Total Variable Costs		(22,630)
Less:Fixed Costs		24,090
Fixed Manufacturing Cost	16,125
Fixed Selling and Administrative Costs	5,200
Total Fixed Costs		(21,325)
Net Operating Income / (Loss)		2,765

Notes

Contribution Margin = Sales Revenue - Total Variable Costs

Net Operating Income / (Loss) = Contribution Margin - Total Fixed Costs

Sales Revenue = 1,460 Units Sold * $ 32 per Unit = $ 46,720

Variable Manufacturing Cost = Units Sold * Variable Manufacturing Costs per Unit

= 1,460 * 14.80

= $ 21,608

Variable Selling and Administrative Expenses = 1,460 Units * $ 0.70 per Unit = $ 1,022

Question 3

Particulars	Amount
Direct Materials Cost per Unit	9.85
Add: Direct Labour Cost per Unit	3.65
Add: Variable Overhead Cost per Unit	1.30
Add: Fixed Manufacturing Overhead per Unit	10.08
Manufacturing Cost as per Full Costing	24.88

Fixed Manufacturing Overhead per Unit = Fixed Manufacturing Costs / Units Produced

= 16125 / 1,600 Units

= $ 10.08 per Unit

Question 4

Absorption Costing Income Statement

Particulars	Amount	Amount
Sales Revenue		46,720
Less: Cost of Goods Sold		(36,325)
Gross Profit		10,395
Less: Selling and Administrative Expenses
Variable Selling and Administrative Expenses	1,022
Fixed Selling and Administrative Expenses	5,200
Total Selling and Administrative Expenses		(6,222)
Net Operating Income / (Loss)		4,173

Notes

Cost of Goods Sold = Units Sold * Manufacturing Cost per Unit using Absorption Costing / Full Costing

Cost of Goods Sold = 1,460 Units * $ 24.88 per Unit = $ 36,325

Question 6

Difference in Operating Income between Variable Costing and Absorption Costing Income = 100 Units * Fixed Manufacturing Overhead per Unit

Fixed Manufacturing Overhead per Unit = $ 10.08

Difference in Operating Income = 100 *10.08

Difference in Operating Income = $ 1008

Income will be higher using Variable Costing.

This is because Absorption Costing treats Fixed Manufacturing Overhead as Product Cost and the entire cost gets Allocated upon the whole production and in the case when there are less units Produced and more units sold which means that Allocated cost of previous perio will decrease the profit of current period whereas Variable Costing treats Fixed Manufacturing Overhead as period cost and Expense it entirely in the period of incurrence due to which there is more income in case of more Unit sold even the Production was less.