Question

Adams Company incurred manufacturing overhead cost for the year as follows.

Direct materials	$	38.70	/unit
Direct labor	$	26.10	/unit
Manufacturing overhead
Variable	$	10.90	/unit
Fixed ($20.10/unit for 1,500 units)	$	30,150
Variable selling and administrative expenses	$	7,700
Fixed selling and administrative expenses	$	15,400

The company produced 1,500 units and sold 1,000 of them at $181.00 per unit. Assume that the production manager is paid a 3 percent bonus based on the company’s net income.

Required

1. Prepare an income statement using absorption costing.

2. Prepare an income statement using variable costing.

3. Determine the manager’s bonus using each approach. Which approach would you recommend for internal reporting?

Answer 1

A	Calculation of Product Cost Using Absorbtion Costing
	Direct Material	38.7
	Direct Labour	26.1
	Manufacturing OH (Variable)	10.9
	Fixed Manufacturing OH (Per Unit)	20.1	(Fixed Manufacturing OH / Units Produced)
	Total Product Cost	95.8
B	Income statement under absorption costing
	Sales	181000
	Less: Cost of Goods Sold	95800
	(1000*95.8)
	Gross profit Margin	85200
	Less:
	Selling and Administrative Expense(Variable)	7700
	Selling and Administrative Expense(Fixed)	15400
	Net Income	62100
a)	Calculation of Product Cost Using Variable Costing
	Direct Material	38.7
	Direct Labour	26.1
	Manufacturing OH (Variable)	10.9
	Total Product Cost	75.7
b)	Income statement under variable costing
	Sales	181000
	Less: Variable Cost
	Direct Material	38700
	Direct Labour	26100
	Manufacturing OH (Variable)	10900
	Gross profit Margin	105300
	Less:
	Selling and Administrative Expense(Variable)	7700
	Contribution Margin	97600
	Less: Fixed Expenses
	Fixed Manufacturing OH	30150
	Selling and Administrative Expense(Fixed)	15400
	Net Income	52050
		Absorption income	Variable income
C)	Net Income	62100	52050
	Bonus o manage r@ 3%	1863	1561.5
	We would prefer Absorption costing for internal reposting because it gives the most precise result regarding cost of goods sold and net income.