Question

Ida Sidha Karya Company is a family-owned company located in the village of Gianyar on the island of Bali in Indonesia. The company produces a handcrafted Balinese musical instrument called a gamelan that is similar to a xylophone. The gamelans are sold for $860. Selected data for the company’s operations last year follow:

Units in beginning inventory		0
Units produced		320
Units sold		285
Units in ending inventory		35
Variable costs per unit:
Direct materials	$	135
Direct labor	$	355
Variable manufacturing overhead	$	30
Variable selling and administrative	$	15
Fixed costs:
Fixed manufacturing overhead	$	64,000
Fixed selling and administrative	$	27,000

The absorption costing income statement prepared by the company’s accountant for last year appears below:

Sales	$	245,100
Cost of goods sold		205,200
Gross margin		39,900
Selling and administrative expense		31,275
Net operating income	$	8,625

Required:

1. Determine how much of the ending inventory consists of fixed manufacturing overhead cost deferred in inventory to the next period.

2. Prepare an income statement for the year using variable costing.

Answer 1

1) In absorption costing, Fixed manufacturing overhead costs are considered as product costs and included in the value of ending inventory. The amount of fixed manufacturing overhead cost deferred in inventory to the next period is calculated as follows:-

Fixed manufacturing overhead costs = $64,000

units in ending inventory = 35 units

Total units produced = 320 units

Fixed manufacturing overhead cost per unit = Fixed manufacturing overhead costs/units produced

= $64,000/320 units = $200 per unit

Ending inventory in units = 35 units

Fixed manufacturing overhead cost deferred to inventory in next period =

= Ending inventory in units*Fixed manufacturing overhead cost per unit

= 35 units*$200 per unit = $7,000

2) Income statement using variable costing (Amt. in $)

Sales (A)		245,100
Variable expenses:
Direct materials (285 units*$135 per unit)	38,475
Direct Labor (285 units*$355 per unit)	101,175
Variable manufacturing overhead  (285 units*$30 per unit)	8,550
Variable selling and administrative (285 units*$15 per unit)	4,275
Total Variable expenses (B)		152,475
Contribution Margin (C = A-B)		92,625
Fixed Expenses:
Fixed manufacturing overhead	64,000
Fixed selling and administrative	27,000
Total Fixed Expenses (D)		91,000
Net Operating Income (C - D)		1,625

In variable costing income statement , Fixed costs are considered as period cost and not included in the cost of inventory.

The difference in net operating income under absorption costing and variable costing is the amount of fixed manufacturing overhead that is deferred in the inventory to next period.

Operating income using absorption costing = $8,625

Operating Income using variable costing = $1,625

Difference = $8,625 - $1,625 = $7,000 = Deferred to next period in inventory