Question

Income Statements under Absorption Costing and Variable Costing

Fresno Industries Inc. manufactures and sells high-quality camping tents. The company began operations on January 1 and operated at 100% of capacity (46,200 units) during the first month, creating an ending inventory of 4,200 units. During February, the company produced 42,000 units during the month but sold 46,200 units at $100 per unit. The February manufacturing costs and selling and administrative expenses were as follows:

	Number of Units		Unit Cost		Total Cost
Manufacturing costs in February 1 beginning inventory:
Variable	4,200		$40.00		$168,000
Fixed	4,200		15.00		63,000
Total			$55.00		$231,000
Manufacturing costs in February:
Variable	42,000		$40.00		$1,680,000
Fixed	42,000		16.50		693,000
Total			$56.50		$2,373,000
Selling and administrative expenses in February:
Variable	46,200		$19.50		$900,900
Fixed	46,200		7.00		323,400
Total			$26.50		$1,224,300

a. Prepare an income statement according to the absorption costing concept for the month ending February 28.

Fresno Industries Inc.
Absorption Costing Income Statement
For the Month Ended February 28
		$
Cost of goods sold:
	$
		$
		$

b. Prepare an income statement according to the variable costing concept for the month ending February 28.

Fresno Industries Inc.
Variable Costing Income Statement
For the Month Ended February 28
		$
		$
		$
Fixed costs:
	$
		$

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

Under the   method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under  , 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 decreases, the   income statement will have a lower operating income.

Answer 1

(a)	Absorption costing-Income Statement
		Amount in $
	Sales	4,620,000	(46,200 x 100 )
	Cost of Goods Sold:	2,604,000	(46,200 x 40) + ( 4,200 x 15) + ( 42,000 x 16.50 )
	Gross Margin	2,016,000
	Selling and administrative expenses	1,224,300	(900,900 + 323,400 )
	Net Operating Income	791,700
(b)	Variable Costing-Income Statement
		Amount in $
	Sales	4,620,000	(46,200 x 100 )
	Variable expenses:
	Variable cost of goods sold	1,848,000	( 46,200 x 40 )
	Variable selling & administrative expenses	900,900
	Contribution Margin	1,871,100
	Fixed expenses:
	Fixed Manufacturing Overheads	693,000
	Fixed Selling and administrative expenses	323,400
	Net Operating Income	854,700

( C ) Under the Absorption Costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under Variable Costing method, 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 decreases, the Absorption costing method income statement will have a lower operating income.