Question

Question 3

Mr. Livingstone is concerned about the inventories of bottled coconut water the company has been experiencing because of its limited shelf life. He suspects that it is related to bonus packages that the supervisors receive but is uncertain and does not know how to calculate it. The supervisors of Farm Management and the Processing Unit equally share a 2% bonus based on the income of Saddleback Farms every quarter and the company uses the absorption costing approach to financial statement preparation.  He asks for your assistance.

To prepare answers for him, you collect the results of the Coconut water processing activity for the first quarter below.

Budgeted production 108,000 liter

Amount sold   90,000 liters

Selling price                                                                $20 per liter

Variable costs                                                             $12 per liter

Fixed costs                                                                  $216,000

Required:Prepare the income statement under both absorption costing and variable costing to show to Mr. Livingstone the impact of each method on the bonus that the supervisors of the units would earn.  What recommendation (if any) would you make to Mr. Livingstone?

Answer 1

Absorption costing: Absorption costing is one of the methods which is used to calculate the costs which are related to manufacturing costs. The fixed Overheads are treated as the product costs and are deducted as expenses only the fixed costs related to the units sold, while the remaing fixed costs are added to the value of the Closing Inventory.

Variable Costing: Variable Method is another type of method which treats the Fixed Costs as the period costs and the whole fixed costs are deducted as expenses in the income statement.

Given,

Budgeted Production - 108,000 liters

Units Sold - 90,000 liters

Selling Price - $20 per liter

Variable Costs - $12 per liter

Fixed Costs - $216,000

Calculation of Fixed Cost Per Unit Under Absorption Method:

Fixed Cost Per Unit Under Absorption Method = Total Fixed Costs / Budgeted Production

= $216,000 / 108,000

Fixed Cost Per Unit Under Absorption Method = $2

Income Statement Under Absorption and Variable Costing Methods:

Particulars	Absorption Costing	Variable Costing
Sales Revenue	$1,800,000 (90,000 * $20	$1,800,000 (90,000 * $20
Variable Costs	($1,080,000) (90,000 * $12)	($1,080,000) (90,000 * $12)
Contribution Margin (or) Gross Profit	$720,000	$720,000
Fixed Costs	($180,000) (90,000 * $2)	($216,000)
Net Profit	$540,000	$504,000

If Mr. Livingstione uses Absorption Costing the bonus for the supervisors will be $540,000 * 2% = $10,800

If Mr. Livingstione uses Variable Costing the bonus for the supervisors will be $504,000 * 2% = $10,080

By using Variable Costing Method Livingston can save the bonus expense of $720 ($10,800 - $10,080)

So it is recommended to Livingston to use Variable Costing Method to Save the amount of $720.