Question

ABC Company sells 18,000 units of a product at $50 per unit. This is the first year of operations so there is no beginning inventory of finished units. The following information is available:

   Units produced                   20,000

   Raw material costs per unit          $10.00

   Direct labor cost per unit             $4.00

   Variable overhead per unit             $6.00

   Fixed overhead total costs       $50,000

   Fixed overhead costs per unit              $2.50

   Variable selling expense per unit sold          $2.00

   Fixed selling expenses           $40,000

Required:

Calculate operating income under absorption costing – show work.

Calculate operating income under variable costing – show work.

Explain why the difference in incomes exist.

Answer 1

Variable-costing income statements
Sales	$900,000	(18,000 x $50)
Variable expenses:
Material	$180,000	(18,000 x $10)
Labour	$72,000	(18,000 x $4)
Variable factory overhead	$108,000	(18,000 x $6)
Variable selling/marketing expenses	$36,000	(18,000 x $2)
Contribution margin	$504,000
Fixed expenses:
Factory overhead cost	$50,000
Selling/marketing expenses	$40,000
Operating Income	$414,000
Absorption-costing income statements
Sales	$900,000	(18,000 x $50)
Cost of goods sold
Beginning Inventory	$0
variable	$400,000	(20,000 x $20)
Fixed	$50,000
Subtotal	$450,000
Ending Inventory	$45,000	($450,000 x 2,000/20,000)
Total COGS	$405,000
Gross Margin	$495,000
Selling expenses:
Fixed	$40,000
Varaible	$36,000
Operating Income	$419,000
The reason is that the fixed manufacturing overhead cost is not treated the same way under two costing methods.
Net income under variable costing arises because in absorption costing fixed manufacturing overheads are included
in the cost of inventories and subtracted from revenue for the period in which those inventories are sold, while in
variable costing total manufacturing overheads are subtracted in the period in which they are incurred.