Question

Brady Products Manufacturers, which has only one product, has provided the following data concerning its first month of operations: Selling price $120.00 Units produced 4,000 units Units sold 3,600 units Units in ending inventory 400 units Variable manufacturing costs $90.00 Variable selling and administrative costs $8.00 per unit sold Fixed manufacturing overhead costs $56,000 Fixed selling and administrative costs $21,600 The company produces the same number of units every month, although the sales in units vary from month to month. The company’s variable costs per unit and total fixed costs are expected to be constant from month to month. Required: (a) Calculate the operating income for the month under variable costing (b) Prepare an income statement for the month using the absorption costing format and the absorption costing method. (c) Explain the difference between the income reported by variable and absorption costing. (

Answer 1

a)
Income Statement under Variable Costing
Sales	= 3600 * $ 120	432000
Less: Variable Cost of Goods sold
Opening Inventory	0
Add : Cost of goods manufactured Jan (4000 * $ 90)	360000
Cost of goods available for Sale	360000
Less : Closing Inventory (400 * $ 90)	36000	324000
Gross Contribution Margin		108000
Less : Variable Selling and Administrative cost (3600 * $8)		28800
Contribution Margin		79200
Less : Fixed Cost
Manufacturing Overheads	56000
Selling and Administrative Expenses	21600	77600
Net Operating Income		1600
b)
Income Statement under Absorption Costing
	January
Sales	= 3600 * $ 120	432000
Less : Cost of Goods Sold
Opening Inventory	0
Add : Cost of goods manufactured Jan (4000 * $ 104)	416000
Cost of goods available for Sale	416000
Less : Closing Inventory (400 * $ 104)	41600	374400
Gross Profit		57600
Less : Variable Selling and Administrative cost (3600 * $8)		28800
Less : Fixed Selling and administrative expenses		21600
Net Operating Income		7200
c)
The net operating income under absorption costing is $ 5600 more than the net operating income under variable costing . When production is more than sales, the fixed manufacturing overhead is deferred in inventory that causes a higher net operating income under absorption costing than under variable costing.                                                                                 The reconciliation of net operating income is given below:
Net Operating Income Under absorption costing	$	7200
Net Operating Income Under variable costing		1600
Difference in Net Operating Income	$	5600
Change in Inventory		400	units
Fixed Manufacturing OH deferred in inventory = 400 units * 14 per unit	$	5600