Question

Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 26,800 hats, of which 25,500 were sold. Operating data for the month are summarized as follows:

Sales			$183,600
Manufacturing costs:
Direct materials	$109,880
Direct labor	29,480
Variable manufacturing cost	13,400
Fixed manufacturing cost	10,720		163,480
Selling and administrative expenses:
Variable	$10,200
Fixed	7,450		17,650

During August, Head Gear Inc. manufactured 24,200 designer hats and sold 25,500 hats. Operating data for August are summarized as follows:

Sales			$183,600
Manufacturing costs:
Direct materials	$99,220
Direct labor	26,620
Variable manufacturing cost	12,100
Fixed manufacturing cost	10,720		148,660
Selling and administrative expenses:
Variable	$10,200
Fixed	7,450		17,650

Required:

1a. Prepare an income statement for July using the absorption costing concept. Enter all amounts as positive numbers.

Head Gear Inc.
Absorption Costing Income Statement
For the Month Ended July 31
		$
Cost of goods sold:
	$
		$
		$

1b. Prepare an income statement for August using the absorption costing concept. Enter all amounts as positive numbers.

Head Gear Inc.
Absorption Costing Income Statement
For the Month Ended August 31
		$
Cost of goods sold:
	$
		$
		$

2a. Prepare an income statement for July using the variable costing concept. Enter all amounts as positive numbers.

Head Gear Inc.
Variable Costing Income Statement
For the Month Ended July 31
		$
Variable cost of goods sold:
	$
		$
		$
Fixed costs:
	$
		$

2b. Prepare an income statement for August using the variable costing concept. Enter all amounts as positive numbers.

Head Gear Inc.
Variable Costing Income Statement
For the Month Ended August 31
		$
Variable cost of goods sold:
	$
		$
		$
Fixed costs:
	$
		$

3a. For July, income from operations reported under   costing is less than   costing due to part of   manufacturing costs that are expensed.

3b. When large changes in inventory levels occur from one period to the next, it is possible for management to misinterpret such increases (or decreases) in income from operations as due to changes in:

costs.

prices.

sales volume.

"sales volume", "prices" and "costs" are correct.

None of these choices is correct.

The correct answer is:

4. Based on your answers to (1) and (2), did Head Gear Inc. operate more profitably in July or in August? Explain.

Head Gear Inc. was   under the variable costing concept. The difference in income reported under the absorption costing concept is due to allocating   to the  .

Answer 1

		31-Jul
	Per unit cost	Sales		$183,600	7.20
		Manufacturing costs:
	4.10	Direct materials	$109,880
	1.10	Direct labor	29,480
5.70	0.50	Variable manufacturing cost	13,400
6.10	0.40	Fixed manufacturing cost	10,720	163,480
		Selling and administrative expenses:
	0.40	Variable	$10,200
		Fixed	7,450	17,650
		Income statement for July (based on absorption costing concept)
		Head Gear Inc
		Absorption costing Income statement
		For the month ended July 31
		Sales		183600
		25500*7.20
		Less : Cost of Goods Sold		-155550	155550
		(26800-1300)*6.10)
		Gross Profit		28050
		Less :
		Selling and administrative Expenses
		Variable	10200
		Fixed	7450	-17650
		Net operating Income		10400
		Head Gear Inc
		Variable costing Income statement
		For the month ended July 31
		Sales
		25500*7.20		183600
		Less : Cost of Goods sold
		(26800-1300)*5.70		-145350
		Gross contribution margin		38250
		Less : Variable marketing and admin expense		-10200
		Contribution margin		28050
		Less: Fixed expense
		Fixed manufacturing overhead expense	10720
		Fixed marketing and administrative expense	7450	-18170
		Net Operating Income		9880
		Sales		$183,600	25500	$7.20
		Manufacturing costs:
		Direct materials	$99,220		24200	$4.10
		Direct labor	26,620		24200	1.1
		Variable manufacturing cost	12,100		24200	0.5	$5.70
		Fixed manufacturing cost	10,720	148,660	24200	0.44	$6.14
		Selling and administrative expenses:
		Variable	$10,200
		Fixed	7,450	17,650
		Opening	1300
		Produce	24200
		Less : Sold	-25500
			0
		Head Gear Inc.
		Absorption Costing Income Statement
		For the Month Ended August 31
		Sales		183600
		Less: Cost of goods sold
		Opening stock + Purchase = (25500*6.14)		-156570
		Gross Profit		27030
		Less :
		Selling and administrative Expenses
		Variable	10200
		Fixed	7450	-17650
		Net Operating Income		9380
		Head Gear Inc.
		Variable Costing Income Statement
		For the Month Ended August 31
		Sales		183600
		Less: Cost of goods sold
		Opening stock + Purchase = (25500*5.70)		-145350
		Gross Contribution Margin		38250
		Less : Variable selling and administrative expenses		-10200
		Contribution Margin		28050
		Less : Fixed expense
		Fixed manufacturing overhead expense	10720
		Fixed marketing and administrative expense	7450	-18170
		Net Operating Income		9880

3a.For July, income from operations reported under variable costing is less than absorption costing due to part of   manufacturing costs that are expensed.

4.Head Gear Inc operate more profitably in July where under absorption costing the profit is $10400.

Head Gear Inc. was $9880 under the variable costing concept. The difference in income reported under the absorption costing concept is due to allocating to the fixed manufacturing costs.