Question

APL, Inc. began operations on January 1, 2016. The company does not generally carry Work in

Process Inventories at the end of the year. Variable product costs per unit were the same for 2016,

2017 and 2018 and total $68 per unit. Total Fixed Overhead Costs are $600,000 per year. Variable

Selling and Administrative Costs are $9 for each unit sold. Fixed Selling and Administrative Costs are

$230,000 per year. The Selling Price is $450 per unit for all three years. Production and Sales

figures (in units) for three years are below.

2016

2017

2018

Production (units)

4,000 units

5,000 units

3,000 units

Sales (units)

2,000 units

2,500 units

5,000 units

The company uses the FIFO method to assign cost to any units left in ending Finished Goods

Inventory.

TASKS:

A.

Prepare, in good form (to include a proper heading), two Income Statements for 2017: One

using Absorption Costing and one using Variable Costing. Use the formats that I used in the

class example for Chapter 6. Then, prepare a Reconciliation to explain the difference in the

Net Income figures. Again, use the format that I used in the class example.

B.

Now, assume that the Variable Costing Net Income is $1,035,000 for 2018. Prepare a

Reconciliation Schedule to compute the Absorption Costing Net Income for the same year.

DO NOT PREPARE AN ABSORPTION COSTING INCOME STATEMENT.

Answer 1

The solution of the above question is as under:

A) Income Statement for the Year 2017:
a) Absorption Costing Income Statement
APL Inc
Income Statement (Absorption Costing)
For the year ended December 31,2017
Particulars		Amount($)
Sales(2500 Units * $450)		1125000
Less: Cost of Goods Sold:
Opening Inventory (2000 Units * $188^)	376000
Add: Cost of Goods Produced(5000 Units * $188)	940000
Cost of Goods Available for Sale	1316000
Less: Closing Inventory(4500 Units*$188)	846000	470000
Gross Profit		655000
Less: Selling and Administration Expenses
Variable Selling and Administration Expenses(2500 Units*$9)	22500
Fixed Selling and Administration Expenses	230000	252500
Net Operating Income		402500
^ Manufacturing Expenses per Unit
Variable Expenses + Fixed Manufacturing Overhead Expenses
$68 + ($600000/5000 Units)
$68 + $120
$188
b) Variable Costing Income Statement
APL Inc
Income Statement (Variable Costing)
For the year ended December 31,2017
Particulars		Amount($)
Sales(2500 Units * $450)		1125000
Less: Cost of Goods Sold:
Opening Inventory (2000 Units * $68)	136000
Add: Cost of Goods Produced(5000 Units * $68)	340000
Variable Cost of Goods Available for Sale	476000
Less: Closing Inventory(4500 Units*$68)	306000	170000
Gross Contribution Margin		955000
Less: Variable Selling and Administration Expenses (2500*$9)		22500
Contribution Margin		932500
Less: Period Expenses
Fixed Manufacturing Overheads	600000
Fixed Selling and Administration Expenses	230000	830000
Net Operating Income		102500
Reconciliation to explain the difference between Net Operating Income
Particulars	Amount ($)
Net Operating Income under Absorption Costing	402500
Net Operating Income under Variable Costing	102500
Difference in Net Operating Income	300000
Change in Inventory (Closing - Opening i.e. 4500 Units- 2000 Units)	2500 Units
Fixed Manufacturing Overhead Deferred in Inventory (2500 Units * $ 120)	300000

Note: The net operating income under Absorption Costing is $300000 more than the net operating income under Variable Costing because 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.

B) Reconciliation Schedule to Compute Net Operating Income under Absorption Costing for the Year 2018

Particulars	Amount ($)
Net Operating Income under Variable Costing	1035000
Less: Fixed Manufacturing Overhead Expenses released from Inventory	400000
(2000 Units * $200^^)
Net Operating Income under Absorption Costing	635000

^^Calculation of Fixed Manufacturing Overhead Per Unit

Fixed Manufacturing Overhead Expense (Given): $600000

Units produced in the Year 2018: 3000 Units

Per Units Fixed Manufacturing Overhead: $600000/3000=$200

Note: The net operating income under Absorption Costing is $400000 less than the net operating income under Variable Costing because when production is less than sales, the fixed manufacturing overhead is released from Inventory that causes a lower Net Operating Income under Absorption Costing than under Variable Costing.