Question

The Zwatch Company manufactures trendy, high quality, moderately pricedwatches.
As Zwatch’s senior financial analyst, you are asked to recommend a methodof inventory costing.
The CFO will use your recommendation to prepare Zwatch’s 2019 income statement.
The following data are for the year ended December 31, 2019:

Beginning inventory, January 1, 2019 100,000 units
Ending inventory, December 31, 2019 50,000 units
2019 sales 400,000 units
Selling price (to distributor) $25 per unit
Variable manufacturing cost per unit, including direct materials $6 per unit
Variable operating (marketing) cost per unit sold $2 per unit sold
Fixed manufacturing costs $1,625,000
Denominator-level machine-hours 6,500
Standard production rate 50 units per machine-hour
Fixed operating (marketing) costs $1,100,000
Assume standard costs per unit are the same for units in beginning inventory and unitsproduced during the year.
Also, assume no price, spending, or efficiency variances. Anyproduction-volume variance is written off to cost of goods sold in the month in which itoccurs.

1. Prepare income statements under variable and absorption costing forthe year ended December 31, 2019.
2. What is Zwatch’s operating income as percentage of revenues under eachcosting method?
3. Explain the difference in operating income between the two methods.
4. Which costing method would you recommend to the CFO? Why?

Answer 1

ans 1
Income Statement-Absoption costing
For the Year ended Dec 31 2019
Sales (40000*25)		$1,00,00,000
Less: Cost of good sold		$42,75,000
Gross profit		$57,25,000
Selling and adminitrative expenses
Variable operating (marketing	800000
Fixed operating (marketing	1100000	$19,00,000
Net Operating Income		$38,25,000
working
No. of units produced
400000+50000-100000	350000
Fixed overhead rate per unit
1625000/6500 hours	250	per hour
250/50	5	per unit
Production volume variance
Budgted-applied fixed overhead	125000	F
((6500*50)-350000)*5	-125000
cost of good sold
Variable (400000*6)	2400000
Fixed 400000*5	2000000
Less: production volume variance	-125000
cost of good sold	4275000
Income Statement-VAriable costing
For the Year ended Dec 31 2019
Sales (40000*25)		$1,00,00,000
Less: Variable Cost of good sold (400000*6)	2400000
Variable operating (marketing	800000
Total variable expenses		$32,00,000
Contribution margin		$68,00,000
Less: Fixed expenses
Fixed Manufactuirng overhead	1625000
Fixed operating (marketing	1100000
Total fixed expenses		$27,25,000
Net Operating Income		$40,75,000
ans 2	Variable	Absorption
Operating revenue O	$40,75,000	$38,25,000
Sales S	$1,00,00,000	$1,00,00,000
Operating revenue % O/S*100	40.75	38.25	%
ans 3
Variable costing operating income	$40,75,000
Absorption costing opearting income	$38,25,000
Difference	$2,50,000
Difference is due to fixed manufactuirng overhedad deferred in ending inventory
50000*5	250000
ans 4
The more accurate results are provided by absoption costing as it takes fxed manufacturing overhead
in the cost of good sold. It includes all the cost which is specific for the period
If any doubt please comment