Question

Income Statements under Absorption and Variable Costing

Shawnee Motors Inc. assembles and sells MP3 players. The company began operations on August 1 and operated at 100% of capacity during the first month. The following data summarize the results for August:

Sales (20,000 units)				$3,200,000
Production costs (26,000 units):
Direct materials		$1,539,200
Direct labor		738,400
Variable factory overhead		369,200
Fixed factory overhead		247,000		2,893,800
Selling and administrative expenses:
Variable selling and administrative expenses		$448,500
Fixed selling and administrative expenses		173,600		622,100

If required, round interim per-unit calculations to the nearest cent.

a. Prepare an income statement according to the absorption costing concept.

Shawnee Motors Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales	$
Cost of goods sold
Gross profit	$
Selling and administrative expenses
Income from operations	$

b. Prepare an income statement according to the variable costing concept.

Shawnee Motors Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		$
Variable cost of goods sold
Manufacturing margin		$
Variable selling and administrative expenses
Contribution margin		$
Fixed costs:
Fixed factory overhead	$
Fixed selling and administrative expenses
Income from operations
		$

c. What is the reason for the difference in the amount of income from operations reported in (a) and (b)?

Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under variable costing , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the income statement will have a higher income from operations than will the variable costing income statement.

Answer 1

a
Shawnee Motors Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales	3200000
Cost of goods sold	2226000		=2893800/26000*20000
Gross profit	974000
Selling and administrative expenses	622100
Income from operations	351900
b
Shawnee Motors Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		3200000
Variable cost of goods sold		2036000	=(2893800-247000)/26000*20000
Manufacturing margin		1164000
Variable selling and administrative expenses		448500
Contribution margin		715500
Fixed costs:
Fixed factory overhead	247000
Fixed selling and administrative expenses	173600	420600
Income from operations		294900
c
Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues.
Under variable costing , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change.
Thus, when inventory increases, the absorption costing income statement will have a higher income from operations than will the variable costing income statement.