Question

1. Xylo produces xylophones. Each xylophone is sold for $850. Selected data for the company’s operations last year follow:

Units in beginning inventory                                    0

Units Produced                                                          250

Units Sold                                                                 225

Units in ending inventory                                         25

Variable Costs per unit:

            Direct materials                                             $100

            Direct labor                                                   $320

            Variable Mfg Overhead                                $40

            Variable Selling & Admin                            $20

Fixed Costs:

            Fixed Mfg Overhead                                     $60,000

            Fixed Selling & Admin                                 $20,000

1. Refer to Xylo above. The absorption costing income statement prepared by the company’s accountant for last year appears below:

Sales                                       $191,250

Cost of Goods Sold                $157,500

Gross Margin                         $33,750

Selling & Admin Expense     $24,500

Net Operating Income                       $9,250

Required:

1. Determine how much of the ending inventory consists of fixed manufacturing overhead cost deferred in inventory to the next period.

2. Prepare an income statement for the year using variable costing. Explain the difference in net operating income between the two costing methods (1-2 sentences is fine…I’m not looking for an essay).

Answer 1

A.

Ending Inventory consists of fixed manufacturing overhead cost deferred in inventory to the next period:

Units in ending inventory = 25

Total Fixed Manufacturing Overhead = $60,000

Per unit cost of Fixed Manufacturing Overhead = 60,000/250 = $240

Ending Inventory consists of fixed manufacturing overhead cost deferred in inventory to the next period = 25*240 = $6,000

B.

Income statement for the year (Variable Costing Method):

Particulars	$
Sales (225*850)	191,250
Less: Variable Manufacturing Cost ((100+320+40) * 225) The variable cost of Goods Sold	103,500
Less: Variable Selling & Admin. expenses (20 * 225)	4,500
Contribution Margin	83,250
Less:
Fixed Manufacturing Overhead	60,000
Fixed Selling & Admin. expenses	20,000
Net Operating Income	3,250

Reconciliation between two methods:

NOI as per Variable costing $3,250

Fixed manufacturing overhead cost deferred in inventory $6,000

NOI as per absorption costing $9,250

Reasons for the difference in net operating income between the two costing methods:

The reason for the difference is fixed manufacturing overhead is treated differently under two methods. Under the variable costing method, fixed manufacturing overhead is considered as period costs, and the entire amount is charged to the income statement in the relevant period. Under absorption costing, fixed manufacturing overhead is treated as product cost, and remained inventory is assigned with a portion of that based on the manufacturing proportion.