Question

Navaroli Company began operations on January 5, 2015. Cost and sales information for its first two calendar years of operations are summarized below.

Manufacturing Costs: Direct materials $80 per unit Direct labor $120 per unit Factory overhead costs: Variable overhead $30 per unit Fixed overhead $14,000,000 Nonmanufacturing costs Variable selling and administrative $10 per unit Fixed selling and administrative $8,000,000 Production and sales data 2015 2016 Units produced 200,000 units 80,000 Units sold 140,000 140,000 Units in ending inventory 60,000 0 Sales price per unit $600 $600

Required

1. Prepare an income statement for the company for 2015 under absorption costing.

2. Prepare an income statement for the company for 2015 under variable costing.

3. Explain the source(s) of the difference in reported income for 2015 under the two costing methods.

4. Prepare an income statement for the company for 2016 under absorption costing.

5. Prepare an income statement for the company for 2016 under variable costing.

6. Prepare a schedule to convert variable costing income to absorption costing income for the years 2015 and 2016.

Answer 1

Answer

1.

Unit (Variable Costing)
Direct Material		80
Direct Labor		120
Variable Manufacturing Overhead		30
Per unit Cost		230
Income Statement (Variable Costing)
	Year 1					Year 2
	Detail			Net		Detail		Net
Sales (@ 600 per unit)				84,000,000				84,000,000
Less: Cost of Goods Sold
Opening Inventory	-					13,800,000
Add: Cost of goods Manufactured	46,000,000					18,400,000
Less: Closing Inventory	(13,800,000) (60,000 Units * $230)			32,200,000				32,200,000
Gross Contribution Margin				51,800,000				51,800,000
Less: Variable Selling and Adm. Expenses				(1,400,000) (140,000 * $10)				1,400,000
Contribution Margin				50,400,000				50,400,000
Less: Fixed Cost
Fixed Manufacturing Cost	14,000,000					14,000,000
Fixed Selling and Adm. Expenses	8,000,000			22,000,000		8,000,000		22,000,000
Net Operating Income				28,400,000				28,400,000

Unit Cost(Absorption Costing)
	Year 1		Year 2
Direct Material	80		80
Direct Labor	120		120
Variable Manufacturing Overhead	30		30
Fixed Manufacturing per unit	70.0 ($14,000,000 / 200,000 Units)		175.0 ($14,000,000 / 80,000 Units)
Per unit Cost	300.0		405.0
Income Statement
	Year 1			Year 2
	Detail	Net		Detail		Net
Sales		84,000,000				84,000,000
Less: Cost of Goods Sold
Opening Inventory	-			18,000,000
Add: Cost of goods Manufactured	60,000,000			30,375,000
Less: Closing Inventory	(18,000,000) (60,000 * $300)	42,000,000		-		30,375,000
Gross Profit		42,000,000				53,625,000
Less: Selling and Administrative Cost
Variable Selling and Adm. Expenses	1,400,000			1,400,000
Fixed Selling and Adm. Expenses	8,000,000	9,400,000		8,000,000		9,400,000
Net Operating Income		32,600,000				44,225,000

3.

The difference between two costing methods in 2015 is due to the cost of Fixed Manufacturing Cost included in the Closing stock while calculating Income Under Variable costing.

As we know that Fixed Manufacturing cost per unit is $70 per unit ($14,000,000 / 200,000 Units) but while calculating profit under Variable costing we didn’t considered this cost while calculating Closing stock so the profit is Under-valued.

6.

Profit under Variable costing in 2015	28,400,000
Fixed Mfg. cost included in Closing Stock ($70 per unit * 60,000 Units)	4,200,000
Profit as per Absorption Costing in 2015	32,600,000

Profit under Variable costing in 2016	28,400,000
Fixed Mfg. cost included in Opening Stock ($70 per unit * 60,000 Units)	(4,200,000)
Profit as per Absorption Costing in 2016	24,200,000