Question

Tami Tyler opened Tami’s Creations, Inc., a small manufacturing company, at the beginning of the year. Getting the company through its first quarter of operations placed a considerable strain on Ms. Tyler’s personal finances. The following income statement for the first quarter was prepared by a friend who has just completed a course in managerial accounting at State University.

Tami’s Creations, Inc. Income Statement For the Quarter Ended March 31
Sales (28,450 units)				$	1,138,000
Variable expenses:
Variable cost of goods sold	$	432,440
Variable selling and administrative		199,150			631,590
Contribution margin					506,410
Fixed expenses:
Fixed manufacturing overhead		267,600
Fixed selling and administrative		258,810			526,410
Net operating loss				$	( 20,000)

Ms. Tyler is discouraged over the loss shown for the quarter, particularly because she had planned to use the statement as support for a bank loan. Another friend, a CPA, insists that the company should be using absorption costing rather than variable costing and argues that if absorption costing had been used the company probably would have reported at least some profit for the quarter.

At this point, Ms. Tyler is manufacturing only one product—a swimsuit. Production and cost data relating to the swimsuit for the first quarter follow:

Units produced	33,450
Units sold	28,450
Variable costs per unit:
Direct materials		$	7.20
Direct labor		$	6.00
Variable manufacturing overhead		$	2.00
Variable selling and administrative		$	7.00

1.During the second quarter of operations, the company again produced 33,450 units but sold 38,450 units. (Assume no change in total fixed costs.) What is the company’s absorption costing net operating income (loss) for the second quarter?

2.During the second quarter of operations, the company again produced 33,450 units but sold 38,450 units. (Assume no change in total fixed costs.) Reconcile the variable costing and absorption costing net operating incomes (losses) for the second quarter.

Answer 1

Under absorption costing, the per unit cost of the product includes the fixed manufacturing overhead per unit. But under variable costing fixed manufacturing overhead per unit is not included in the per unit cost. It is included as a period cost. Therefore, the net income under absorption costing and variable costing will vary to the extent of the Fixed manufacturing overhead cost deferred in ending inventory.

• Absorption Costing Per unit cost = $23.20

Fixed manufacturing overhead per unit = Fixed manufacturing overhead ÷ Units produced = $267,600 ÷ 33,450 = $8 per unit

• Variable Costing Per unit cost = $15.20

Ending inventory quarter 1 = Units produced - Units sold = 33,450 - 28,450 = 5,000 units

Fixed manufacturing overhead deferred in ending inventory under absorption costing = Ending inventory quarter 1 × Fixed manufacturing overhead per unit = 5,000 × $8.00 = $40,000.

Selling price per unit = Total sales ÷ Units sold = $ 1,138,000 ÷ 28,450 = $40.00

1. Absorption costing Income statement:

Sales when 38,450 units are sold = Units sold × Selling price per unit = 38,450 × $40.00 = $1,538,000

Cost of goods sold = Units sold × Per unit cost under Absorption Costing = 38,450 × $23.20 = $892,040

Variable selling and administrative expenses = Units sold × Variable selling and administrative expenses per unit = 38,450 × $7.00 = $269,150

Variable costing Income statement:

Variable cost of goods sold = Units sold × Per unit cost under Variable Costing = 38,450 × $15.20 = $584,440

Variable selling and administrative = Units sold × Variable selling and administrative expenses per unit = 38,450 × $7.00 = $269,150

2. Reconciliation of the variable costing and absorption costing net operating incomes (losses) for the second quarter.

The fixed manufacturing overhead deferred in ending inventory of quarter 1 is now released in the beginning inventory of quarter 2.