Question

Prior to the first month of operations ending October 31, Marshall Inc. estimated the following operating results:

1	Sales (28,800 × $80)	$2,304,000.00
2	Manufacturing costs (28,800 units):
3	Direct materials	1,152,000.00
4	Direct labor	259,200.00
5	Variable factory overhead	172,800.00
6	Fixed factory overhead	244,800.00
7	Fixed selling and administrative expenses	29,400.00
8	Variable selling and administrative expenses	34,500.00

The company is evaluating a proposal to manufacture 36,000 units instead of 28,800 units, thus creating an ending inventory of 7,200 units. Manufacturing the additional units will not change sales, unit variable factory overhead costs, total fixed factory overhead cost, or total selling and administrative expenses.

Required:

a.

Prepare an estimated income statement, comparing operating results if 28,800 and 36,000 units are manufactured in (1) the absorption costing format and (2) the variable costing format. Refer to the lists of Labels and Amount Descriptions for the exact wording of the answer choices for text entries. Be sure to complete the statement heading. A colon (:) will automatically appear if required. Round your unit cost to two decimal places and final answers to the nearest dollar amount. Enter all amounts as positive numbers.

b.

What is the reason for the difference in income from operations reported for the two levels of production by the absorption costing income statement?

Answer 1

Answer a.

Absorption Costing:

Cost of Goods Sold = Direct Materials + Direct Labor + Variable Factory Overhead + Fixed Factory Overhead
Cost of Goods Sold = $1,152,000 + $259,200 + $172,800 + $244,800
Cost of Goods Sold = $1,828,800

If 36,000 units are manufactured:

Cost per unit = Cost of Goods Sold / Number of units manufactured
Cost per unit = $1,828,800 / 36,000
Cost per unit = $50.80

Ending Inventory = Cost per unit * Number of units in ending inventory
Ending Inventory = $50.80 * 7,200
Ending Inventory = $365,760

Variable Costing:

Variable Cost of Goods Sold = Direct Materials + Direct Labor + Variable Factory Overhead
Variable Cost of Goods Sold = $1,152,000 + $259,200 + $172,800
Variable Cost of Goods Sold = $1,584,000

If 36,000 units are manufactured:

Variable Cost per unit = Variable Cost of Goods Sold / Number of units manufactured
Variable Cost per unit = $1,584,000 / 36,000
Variable Cost per unit = $44.00

Ending Inventory = Variable Cost per unit * Number of units in ending inventory
Ending Inventory = $44.00 * 7,200
Ending Inventory = $316,800

Answer b.

The increase in income from operations under absorption costing is caused by the allocation of fixed factory overhead cost over a fewer number of units. Thus, the cost of goods sold is less. The difference can also be explained by the amount of fixed factory overhead cost included in the beginning inventory.