Question

Patsy’s Pillows produces and sells a decorative pillow for $50 per unit. In its first month of operation, the company produced 5,000 pillows and sold 3,000 pillows. There were no beginning inventories. Cost information for the month was as follows:

Variable Manufacturing Costs = $20/unit produced

Variable Marketing Costs = $10/unit sold

Fixed Manufacturing Costs = $60,000

Fixed Administrative Expense = $15,000

1.What is the value of ending inventory using variable costing?

2.What is the value of ending inventory using absorption costing?

3.What are profits using variable costing? (hint: use contribution I/S)

4.What are profits using absorption costing? (hint: use traditional I/S)

5.How would the answers to (3) and (4) change if the firm instead produced 4,000 units instead of 5,000 units and all other information remains the same?

Answer 1

Solution 1:

Total units manufactured = 5000

Unit sold = 3000

Units in ending inventory = 5000 -3000 = 2000

Value of ending inventory using variable costing = Variable manufacturing cost per unit * Nos of units in ending inventory = 2000 * $20 = $40,000

Solution 2:

Manufacturing cost per unit - Absorption costing
Particulars	Per unit
Variable manufacturing cost	$20.00
Fixed manufacturing cost ($60,000/5000)	$12.00
Manufacturing cost per unit	$32.00

Value of enging inventory using absorption costing = Manufacturing cost per unit * Units in ending inventory

= $32 * 2000 = $64,000

Solution 3:

Contribution format Income statement
Particulars	Amount
Sales revenue	$150,000.00
Variable cost:
Variable manufacturing cost	$60,000.00
Variable markeing cost	$30,000.00
Contribution margin	$60,000.00
Fixed Cost:
Fixed manufacturing cost	$60,000.00
Fixed administrative expense	$15,000.00
Net Operating income	-$15,000.00

Solution 4:

Income statement - Traditional Costing
Particulars	Amount
Sales revenue	$150,000.00
Cost of goods sold	$96,000.00
Gross Margin	$54,000.00
Variable Marketing Cost	$30,000.00
Fixed administrative expense	$15,000.00
Net Operating income	$9,000.00

Solution 5:

Contribution format Income statement
Particulars	Amount
Sales revenue	$150,000.00
Variable cost:
Variable manufacturing cost	$60,000.00
Variable markeing cost	$30,000.00
Contribution margin	$60,000.00
Fixed Cost:
Fixed manufacturing cost	$60,000.00
Fixed administrative expense	$15,000.00
Net Operating income	-$15,000.00

Manufacturing cost per unit - Absorption costing
Particulars	Per unit
Variable manufacturing cost	$20.00
Fixed manufacturing cost ($60,000/4000)	$15.00
Manufacturing cost per unit	$35.00

Income statement - Traditional Costing
Particulars	Amount
Sales revenue	$150,000.00
Cost of goods sold	$105,000.00
Gross Margin	$45,000.00
Variable Marketing Cost	$30,000.00
Fixed administrative expense	$15,000.00
Net Operating income	$0.00

From above, there will be no change in contribution fromat income statement if production level changed from 5000 units to 4000 units, however income will be reduced by $15,000 under traditional income statement approach if production level decreases from 5000 units to 4000 units.