Question

Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goods sold.

Saxon, Inc.

Absorption Costing Income Statement

For the Year Ended December 31

1	Sales		$1,200,000.00
2	Cost of goods sold:
3	Beginning inventory	$0.00
4	Cost of goods manufactured	800,000.00
5	Ending inventory	(160,000.00)
6	Total cost of goods sold		640,000.00
7	Gross profit		$560,000.00
8	Selling and administrative expenses		289,000.00
9	Income from operations		$271,000.00

Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statement includes a computation of manufacturing margin.

Saxon, Inc.

Variable Costing Income Statement

For the Year Ended December 31

1	Sales		$1,200,000.00
2	Variable cost of goods sold:
3	Beginning inventory	$0.00
4	Variable cost of goods manufactured	560,000.00
5	Ending inventory	(112,000.00)
6	Total variable cost of goods sold		448,000.00
7	Manufacturing margin		$752,000.00
8	Variable selling and administrative expenses		224,000.00
9	Contribution margin		$528,000.00
10	Fixed costs:
11	Fixed manufacturing costs	$240,000.00
12	Fixed selling and administrative expenses	65,000.00
13	Total fixed costs		305,000.00
14	Income from operations		$223,000.00

Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing income from operations, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.

All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.

The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement panel and the Variable Statement panel, he notices that the income from operations is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the company’s capacity for manufacturing, in the coming year. He reasons that this will boost income from operations and satisfy the company’s owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow. If the answer is zero, enter "0".

1. Use the income statements on the Absorption Statement and Variable Statement panels to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.

Income From Operations
Original	Original	Additional	Additional
Production	Production	10,000	10,000
Level-Absorption	Level-Variable	Units-Absorption	Units-Variable

2.What is the change in income from operations from producing 10,000 additional units under absorption costing?

3. What is the change in income from operations from producing 10,000 additional units under variable costing?

Answer 1