Question

Sells price per unit=$200

variable manufacturing costs per unit= $50

variable S&A costs per unit= $10

Fixed MOH= $50,000

Fixed S&A costs=$10,000

Units produced=5000

Units sold= 4000

Produce a full absorption income statement, what is the operating income

produce a variable costing income statement, what is the operating income

if units produced exceeds untis sold, does full absorption accounting or varible cost account result in a higher operating income

Answer 1

Analysis of question

Selling price per unit $200

Variable manufacturing costs per unit $50

Variable selling and administration cost per unit $10

Fixed manufacturing overhead $50,000

Fixed selling and administration costs = $ 10,000

Units produced 5000 units

Units sold 4000 units

Question 1: Produce a full absorption costing income statement, what is the operating income?

Question 2: Produce a variable costing income statement, what is the operating income?

Question 3: if units produced exceeds units sold, does full absorption accounting or variable cost accounting result in higher operating income?

Answers

Question 1: Produce a full absorption costing income statement, what is the operating income?

Step 1: Calculate cost per unit of the product under absorption costing. The cost per unit includes direct materials per unit, direct labour per unit, variable manufacturing overheads per unit and fixed manufacturing overhead per unit.

Calculation of cost per unit (Absorption Costing)
Direct material	-
Direct labour	-
Variable manufacturing overhead per unit	50
Fixed manufacturing overhead per unit($50,000/5000 units)	10
Cost per unit	60

Step 2: Prepare income statement under Absorption costing

Income statement (Absorption Costing)
Sales (4000 units x $200)		800,000
Less: Cost of Goods sold
Opening inventory	Nil
Add: Cost of goods manufactured(5000 units x $60)	300,000
	300,000
Less: Closing Inventory(1000 units x $60)	60,000	240,000
Gross Profit		560,000
Less: Sales and administration expenses
Variable selling and administration overheads(4000 units x $10)	40,000
Fixed selling and administration overheads	10,000	50,000
Net Operating Income		510,000

Question 2: Produce a variable costing income statement, what is the operating income?

Step 1: Calculate cost per unit of the product under variable costing. The cost per unit includes direct materials per unit, direct labour per unit, variable manufacturing overheads per unit and excludes all fixed costs.

Calculation of cost per unit (Variable Costing)
Direct material	Nil
Direct labour	Nil
Variable manufacturing costs per unit	50
Cost per unit	50

Income statement (Variable Costing)
Sales (4000 units x $200)		800,000
Less: Cost of Goods sold
Opening inventory	Nil
Add: Variable Cost of goods manufactured(5000 units x $50)	250,000
	250,000
Less: Closing Inventory(1000 units x $50)	50,000	200,000
Gross Contribution Margin		600,000
Less: Variable Selling and Administration overheads (4000 units x $10)		40,000
Contribution Margin		560,000
Less: Fixed Expenses
Fixed manufacturing overheads	50,000
Fixed selling and administration overheads	10,000	60,000
Net Operating Income		500,000

Question 3: if units produced exceeds units sold, does full absorption accounting or variable cost accounting result in higher operating income?

Yes. If units produced(5000 units) exceeds units sold(4000 units), full absorption costing results in higher operating income, that is $510,000 ($10,000 more than that of Variable costing)

Explanation:

1. The single difference between Absorption costing and variable costing is, in absorption costing fixed manufacturing overhead is absorbed to units produced.
2. The value of opening inventory, cost of goods manufactured and value of closing inventory are calculated based on the cost per unit which includes fixed manufacturing overhead also.
3. Due to this reason, cost per unit in absorption costing is higher($60) than it is in variable costing
4. This increases the value of closing inventory while calculating cost of goods sold. So the some portion of fixed overhead absorbed on closing inventory is subtracted to calculate cost of goods sold. So the cost of goods sold becomes less in Absorption Costing($240,000) and Operating income goes higher ($510,000)
5. But in variable costing, only the variable costs include in cost per unit. Cost per unit becomes less in variable costing. While calculating cost of goods sold, only variable cost per unit is taken into consideration ($50).
6. Because of this reason, only variable cost of closing inventory(1000 units x $50= 50,000) is subtracted to calculate cost of goods sold in Variable costing method.
7. Fixed costs are not absorbed by units produced but the total fixed manufacturing costs are subtracted to calculate operating income. This leads to subtraction of $10,000 more in variable costing method.
8. The total variable and fixed manufacturing costs subtracted in absorption costing is $240,000.
9. But the total variable and fixed manufacturing costs subtracted in variable costing is $250,000 (cost of goods sold $200,000 + fixed manufacturing costs $50,000)
10. This leads to high operating income in absorption costing.
11. This difference happens only when units produced exceeds units sold.
12. Because fixed manufacturing costs absorbed to production gets subtracted for the number of units at the closing inventory.