Question

Problem 19-1A Variable costing income statement and conversion to absorption costing income (two consecutive years) LO P2, P3

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Dowell Company produces a single product. Its income statements under absorption costing for its first two years of operation follow.

		2016			2017
Sales ($46 per unit)	$	966,000		$	1,886,000
Cost of goods sold ($31 per unit)		651,000			1,271,000
Gross margin		315,000			615,000
Selling and administrative expenses		287,000			327,000
Net income	$	28,000		$	288,000

Additional Information

Sales and production data for these first two years follow.

	2016		2017
Units produced	31,000		31,000
Units sold	21,000		41,000

Variable cost per unit and total fixed costs are unchanged during 2016 and 2017. The company's $31 per unit product cost consists of the following.

Direct materials	$	5
Direct labor		9
Variable overhead		7
Fixed overhead ($310,000/31,000 units)		10
Total product cost per unit	$	31

Selling and administrative expenses consist of the following.

		2016			2017
Variable selling and administrative expenses ($2 per unit)	$	42,000		$	82,000
Fixed selling and administrative expenses		245,000			245,000
Total selling and administrative expenses	$	287,000		$	327,000

Problem 19-1A Part 1

1. Complete income statements for the company for each of its first two years under variable costing. (Loss amounts should be entered with a minus sign.)

	DOWELL Company Variable Costing Income Statements 2016 2017 Net income (loss)

2. What are the differences between the absorption costing income and the variable costing income for these two years? (Loss amounts should be entered with a minus sign.)

	DOWELL COMPANY Reconciliation of Variable Costing Income to Absorption Costing Income 2016 2017 Variable costing income (loss) Absorption costing income (loss)

Answer 1

The main difference between absorption costing and variable costing is that the absorption costing treats fixed production cost as the product cost whereas variable costing considers fixed cost as the period cost.

As per the variable costing, profit will be calculated as follows:

Sales – Variable cost = Contribution.

Contribution – Fixed cost = Profit.

So, now we need to identify separately the variable and fixed costs.

Variable Costs:

Direct material = $5

Direct Labor = $9

Variable overhead = $7

Don’t include the fixed overhead here as this will be considered as period cost and will be deducted entirely i.e. $310000 will be deducted from contribution to calculate profit.

Variable product cost per unit = 5+9+7 = $21.

Now let’s analyze the selling and administrative expenses:

It is given that $2 per unit is the variable selling and administrative expenses.

Therefore, Variable Selling and administrative expenses per unit = $2.

Fixed production overhead = $310000

Fixed Selling and administrative expenses = $245000.

DOWELL Company
Variable Costing Income Statements
	2016	2017
Number of Units sold	21000	41000
Sales (1)	966000	1886000
Less: Varaible Costs
Variable Product @ $21 : 21000*21, 41000*21	441000	861000
Variable Selling and admin exp @ $2 : 21000*2, 41000*2	42000	82000
Total Variable cost (2)	483000	943000
Contribution (3) = (1)-(2)	483000	943000
Less: Fixed Costs
Fixed production overhead	310000	310000
Fixed Selling and administrative expenses	245000	245000
Total Fixed costs (4)	555000	555000
Profit (5) = (3)-(4)	-72000	388000

1. The differences between the absorption costing income and the variable costing income for these two years is because of the treatment of fixed production cost.

For 2016:

Production units are 31000 units.

Sold units are 21000 units.

In absorption costing, as it treats fixed production cost as product cost, it recovered $10 per unit sold.

I.e. 21000*10 = $210000.

Whereas, absorption costing recovers entire amount of fixed production overhead $310000.

The difference is 310000 – 210000 = $100000.

This means, $100000 is under absorbed in absorption costing.

For 2017:

As the no of units sold is 41000 which is higher than the units produced 31000 in 2017, there will over absorption in absorption costing.

Fixed overhead absorbed as per absorption costing in 2017 is 41000*10 = $410000.

But, Variable costing considers $310000 as it treats fixed production overhead as the period cost.

This means, $100000 is over absorbed in absorption costing.

Now, if we add the under absorption to and deduct the over absorption from Variable costing income, we can arrive to the Absorption costing income.

DOWELL COMPANY
Reconciliation of Variable Costing Income to Absorption Costing Income
	2016	2017
Variable costing income (loss)	-72000	388000
Add Underabsorption in absorption costing	100000
Less Overabsorption in absorption costing		(100000)
Absorption costing income (loss)	28000	288000