Question

Estimated Income Statements, using Absorption and Variable Costing

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

Sales (16,800 x $58)	$974,400
Manufacturing costs (16,800 units):
Direct materials	588,000
Direct labor	139,440
Variable factory overhead	65,520
Fixed factory overhead	77,280
Fixed selling and administrative expenses	21,000
Variable selling and administrative expenses	25,400

The company is evaluating a proposal to manufacture 18,400 units instead of 16,800 units, thus creating an ending inventory of 1,600 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.

a. 1. Prepare an estimated income statement, comparing operating results if 16,800 and 18,400 units are manufactured in the absorption costing format. If an amount box does not require an entry leave it blank.

Marshall Inc.
Absorption Costing Income Statement
For the Month Ending October 31
	16,800 Units Manufactured	18,400 Units Manufactured
	$	$
	$	$
	$	$
	$	$
	$	$

a. 2. Prepare an estimated income statement, comparing operating results if 16,800 and 18,400 units are manufactured in the variable costing format. If an amount box does not require an entry leave it blank.

Marshall Inc.
Variable Costing Income Statement
For the Month Ending October 31
	16,800 Units Manufactured	18,400 Units Manufactured
	$	$
Variable cost of goods sold:
Variable cost of goods manufactured	$	$
	$	$
	$	$
	$	$
Fixed costs:
	$	$
Total fixed costs	$	$
	$	$

b. What is the reason for the difference in operating income reported for the two levels of production by the absorption costing income statement?

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.

Answer 1

	A1
		16800	18400
	Particulars	Units Manufactured	Units Manufactured		Per Unit Manufactuing Cost
	Sales (16,800 x $58)	974,400	1067200		58
	Manufacturing costs:
	Direct materials	588,000	644000		35
	Direct labor	139,440	152720		8.3
	Variable factory overhead	65,520	71760		3.9
	Fixed factory overhead	77,280	77,280		77,280	Will not change as quantity increases
	Fixed selling and administrative expenses	21,000	21,000		21,000	Will not change as quantity increases
	Variable selling and administrative expenses	25,400	27819.05		1.51
	Income	57,760	72,621
	Overhead recovery rates
	Fixed factory overhead (amount / units produced	5	4.2
	Fixed selling and administrative expenses (amount / units produced	1	1
	A2
		16800	18400
	Particulars	Units Manufactured	Units Manufactured
	Variable cost of goods sold:	792960	792960
	(Note1)
	Variable cost of goods manufactured	792960	868480
	(Note2)
	Fixed costs:
	Fixed Factory Overhead	77280	77280
	Total fixed costs	77280	77280
	Note1
		16800	18400
		Units Manufactured	Units Manufactured
	Variable cost of goods sold:
	Opening Inventory	0	0
Add:	Variable cost of goods manufactured	792960	868480
Less:	Closing Inventory	0	75520 (1600*47.2)
	Total	792960	792960
	Note2
	Variable cost of goods manufactured
	Direct materials	588000	644000
	Direct labor	139440	152720
	Variable factory overhead	65520	71760
	Total	792960	868480
	Per Unit Cost	47.2	47.2
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