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 (27,200 x $96) $2,611,200 Manufacturing costs (27,200 units): Direct materials 1,572,160 Direct labor 372,640 Variable factory overhead 174,080 Fixed factory overhead 206,720 Fixed selling and administrative expenses 56,200 Variable selling and administrative expenses 68,000 The company is evaluating a proposal to manufacture 30,400 units instead of 27,200 units, thus creating an ending inventory of 3,200 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 27,200 and 30,400 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 27,200 Units Manufactured 30,400 Units Manufactured Sales $ 2,611,200 $ 2,611,200 Cost of goods sold: Cost of goods manufactured $ 2,325,600 $ 2,449,800 Inventory, October 31 0 Total cost of goods sold $ 2,325,600 $ Gross profit $ 285,600 $ Selling and administrative expenses 124,200 124,200 Operating income $ 161,400 $ Feedback a. 1. Recall that under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead. Calculate unit cost for direct materials, direct labor, variable factory overhead, fixed factory overhead. Add together to get total unit cost. For 30,400 units, use the same unit costs for direct materials, direct labor, and variable overhead, but instead recalculate the fixed factory overhead and add this to obtain the unit cost at the 30,400 unit level. Sales - (cost of goods manufactured - Inventory, October 31) = Gross profit; gross profit - selling and administrative expenses = income from operations. Remember that the Inventory, October 31 adjustment will only be necessary at the 30,400 level. a. 2. Prepare an estimated income statement, comparing operating results if 27,200 and 30,400 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 27,200 Units Manufactured 30,400 Units Manufactured Sales $ 2,611,200 $ 2,611,200 Variable cost of goods sold: Variable cost of goods manufactured $ 2,118,880 $ Inventory, October 31 0 Total variable cost of goods sold $ 2,118,880 $ Manufacturing margin $ 1,572,600 $ Variable selling and administrative expenses Contribution margin $ $ Fixed costs: Fixed factory overhead $ $ Fixed selling and administrative expenses Total fixed costs $ $ Operating income $ $ Feedback a. 2. Recall that under variable costing, fixed factory overhead costs are not a part of the cost of goods manufactured. Instead, fixed factory overhead costs are treated as a period expense. Therefore, recast the income statement such that Net sales - variable cost of products sold = Manufacturing margin; Manufacturing margin - variable selling and administrative expenses = Contribution margin; Contribution margin - (fixed manufacturing costs + fixed selling and administrative expenses) = income from operations. Remember that the variable cost of manufacturing will be the same at both levels after adjusting for Inventory, October 31. Thus manufacturing margin should also be the same for both levels. 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 larger 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 ending inventory.