Question

Dance Creations manufactures authentic Hawaiian hula skirts that are purchased for traditional Hawaiian celebrations, costume parties, and other functions. During its first year of business, the company incurred the following costs:

Variable Cost per Hula Skirt
Direct materials	$	10.00
Direct labor		3.80
Variable manufacturing overhead		1.45
Variable selling and administrative expenses		0.85
Fixed Cost per Month
Fixed manufacturing overhead	$	18,040
Fixed selling and administrative expenses		5,350

Dance Creations charges $33 for each skirt that it sells. During the first month of operation, it made 1,640 skirts and sold 1,520.

Required:
1. Assuming Dance Creations uses variable costing, calculate the variable manufacturing cost per unit for last month.
2. Complete a variable costing income statement for the last month.
3. Assuming Dance Creations uses full absorption costing, calculate the full manufacturing cost per unit for the last month.
4. Complete a full absorption costing income statement.
6. Suppose next month Dance Creations expects to produce 1,640 hula skirts and sell 1,740. Without recreating the new income statements, calculate the difference in profit between variable costing and full absorption costing. Which would be higher?

Complete a full absorption costing income statement. (Round your intermediate calculations to 2 decimal places.)

	Dance Creations Full Absorption Income Statement For Last Month Gross Margin Net Operating Income

Suppose next month Dance Creations expects to produce 1,640 hula skirts and sell 1,740. Without recreating the new income statements, calculate the difference in profit between variable costing and full absorption costing. Which would be higher?

	Difference in profit Which would be higher?

Answer 1

1. Variable Manufacturing Cost per Unit Direct Materials Direct Labor Variable Manufacturing Overhead Variable Manufacturing Cost per Unit $10.00 $3.80 $1.45 $15.25

Variable Costing Income Statement Particulars Calculation Amount Sales ($33 x 1,520) $50,160.00 Less: Variable Cost per unit Variable Manufacturing Cost ($15.25 x 1,520) $23,180.00 Variable Selling and administrative expenses ($0.85 x 1,520) $ 1,292.00 Contribution Margin $ 25,688.00 Less: Fixed Costs Fixed Manufacturing Overheads $ 18,040.00 Fixed Selling and administrative expenses $ 5,350.00 Net Operating Income $ 2,298.00

3. 10.00 3.80 Full Manufacturing Cost per Unit Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overheads Full Manufacturing Cost per Unit $ $ $ ($18,040/1640) $ $ 1.45 11.00 26.25

4. Absorption Costing Income Statement Particulars Sales Cost of Goods Sold Gross Margin Less: Selling and Administrative Expenses Variable Fixed Net Operating Income Calculation Amount ($33 x 1,520) $50,160.00 ($26.25 x 1,520) $39,900.00 $ 10,260.00 ($0.85 x 1,520) $ 1,292.00 $ 5,350.00 $ 3,618.00

6. Profit in Absorption costing will be higher than that in variable Costing This is because the difference will be the difference of the fixed manufacturing costs per unit The difference will be 100 ($18,040/1,640) = $1,100 Explanation: In absorption costing, cost of goods sold is subtracted from the revenues, which incldues both the variable as well as the fixed manufacturing costs per unit produced. In variable costing, manufacturing variable costs per unit sold is subtracted and total manufacturing fixed costs are subtracted. Hence, the difference is the fixed costs of the excess units produced over the units sold. As we can check from the last month calculations, Net operating Income as per Absorption Costing Net operating Income as per variable Costing Difference $3,618.00 $2,298.00 $1,320.00 Which is equal to the difffernce of Units produced and Units sold which are 1,640 and 1,520 respectively multiplied by the manufacturing fixed cost per unit which is $11 (1,640 - 1,520) < $11 $1,320.00 Hence, in the next month the difference will be The difference will be (1,740-1,640) $11 = $1,100

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