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 (21,600 x $75)	$1,620,000
Manufacturing costs (21,600 units):
Direct materials	984,960
Direct labor	233,280
Variable factory overhead	108,000
Fixed factory overhead	129,600
Fixed selling and administrative expenses	35,300
Variable selling and administrative expenses	42,600

The company is evaluating a proposal to manufacture 24,000 units instead of 21,600 units, thus creating an Inventory, October 31 of 2,400 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 21,600 and 24,000 units are manufactured in the absorption costing format. If an amount box does not require an entry leave it blank or enter “0”.

Marshall Inc.
Absorption Costing Income Statement
For the Month Ending October 31
	21,600 Units Manufactured	24,000 Units Manufactured
Sales	$	$
Cost of goods sold:
Cost of goods manufactured	$	$
Inventory, October 31
Total cost of goods sold	$	$
Gross profit	$	$
Selling and administrative expenses
Income from operations	$	$

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a. 2. Prepare an estimated income statement, comparing operating results if 21,600 and 24,000 units are manufactured in the variable costing format. If an amount box does not require an entry leave it blank or enter “0”.

Marshall Inc.
Variable Costing Income Statement
For the Month Ending October 31
	21,600 Units Manufactured	24,000 Units Manufactured
Sales	$	$
Variable cost of goods sold:
Variable cost of goods manufactured	$	$
Inventory, October 31
Total variable cost of goods sold	$	$
Manufacturing margin	$	$
Variable selling and administrative expenses
Contribution margin	$	$
Fixed costs:
Fixed factory overhead	$	$
Fixed selling and administrative expenses
Total fixed costs	$	$
Income from operations	$	$

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b. What is the reason for the difference in income from operations 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.

Answer 1

	Absorption Costing		Variable Costing
	21600 Units	24000 Units
Direct materials ($984960/21600)	45.60	45.60	45.60
Direct labor ($233280/21600)	10.80	10.80	10.80
Variable factory overhead ($108000/21600)	5.00	5.00	5.00
Fixed factory overhead ($129600/21600);($129600/24000)	6.00	5.40	-
Per unit cost $	67.40	66.80	61.40

a.1.

Marshall Inc.
Absorption Costing Income Statement
For the Month Ending October 31
	21600 Units Manufactured	24000 Units Manufactured
Sales	1620000	1620000
Cost of goods sold:
Cost of goods manufactured	1455840	1603200
Inventory, October 31	0	160320
Total cost of goods sold	1455840	1442880
Gross profit	164160	177120
Selling and administrative expenses	77900	77900
Income from operations	86260	99220

a.2.

Marshall Inc.
Variable Costing Income Statement
For the Month Ending October 31
	21600 Units Manufactured	24000 Units Manufactured
Sales	1620000	1620000
Variable cost of goods sold:
Variable cost of goods manufactured	1326240	1473600
Inventory, October 31	0	147360
Total variable cost of goods sold	1326240	1326240
Manufacturing margin	293760	293760
Variable selling and administrative expenses	42600	42600
Contribution margin	251160	251160
Fixed costs:
Fixed factory overhead	129600	129600
Fixed selling and administrative expenses	35300	35300
Total fixed costs	164900	164900
Income from operations	86260	86260