Question

Absorption Statement Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goods sold.
Saxon, Inc.
Absorption Costing Income Statement
For the Year Ended December 31
Sales $1,360,000
Cost of goods sold:
Cost of goods manufactured $800,000
Ending inventory (120,000)
Total cost of goods sold (680,000)
Gross profit $680,000
Selling and administrative
expenses (303,000)
Operating income $377,000
Saxon, Inc.
Variable Costing Income Statement
For the Year Ended December 31
Sales $1,360,000
Variable cost of goods sold:
Variable cost of goods manufactured $560,000
Ending inventory (84,000)
Total variable cost of goods sold (476,000)
Manufacturing margin $884,000
Variable selling and administrative expenses (238,000)
Contribution margin $646,000
Fixed costs:
Fixed manufacturing costs $240,000
Fixed selling and administrative
expenses 65,000
Total fixed costs (305,000)
Operating income $341,000
Method Comparison
Review the income statements on the Absorption Statement and Variable Statement, then complete the following table. The company’s sales price per unit is $80, and the number of units in ending inventory is 3,000. There was no beginning inventory.
Item Amount
Number of units sold
Variable sales and administrative cost per unit $
Number of units manufactured
Variable cost of goods manufactured per unit $
Fixed manufacturing cost per unit $
Feedback
Review the definitions of the items in the table, and think backwards from one of the income statements to get the desired values.
Manufacturing Decisions
Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing operating income, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.
All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.
The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement and the Variable Statement, he notices that the operating income is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the company’s capacity for manufacturing, in the coming year. He reasons that this will boost operating income and satisfy the company’s owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow.
1. Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.
Operating Income
Original Production
Level-Absorption Original Production
Level-Variable Additional 10,000
Units-Absorption Additional 10,000
Units-Variable
2. What is the change in operating income from producing 10,000 additional units under absorption costing?
3. What is the change in operating income from producing 10,000 additional units under variable costing?

Answer 1

Answer:

Item                                                                         Amount

Number of units sold                                              17,000 ($1,360,000/$80)

Variable sales and administrative cost per unit $14 ($238,000/17,000)

Number of units manufactured                            20,000 (17,000 + 3,000)

Variable cost of goods manufactured per unit $28 ($560,000/20,000)

Fixed manufacturing cost per unit                     $12  ( $240,000/20,000)

2. There is a $68,000 increase in operating income from producing 10,000 additional units under absorption costing.

3. There is no change in operating income from producing 10,000 additional units under variable costing.

Explanation:

a) Data and Calculations:

Saxon, Inc.

Absorption Costing Income Statement

For the Year Ended December 31

Sales                                                        $1,360,000

Cost of goods sold:

Cost of goods manufactured $800,000

Ending inventory                       (120,000)

Total cost of goods sold                           (680,000)

Gross profit                                              $680,000

Selling and administrative  expenses      (303,000)

Operating income                                   $377,000

Saxon, Inc.

Variable Costing Income Statement

For the Year Ended December 31

Sales                                                     $1,360,000

Variable cost of goods sold:

Variable cost of goods manufactured $560,000

Ending inventory                                      (84,000)

Total variable cost of goods sold          (476,000)

Manufacturing margin                          $884,000

Variable selling and

administrative expenses                      (238,000)

Contribution margin                             $646,000

Fixed costs:

Fixed manufacturing costs                  $240,000

Fixed selling and administrative

 expenses                                                65,000

Total fixed costs                                   (305,000)

Operating income                                $341,000

Sales price per unit = $80

Ending inventory = 3,000 units

Beginning inventory = 0

Item                                                                         Amount

Number of units sold                                              17,000 ($1,360,000/$80)

Variable sales and administrative cost per unit $14 ($238,000/17,000)

Number of units manufactured                            20,000 (17,000 + 3,000)

Variable cost of goods manufactured per unit $28 ($560,000/20,000)

Fixed manufacturing cost per unit                     $12  ( $240,000/20,000)

Manufacturing Decisions:

Additional production of 10,000 units:

Absorption Costing Income Statement

For the Year Ended December 31         Normal            Additional 10,000

Sales                                                        $1,360,000               $1,360,000

Cost of goods sold:

Cost of goods manufactured $800,000                  $1,080,000*

Ending inventory                       (120,000)                      468,000

Total cost of goods sold                           (680,000)                  (612,000)

Gross profit                                              $680,000                  $748,000

Selling and administrative  expenses      (303,000)                   (303,000)

Operating income                                   $377,000                  $445,000

Cost of goods manufactured:

Variable manufacturing cost = $840,000 (30,000 * $28)

Fixed manufacturing cost =      $240,000

Total cost of goods manufactured = $1,080,000

Per unit cost = $36 ($1,080,000/30,000)

Ending inventory = $468,000 ($36 * 13,000)

Cost of goods sold = $612,000 ($36 * 17,000)

Saxon, Inc.

Variable Costing Income Statement

For the Year Ended December 31          Normal            Additional 10,000

Sales                                                        $1,360,000               $1,360,000

Variable cost of goods sold:

Variable cost of goods manufactured   $560,000                  $840,000

Ending inventory                                        (84,000)                   (364,000)

Total variable cost of goods sold            (476,000)                  (476,000)

Manufacturing margin                            $884,000                 $884,000

Variable selling and

administrative expenses                        (238,000)                 (238,000)

Contribution margin                               $646,000                $646,000

Fixed costs:

Fixed manufacturing costs                   $240,000                $240,000

Fixed selling and administrative

 expenses                                                 65,000                    65,000

Total fixed costs                                    (305,000)                (305,000)

Operating income                                 $341,000                 $341,000