Question

Income Statements under Absorption Costing and Variable Costing

Gallatin County Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1 and operated at 100% of capacity during the first month. The following data summarize the results for July:

Sales (16,000 units)				$2,400,000
Production costs (21,000 units):
Direct materials		$1,165,500
Direct labor		558,600
Variable factory overhead		279,300
Fixed factory overhead		186,900		2,190,300
Selling and administrative expenses:
Variable selling and administrative expenses		$339,500
Fixed selling and administrative expenses		131,400		470,900

If required, round interim per-unit calculations to the nearest cent.

a. Prepare an income statement according to the absorption costing concept.

Gallatin County Motors Inc.
Absorption Costing Income Statement
For the Month Ended July 31
	$
	$
	$

b. Prepare an income statement according to the variable costing concept.

Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31
		$
		$
		$
Fixed costs:
	$
		$

c. What is the reason for the difference in the amount of operating income reported in (a) and (b)?

Under the   method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under  , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the   income statement will have a higher operating income.

Answer 1

Gallatin County Motors Inc
Absorption Costing Income Statement
For the Month Ended July 31
Sales	2400000
Cost of goods sold	1668800		=2190300/21000*16000
Gross profit	731200
Selling and administrative expenses	470900
Income from operations	260300
2
Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31
Sales		2400000
Variable cost of goods sold		1526400	=(2190300-186900)/21000*16000
Manufacturing margin		873600
Variable selling and administrative expenses		339500
Contribution margin		534100
Fixed costs:
Fixed factory overhead	186900
Fixed selling and administrative expenses	131400
Total fixed costs		318300
Income from operations		215800
3
Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues.
Under variable costing, all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change
Thus, when inventory increases, the absorption costing income statement will have a higher operating income