Question

The management accountant at Clarkson Company has prepared the following income statement for March using variable costing:

Sales		$2,600,000
Variable production costs		1,300,000
Contribution Margin		1,300,000
Fixed production costs		688,000
Fixed selling and administrative costs		392,000
Operating income		$   220,000

The accountant provided the following information along with the statement:

The unit sales price for March was $26

Production for March was 6,000 units in excess of sales

The inventory on the last day of March was 40,000 units

Fixed manufacturing costs are allocated to each unit at a predetermined rate based on normal monthly production of 86,000 units

Materiality of the volume variance is calculated as a percentage of COGS (i.e written off to COGS)

Required:

a) Prepare an income statement for March using absorption costing.

b) Reconcile the difference in income under absorption and variable costing and explain why the difference arises.

c) Which is a better method – absorption or variable costing – for evaluating management performance? Explain your recommendation.

Answer 1

a) Income Statement - Absorption Costing:
Sales		2600000
Less: Manuf costs:
Variable	1300000
Fixed	688000
Total Manuf costs		1988000
Less:CS Manuf cost		-48000		6000*8
Net Manuf costs		1940000
Gross Profit		660000
Less: Admin & Sell costs:
Fixed Sell & Adm costs		392000
Operating Income		$268,000
b) reconciliation of difference of income under absorption and variable:
	$
Operating Income as per Variable costing	220000
Add: CS Fixed Manufacturing cost:	48000
Operating income as per Absorption costing	268000
c)Variable costing is the better method because it explains what is the return after variable costs
All the fixed costs are dealt after the variable costs which varies according to quantum of production.