Question

Income Statements under Absorption and Variable Costing

Shawnee Motors Inc. assembles and sells MP3 players. The company began operations on August 1 and operated at 100% of capacity during the first month. The following data summarize the results for August:

Sales (17,000 units)				$2,210,000
Production costs (22,000 units):
Direct materials		$1,058,200
Direct labor		508,200
Variable factory overhead		253,000
Fixed factory overhead		169,400		1,988,800
Selling and administrative expenses:
Variable selling and administrative expenses		$308,300
Fixed selling and administrative expenses		119,300		427,600

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

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

Shawnee Motors Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales	$
Cost of goods sold
Gross profit	$
Selling and administrative expenses
Income from operations	$

Feedback

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

Shawnee Motors Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		$
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		$

Feedback

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

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 income from operations than will the variable costing income statement.

Answer 1

Shawnee Motors Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales	2210000
Cost of goods sold	1536800		=1988800/22000*17000
Gross profit	673200
Selling and administrative expenses	427600
Income from operations	245600
2
Shawnee Motors Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		2210000
Variable cost of goods sold		1405900	=(1988800-169400)/22000*17000
Manufacturing margin		804100
Variable selling and administrative expenses		308300
Contribution margin		495800
Fixed costs:
Fixed factory overhead	169400
Fixed selling and administrative expenses	119300
Total fixed costs		288700
Income from operations		207100
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 income from operations than will the variable costing income statement.