A. Prepare an estimated income statement, comparing operating results if 40,000 and 50,000 units are manufactured in (1) the absorption costing format and (2) the variable costing format. В. What is the reason for the difference in income from operations reported for the two levels of production by the absorption costing income statement?

A. Prepare an estimated income statement, comparing operating results if 40,000 and 50,000 units are manufactured in (1) the absorption costing format and (2) the variable costing format. В. What is the reason for the difference in income from operations reported for the two levels of production by the absorption costing income statement?

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

**EX 20-8 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 (40,000 units × $90):** $3,600,000

**Manufacturing Costs (40,000 units):**
- Direct materials: $1,440,000
- Direct labor: $480,000
- Variable factory overhead: $240,000
- Fixed factory overhead: $120,000
- Fixed selling and administrative expenses: $75,000
- Variable selling and administrative expenses: $200,000

The company is evaluating a proposal to manufacture 50,000 units instead of 40,000 units, thus creating an ending inventory of 10,000 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.** Prepare an estimated income statement, comparing operating results if 40,000 and 50,000 units are manufactured in:
1. The absorption costing format
2. The variable costing format

**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?

**Explanation of Concepts:**

- **Absorption Costing:** All manufacturing costs (fixed and variable) are considered product costs.
- **Variable Costing:** Only variable manufacturing costs are treated as product costs; fixed manufacturing costs are period costs.

When comparing these two methods, absorption costing will report the fixed factory overhead as part of inventory, while variable costing does not include it in the inventory value. This difference can affect the income reported in financial statements, particularly when production levels change.

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