Chapter 18, Problem 29P

Jellison Company had the following operating data for its first two years of operations:

Jellison produced 90,000 units in the first year and sold 80,000. In the second year, it produced 80,000 units and sold 90,000 units. The selling price per unit each year was $12. Jellison uses an actual costing system for product costing.

Required:

1. 1. Prepare income statements for both years using absorption costing. Has firm performance, as measured by income, improved or declined from Year 1 to Year 2?
2. 2. Prepare income statements for both years using variable costing. Has firm performance, as measured by income, improved or declined from Year 1 to Year 2?
3. 3. Which method do you think most accurately measures firm performance? Why?

To determine

Prepare income statement for both years using absorption costing and explain whether the firm performance has improved or declined.

Explanation of Solution

Absorption costing income statement: It is one of the important types of income statement, in which the cost of goods sold are deducted from the revenue, company’s contribution margin will get. Net income can be calculated by deducting total selling and administrative expenses from the contribution margin of the company.

Prepare and income statement using absorption costing for Year 1 ad Year 2:

Company J
Absorption Costing income statement
For Year 1 and Year 2
Particulars	Year 1	Year 2
Sales $\left(\$12\times \text{Units sold}\right)$	$960,000	$1,080,000
Less: Cost of goods sold (3)	($832,000)	($956,000)
Gross profit	$128,000	$124,000
Less: Selling and administrative expenses	($70,350)	($70,350)
Operating income	$57,650	$53,650

Table (1)

Note: The units sold in Year 1 and Year 2 is 80,000 and 90,000 respectively.

From table (1), the operating income for Year 1 and Year 2 is $57,650 and $53,650 respectively.  Hence, the firm performance has declined in Year 2 from Year 1.

Working note 1: Determine the cost of goods manufactured for Year 1 and Year 2:

Computation of cost of goods manufactured
Particulars	Year 1	Year 2
Units produced (A)	90,000	80,000
Direct materials	$4.00	$4.00
Direct labor	$2.90	$2.90
Variable overhead	$1.50	$1.50
Fixed overhead $\left(\frac{\text{Fixed overhead}}{\text{Units produced}}\right)$	$2.00	$2.25
Total cost (B)	$10.40	$10.65
Cost of goods manufactured $\left(\text{A}\right)\times \left(\text{B}\right)$	$936,000	$852,000

Table (2)

Working note 2: Calculate the ending inventory for Year 1:

$\begin{array}{c}\text{Ending inventory}=\left(\text{Units Sold}-\text{Units Produced}\right)\times \left(\begin{array}{l}\text{Total cost }\\ \text{per unit}\end{array}\right)\\ =\left(90,000\text{ units}-80,000\text{ units}\right)\times \$10.40\text{ per unit}\\ \text{=10,000 units}\times \$10.40\text{ per unit}\\ =\$104,000\end{array}$

Working note 3: Determine the total cost of goods sold for Year 1 and Year 2:

Computation of cost of goods sold
Particulars	Year 1	Year 2
Beginning inventory	$0	$104,000
Add: Cost of goods manufactured (1)	$936,000	$852,000
Goods available for sale	$936,000	$956,000
Less: Ending inventory (2)	($104,000)	$0
Cost of goods sold	$832,000	$956,000

Table (3)

To determine

Prepare income statement for both years using variable costing and explain whether the firm performance has improved or declined.

Explanation of Solution

Variable costing income statement: It is one of the important types of income statement, in which the entire variable costs are deducted from the revenue and the company’s contribution margin would be determined. Deducting all the fixed expenses from the contribution margin would result in company’s net income.

Prepare an income statement using variable costing:

Company J
Variable Costing income statement
For Year 1 and Year 2
Particulars	Year 1	Year 2
Sales $\left(\$12\times \text{Units sold}\right)$	$960,000	$1,080,000
Less: Variable cost of goods sold (6)	($672,000)	($756,000)
Contribution margin	$288,000	$324,000
Less:
Fixed overhead	($180,000)	($180,000)
Fixed selling and administrative expenses	($70,350)	($70,350)
Operating income	$37,650	$73,650

Table (4)

Note: The units sold in Year 1 and Year 2 is 80,000 and 90,000 respectively.

From table (4), the operating income for Year 1 and Year 2 is $37,650 and $73,650 respectively.  Hence, the firm performance has improved in Year 2 from Year 1.

Working note 4: Determine the variable cost of goods manufactured for Year 1 and Year 2:

Computation of variable cost of goods manufactured
Particulars	Year 1	Year 2
Units produced (A)	90,000	80,000
Direct materials	$4.00	$4.00
Direct labor	$2.90	$2.90
Variable overhead	$1.50	$1.50
Total cost (B)	$8.40	$8.40
Cost of goods manufactured $\left(\text{A}\right)\times \left(\text{B}\right)$	$756,000	$672,000

Table (5)

Working note 5: Calculate the ending inventory for Year 1:

$\begin{array}{c}\text{Ending inventory}=\left(\text{Units Sold}-\text{Units Produced}\right)\times \left(\begin{array}{l}\text{Total cost }\\ \text{per unit}\end{array}\right)\\ =\left(90,000\text{ units}-80,000\text{ units}\right)\times \$8.40\text{ per unit}\\ \text{=10,000 units}\times \$8.40\text{ per unit}\\ =\$84,000\end{array}$

Working note 6: Determine the variable cost of goods sold for Year 1 and Year 2:

Computation of cost of goods sold
Particulars	Year 1	Year 2
Beginning inventory	$0	$84,000
Add: Variable cost of goods manufactured (4)	$756,000	$672,000
Goods available for sale	$756,000	$756,000
Less: Ending inventory (5)	($84,000)	$0
Variable Cost of goods sold	$672,000	$756,000

Table (6)

To determine

Identify the method that evaluates the performances accurately and explain the same.

Explanation of Solution

The costs remaining the same, the sales have also increased. The operating income has increased under variable costing due to the absence of fixed costs in ending inventory cost. On the other hand, the operating income has decreased under absorption costing as the fixed costs in ending inventory cost have been included. Therefore, variable costing is better and evaluates the performances accurately reflecting the economic performance