Chapter 18, Problem 46E

1.

To determine

Prepare an income statement for both the years 2015 and 2016 by using full costing method.

Explanation of Solution

Strategic Performance Measurement (SPM) for companies may be both functional and inefficient. It may enable companies to identify and accomplish their strategic goals, match behaviors and attitudes, and eventually have a positive effect on success in companies.

Performance measurement is a mechanism by which managers gain details about the execution of activities at all levels in the firm and judge the success against pre-established parameters as outlined in budgets, plans and objectives.

A profit center produces all income and incurs the brunt of the expense of generating those sales.

Full costing is a cost accounting technique used to estimate the entire end-to - end cost of manufacturing goods or services.

Variable costing is a method for handling accounts expenses. This is a costing process that integrates only variable cost of manufacturing i.e. direct products, direct labor and variable overhead input in unit cost of product.

An income statement for both the years 2015 and 2016 by using full costing is as follows:

Data Summary	2015	2016
Units
Beginning Inventory	800	1,400
Price	$ 2,095	$ 1,995
Sold	3,200	2,800
Actual Produced	3,800	2,300
Budgeted Production	4,000	3,400
Units Variable costs
Manufacturing	$ 1,200	1,200
Selling and Administrative	$ 125	$ 125	Fixed manufacturing cost/per unit
Fixed Costs			2015	2016
Manufacturing	$ 700,000	$ 595,000	$ 175.00	$175.00
Selling and Administrative	$ 120,000	$ 120,000
Ending Inventory	1,400	900

2.

To determine

Prepare an income statement using variable costs for each year and mention the difference in operating income obtained by using variable and full costing method.

Explanation of Solution

Strategic Performance Measurement (SPM) for companies may be both functional and inefficient. It may enable companies to identify and accomplish their strategic goals, match behaviors and attitudes, and eventually have a positive effect on success in companies.

Performance measurement is a mechanism by which managers gain details about the execution of activities at all levels in the firm and judge the success against pre-established parameters as outlined in budgets, plans and objectives.

A profit center produces all income and incurs the brunt of the expense of generating those sales.

Full costing is a cost accounting technique used to estimate the entire end-to - end cost of manufacturing goods or services.

Variable costing is a method for handling accounts expenses. This is a costing process that integrates only variable cost of manufacturing i.e. direct products, direct labor and variable overhead input in unit cost of product.

The income statement for 2015 by using variable costs for each year:

Income Statement	Full costing		Variable costing
		Income statement for 2015
Sales		$6,704,000		$6,704,000
Less: Cost of goods sold
Beginning inventory	1,100,000		960,000
Cost of goods produced	5,225,000		4,560,000
COGS available for sale	$6,325,000		$5,520,000
Less: Ending Inventory	1,925,000		1,680,000
Cost of goods sold		4,400,000	3,840,000
Adjust: Production Volume Variance		35,000
Adjusted: Cost of goods sold		4,435,000	400,000	4,240,000
Add: Variable selling and administrative costs
Gross Margin		$ 2,269,000
Contribution Margin				$2,464,000
Less: Fixed manufacturing costs			700,000
Less: Selling and administrative costs
Variable	400,000
Fixed	120,000	520,000	120,000	820,000
Operating Income		$1,749,000		$1,644,000

The income statement for 2016 by using variable costs for each year:

Income Statement	Full costing		Variable costing
		Income statement for 2016
Sales		$5,586,000		$5,586,000
Less: Cost of goods sold
Beginning inventory	1,925,000		1,680,000
Cost of goods produced	3,162,500		2,760,000
COGS available for sale	$5,087,500		$4,440,000
Less: Ending Inventory	1,237,500		1,080,000
Cost of goods sold		3,850,000	3,360,000
Adjust: Production Volume Variance		192,500
Adjusted: Cost of goods sold		4,042,500	350,000	3,710,000
Add: Variable selling and administrative costs
Gross Margin		$ 1,543,500
Contribution Margin				$1,876,000
Less: Fixed manufacturing costs			595,000
Less: Selling and administrative costs
Variable	350,000
Fixed	120,000	470,000	120,000	715,000
Operating Income		$1,073,500		$1,161,000

3.

To determine

Create a brief memo report to the company describing the difference in operating income between variable costing and full costing.

Explanation of Solution

Strategic Performance Measurement (SPM) for companies may be both functional and inefficient. It may enable companies to identify and accomplish their strategic goals, match behaviors and attitudes, and eventually have a positive effect on success in companies.

Performance measurement is a mechanism by which managers gain details about the execution of activities at all levels in the firm and judge the success against pre-established parameters as outlined in budgets, plans and objectives.

A profit center produces all income and incurs the brunt of the expense of generating those sales.

Full costing is a cost accounting technique used to estimate the entire end-to - end cost of manufacturing goods or services.

Variable costing is a method for handling accounts expenses. This is a costing process that integrates only variable cost of manufacturing i.e. direct products, direct labor and variable overhead input in unit cost of product.

Reconciling Difference in Operating Income between Full and Variable Costing
		2015	2016
Change in Inventory in Units		600	(500)
Multiply: times Fixed Overhead Rate		$ 175	$ 175
Difference in Operating Income		$ 105,000	$ (87,500)

The rise in inventory units means overall operating profit for costing is higher than operating income for variable costs. A reduction in inventory units means that variable operating costing profit is higher than complete operating costing profits.

For 2015, units of inventory increasing, and operating profits for full costing in that year is higher than variable costs.

Inventory units decreased in 2016, thus operating profits for variable costs in that year is higher than full costs.

A memorandum, most popularly known as a memo, is a brief note or document that is used in a organization for internal correspondence. They have a dual purpose: they draw attention to issues and solve problems. They achieve their objectives by reminding the readers of new knowledge, such as policy changes, price rises, or by persuading the reader to take action, such as attending a meeting, or by modifying the existing production process.

MEMO

Date: 1 Aug, 2020

To: Incorporation, MH

From: XYZ

Subject: Difference in operating income between variable costing and full costing.

The discrepancy in operating profit between variable costing and full costing is attributed to the fact that the number of units in the inventory of finished products rose by 600 units in 2015 (from 800 to 1400) and declined by 500 units in 2016 (from 1,400 to 900).  The variable cost income statements do not contain fixed cost of manufacturing in the inventory, but rather view these costs as the current period expense. Changes in inventory rates therefore do not impact variable costing income statements.

Thus, when fixed production costs are high and inventory shifts dramatically, as in this case, the Incorporation, MH can use the variable cost income statement as a more accurate indicator of operating revenue. In comparison, the profit estimates for the full costing system contain fixed inventory costs and are thus skewed by adjustments in inventory rates. In addition, in periods of decreasing inventory, as in 2016, the maximum costing method shows revenue as lower than expected. The explanation is that, in the present period, fixed production costs of a prior era kept in inventory are high as the goods are sold. The variation in the amount of output does not influence the disparity between variable and maximum costing revenues. The difference in sales is explained in full by the increase in inventory compounded by the fixed overhead rate.