Chapter 19, Problem 19SP

1.

To determine

To compute:

Company’s income under absorption costing.

Explanation of Solution

a.

Income statement under absorption costing when 300 workstations are produced is:

S.R. Company
Income Statement (Absorption Costing)
For the Year Ended 2016
Particulars	Amount ($)	Amount ($)
Sales $\left(300\times \$3,000\right)$		900,000
Cost of Goods sold (working note)		(414,000)
Gross Margin		486,000
Variable Selling and Administrative Cost $\left(300\times \$50\right)$	(15,000)
Fixed Selling and Administrative Cost	(4,000)	(19,000)
Net Income		467,000

Table (1)

The net income under absorption costing at 300 units of production is $467,000.

Working Note:

Calculation of cost of goods sold is,

$\text{Cost of goods sold}=\text{Number of units sold}\times \text{Cost per unit}$

Where, the cost per unit can be calculated as,

Particulars	Amount ($) Per Unit
Direct Materials	800
Direct Labor	400
Variable Overheads	100
Fixed Overheads $\left(\frac{\$24,000}{300}\right)$	80
Total Cost Per Unit	1,380

Table (2)

Substitute 300 for the number of units and $1,380 for the cost per unit in the above formula,

$\begin{array}{c}\text{Cost of goods sold}=300\times \$1,380\\ =\$414,000\end{array}$

Thus, the net income under absorption costing at 300 units of production is $467,000.

b.

Solution:

Income statement under absorption costing when 320 workstations are produced is,

S.R. Company
Income Statement (Absorption Costing)
For the Year Ended 2016
Particulars	Amount ($)	Amount ($)
Sales $\left(300\times \$3,000\right)$		900,000
Cost of Goods sold (working note)		(412,500)
Gross Margin		487,500
Variable Selling and Administrative Cost $\left(300\times \$50\right)$	(15,000)
Fixed Selling and Administrative Cost	(4,000)	(19,000)
Net Income		468,500

Table (3)

The net income under absorption costing at 320 units of production is $468,500.

Working note:

Calculation of cost of goods sold is,

$\text{Cost of goods sold}=\text{Number of units sold}\times \text{Cost per unit}$

Where, the cost per unit can be calculated as,

Particulars	Amount ($) Per Unit
Direct Materials	800
Direct Labor	400
Variable Overheads	100
Fixed Overheads $\left(\frac{\$24,000}{320}\right)$	75
Total Cost Per Unit	1,375

Table (4)

Substitute 300 for the number of units and $1,375 for the cost per unit in the above formula,

$\begin{array}{c}\text{Cost of goods sold}=300\times \$1,375\\ =\$412,500\end{array}$

Thus, the net income under absorption costing at 320 units of production is $468,500.

2.

To determine

To compute:

Company’s income under variable costing.

a.

Explanation of Solution

Income statement under variable costing when 300 workstations are produced is,

S.R. Company
Income Statement (Variable Costing)
For the Year Ended 2016
Particulars	Amount ($)	Amount ($)
Sales $\left(300\times \$3,000\right)$		900,000
Direct Materials $\left(300\times \$800\right)$	(240,000)
Direct Labor $\left(300\times \$400\right)$	(120,000)
Variable production Overhead $\left(300\times \$100\right)$	(30,000)
Variable Selling and Administrative Cost $\left(300\times \$50\right)$	(15,000)	(405,000)
Contribution Margin		495,000
Fixed Production Overhead	(24000)
Fixed Selling and Administrative Cost	(4,000)	(28,000)
Net Income		467,000

Table (5)

Thus, the net income under variable costing at 300 units of production is $467,000.

b.

Solution:

Income statement under variable costing when 320 workstations are produced is,

S.R. Company
Income Statement (Variable Costing)
For the Year Ended 2016
Particulars	Amount ($)	Amount ($)
Sales $\left(300\times \$3,000\right)$		900,000
Direct Materials $\left(300\times \$800\right)$	(240,000)
Direct Labor $\left(300\times \$400\right)$	(120,000)
Variable production Overhead $\left(300\times \$100\right)$	(30,000)
Variable Selling and Administrative Cost $\left(300\times \$50\right)$	(15,000)	(405,000)
Contribution Margin		495,000
Fixed Production Overhead	(24000)
Fixed Selling and Administrative Cost	(4,000)	(28,000)
Net Income		467,000

Table (6)

Thus, the net income under variable costing at 320 units of production is $467,000.

3.

To determine

To explain:

The difference in income figures determined in part 1 and part 2 and the way the company should use the information from part 1 and part 2 to make production decision.

Explanation of Solution

• The income statement prepared under variable costing includes the costing of a product on only direct or variable cost, so, the valuation of the ending inventory is done only on variable cost and not on the fixed cost.

• The income statement prepared under absorption costing includes the costing of a product on both fixed and variable costs, so, the valuation of the ending inventory is done on both the cost that is fixed and variable.

• The difference in the value of the closing inventory creates the difference in the incomes under the absorption and variable method.

• When the value of closing inventory becomes zero or same under both methods, the difference between their incomes becomes zero. So, the difference in income between the variable costing and absorption costing is due to the difference in the value of closing inventory under both the methods.

• From the calculation above in part 1 and 2 it can be seen that the income is greater when the company produces 320 units and uses the absorption costing, so, the company should take the income as the measure to take decision regarding production.

Thus, the difference in income between the variable costing and absorption costing is due to the difference in the value of closing inventory under both the methods and the company can take the production decision by looking at the income figures under the two methods.