Chapter 6, Problem 19P

Answer 1:

To determine

Variable Costing: is also known as Direct costing method. In this method, those costs which vary directly with production are considered in product cost. Fixed Manufacturing Expenses are treated as period cost and not product cost. Selling Expenses (since they do not vary with production), both variable and fixed, are charged off completely in the period in which the expenses get incurred.

Unit product Cost for two years

Answer 2

To determine

Net Operating Income under variable costing system for 2 years

Answer 3:

To determine

Reconciliation: Reconciliation is done between Net Operating Income as per Variable Costing and that as per Absorption Costing.

The difference between the two net operating income figures would be on account of fixed cost element on inventory.

Under Variable costing, the inventory is valued at Unit product cost as per variable costing method which is direct material plus direct labour plus variable manufacturing expenses.

Whereas

Under Absorption costing, the inventory is valued at Unit product cost as per absorption costing method which is direct material plus direct labour plus variable manufacturing expenses plus fixed cost per unit.

Due to the inclusion of fixed cost in inventory in absorption costing, following is the impact:

1. Opening inventory is higher resulting in decrease in profit
2. Closing inventory is higher resulting in increase in profit

Reconciliation of net operating income under variable and absorption costing