Chapter 6, Problem 2PSA

To determine

Income Statement:

It is also known as profit and loss statement. It refers to that financial statement that is made to show the net income or loss that a company or a business has made by the end of a particular period.

Variable Costing:

It refers to the method of product costing in which the price of the product is calculated considering only the variable or direct costs or the cost that happened to occurred due to the product only. It is also called as marginal costing as it takes marginal costs while calculating the product cost.

Absorption Costing:

It refers to the method of product costing in which the price of the product is calculated considering all the fixed as well as the variable or direct costs. The valuation of closing inventory in this method is consists of both fixed and variable costs.

1.

To prepare: Income statement of the company for the year using variable costing

Given,
Selling price is $50 per unit.
Direct Material is $5 per unit.
Direct Labor is $14 per unit.
Variable overhead is $2 per unit.
Fixed Overhead is $900,000 in total.
Variable selling and administration cost is $2.25 per unit.
Fixed selling and administration cost is $350,000 in total.
Number of units produced by the company is 100,000.
Number of units sold by the company is 80,000.

The income statement under variable costing is,

T Company Income Statement (Variable Costing)
Particulars	Amount ($)	Amount($)
Sales $\left(80,000\times \$50\right)$		4,000,000
Direct Materials $\left(80,000\times \$5\right)$	(400,000)
Direct Labor $\left(80,000\times \$14\right)$	(1,120,000)
Variable Production Overheads $$(80,000\times \$2)$$	(160,000)
Variable Selling & Administrative Overheads $$(80,000\times \$2.25)$$	(180,000)	(1,860,000)
Contribution Margin		2,140,000
Fixed Production Overheads	(900,000)
Fixed Selling & Administrative Overheads	(350,000)	(1,250,000)
Net Income		890,000
Table (1)

Thus, the net income under variable costing is $890,000.

Explanation of Solution

Given,
Selling price is $50 per unit.
Direct Material is $5 per unit.
Direct Labor is $14 per unit.
Variable overhead is $2 per unit.
Fixed Overhead is $900,000 in total.
Variable selling and administration cost is $2.25 per unit.
Fixed selling and administration cost is $350,000 in total.
Number of units produced by the company is 100,000.
Number of units sold by the company is 80,000.

The income statement under variable costing is,

T Company Income Statement (Variable Costing)
Particulars	Amount ($)	Amount($)
Sales $\left(80,000\times \$50\right)$		4,000,000
Direct Materials $\left(80,000\times \$5\right)$	(400,000)
Direct Labor $\left(80,000\times \$14\right)$	(1,120,000)
Variable Production Overheads $$(80,000\times \$2)$$	(160,000)
Variable Selling & Administrative Overheads $$(80,000\times \$2.25)$$	(180,000)	(1,860,000)
Contribution Margin		2,140,000
Fixed Production Overheads	(900,000)
Fixed Selling & Administrative Overheads	(350,000)	(1,250,000)
Net Income		890,000
Table (1)

Thus, the net income under variable costing is $890,000.

2.

To determine

To explain: The difference in income between the variable costing and absorption costing income statement.

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.

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.