Chapter 6, Problem 3PA

1.(A)

To determine

Absorption Costing

Absorption costing is compulsory under Generally Accepted Accounting Principles (GAAP) for financial statements circulated to the external users. Under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Fixed factory overhead and variable factory overhead are included as part of factory overhead.

Variable Costing

Managers frequently use variable costing for internal purposes for taking decision making. The cost of goods manufactured includes direct materials, direct labor, and variable factory overhead. Fixed factory overhead is treated as period (fixed) expense.

The income statement according to the absorption costing concept of the Company WC for the month of July.

Answer to Problem 3PA

Calculate the income statement according to the absorption costing concept of the Company WC as shown below:

Company WC
Absorption costing income statement for the month ended
July 31
Particulars	$	$
Sales		4,320,000
Less: Cost of goods sold
Cost of goods manufactured	3,600,000
Inventory on July, 31 $\left(8,000\text{Units}\times \text{\$45(1)}\right)$	(360,000)
Total cost of goods sold		3,240,000
Gross profit		1,080,000
Less: Selling and administrative expenses		169,000
Income from operations		911,000

Table (1)

Explanation of Solution

Working notes:

1. Calculate the value of ending inventory per unit.

$\begin{array}{c}\text{Ending inventory =}\frac{\text{Cost of good manufactured}}{\text{Units manufactured}}\\ =\frac{\$3,600,000}{80,000\text{ Units}}\\ =\$45\end{array}$ (1)

Conclusion

Therefore, income from operations under absorption costing concept of Company WC for the month ended July 31 is $911,000.

2.(A)

To determine

The income statement according to the variable cost concept of the Company WC for the month ended July, 31.

Answer to Problem 3PA

Calculate the income statement according to the variable costing concept of the Company WC as shown below:

Company WC
Variable costing income statement for the month ended
July 31
Particulars	$	$
Sales		4,320,000
Less: Variable cost of goods sold
Variable cost of goods manufactured	3,280,000
Inventory on July, 31 $\left(8,000\text{Units}\times \text{\$41(2)}\right)$	(328,000)
Total variable cost of goods sold		2,952,000
Manufacturing margin		1,368,000
Less: Variable selling and administrative expenses		144,000
Contribution margin		1,224,000
Less: Fixed costs
Fixed manufacturing costs	320,000
Fixed selling and administrative expenses	25,000
Total fixed cost		345,000
Income from operations		879,000

Table (3)

Explanation of Solution

Working note:

1. Calculate the value of ending inventory per unit.

$\begin{array}{c}\text{Ending inventory =}\frac{\text{Cost of good manufactured}}{\text{Units manufactured}}\\ =\frac{\$3,280,000}{80,000\text{ Units}}\\ =\$41\end{array}$ (2)

Conclusion

Therefore, income from operations under variable costing concept of Company WC for the month ended July, 31 is $879,000.

3.(A)

To determine

To Identify: The reason for the difference between the amount of income from operations reported in absorption costing income statement and variable costing income statement for the month ended July, 31.

Explanation of Solution

The difference between the absorption and variable costing income from operations of $32,000 $\left(\$911,000–\$847,000\right)$ can be explained as follows:

Increase in inventory = 8,000 units $\left(80,000\text{ Units}-72,000\text{ Units}\right)$

Fixed factory overhead per unit = $4 $\left(\frac{\$320,000}{80,000\text{ Units}}\right)$

$\begin{array}{c}\begin{array}{l}\text{Difference in income}\\ \text{ from operations}\end{array})\text{=}\left(\begin{array}{l}\text{Increase in inventory}\times \text{Fixed }\\ \text{factory overhead per unit}\end{array}\right)\\ \text{=}8,0\text{00}\text{units }\times \text{\$4}\text{per unit}\\ \text{=}\text{\$32,000}\end{array}$

Under absorption costing method, the fixed factory overhead cost included in the cost of goods sold is coordinated with the incomes. As an effect, 8,000 units that were produced, but unsold includes fixed factory overhead cost, which is not involved in the cost of goods sold.

Under variable costing, all of the fixed factory overhead cost is subtracted in the period in which it is incurred, regardless of the amount of inventory change. Therefore, when inventory rises, the absorption costing income statement will have a higher income from operations than the variable costing income statement.

4.

To determine

To discuss: Which month Company WC operates more profitability.

Explanation of Solution

Based on variable costing concept, the company WC was equally profitable in July and August. Sales and variable cost per unit were the same for both the month and under both concept. The combined income from operations reported based on absorption concept for July and August $\left(\$911,000+\$847,000=\$1,758,000\right)$ is same in the variable cost concept $\left(\$879,000+\$879,000=\$1,758,000\right)$. Hence, the equal profitability in July and August based on variable cost concept, and the difference between the two concepts are also equal.