Question:
Absorption Costing Versus Variable Costing. Wall Tech Company produces wood siding. The company has no finished goods inventory at the beginning of year 1. The following information pertains to Wall Tech Company.
Required:
a. All 200,000 units produced during year 1 are sold during year 1.
1. Prepare a traditional income statement assuming the company uses absorption costing.
2. Prepare a contribution margin income statement assuming the company uses variable costing.
b. Although 200,000 units are produced during year 2, only 170,000 units are sold during the year. The remaining 30,000 units are in finished goods inventory at the end of year 2.
1. Prepare a traditional income statement assuming the company uses absorption costing.
2. Prepare a contribution margin income statement assuming the company uses variable costing.
c. Although 200,000 units are produced during year 3, a total of 230,000 units are sold during the year. The 30,000 units remaining in inventory at the end of year 2 are sold during year 3.
1. Prepare a traditional income statement assuming the company uses absorption costing.
2. Prepare a contribution margin income statement assuming the company uses variable costing.
d. Analyze the results in years 1 through 3 (requirements athrough c).
Answer:
Answer (a) (1):
Cost of goods sold schedule (For absorption costing income statement):
Particulars | Amount |
|
|
Direct Materials [8 *200000] [a] | 1600000 |
Direct Labour [3 * 200000] [b] | 600000 |
Variable Manufacturing Overheads [4 * 200000] [c] | 800000 |
Fixed Production Costs [d] | 1000000 |
|
|
Cost of goods manufactured [e] = [a+b+c+d] | 4000000 |
|
|
Add: Opening inventory [f] | 0 |
Less: Closing inventory [g] | 0 |
|
|
Cost of goods sold [h] = [e+f-g] | 4000000 |
Traditional income statement (As per absorption costing)
Particulars | Amount |
|
|
Sales [30 * 200000] [a] | 6000000 |
Less: Cost of goods sold [b] | (4000000) |
Gross Margin [c] = [a – b] | 2000000 |
Less: Variable selling and administrative cost [2 * 200000] [d] | (400000) |
Less: Fixed selling and administrative cost [e] | (800000) |
Net Operating Income [f] = [c – d – e] | 800000 |
Answer (a) (2):
Variable cost of goods sold schedule (For variable costing income statement):
Particulars | Amount |
|
|
Direct Materials [8 *200000] [a] | 1600000 |
Direct Labour [3 * 200000] [b] | 600000 |
Variable Manufacturing Overheads [4 * 200000] [c] | 800000 |
|
|
Cost of goods manufactured [d] = [a+b+c] | 3000000 |
|
|
Add: Opening inventory [e] | 0 |
Less: Closing inventory [f] | 0 |
|
|
Variable cost of goods sold [g] = [d+e-f] | 3000000 |
Contribution margin income statement (As per variable costing)
Particulars | Amount |
|
|
Sales [30 * 200000] [a] | 6000000 |
Less: Variable cost of goods sold [b] | (3000000) |
Less: Variable selling and administrative cost [2 * 200000] [c] | (400000) |
Contribution Margin [d] = [a – b – c] | 2600000 |
Less: Fixed production costs [e] | (1000000) |
Less: Fixed selling and administrative expenses [f] | (800000) |
Net Operating Income [g] = [d – e – f] | 800000 |
Answer (b) (1):
Cost of goods sold schedule (For absorption costing income statement):
Particulars | Amount |
|
|
Direct Materials [8 *200000] [a] | 1600000 |
Direct Labour [3 * 200000] [b] | 600000 |
Variable Manufacturing Overheads [4 * 200000] [c] | 800000 |
Fixed Production Costs [d] | 1000000 |
|
|
Cost of goods manufactured [e] = [a+b+c+d] | 4000000 |
|
|
Add: Opening inventory [f] | 0 |
Less: Closing inventory [4000000 * 30000 / 200000] [g] | (600000) |
|
|
Cost of goods sold [h] = [e+f-g] | 3400000 |
Traditional income statement (As per absorption costing)
Particulars | Amount |
|
|
Sales [30 * 170000] [a] | 5100000 |
Less: Cost of goods sold [b] | (3400000) |
Gross Margin [c] = [a – b] | 1700000 |
Less: Variable selling and administrative cost [2 * 170000] [d] | (340000) |
Less: Fixed selling and administrative cost [e] | (800000) |
Net Operating Income [f] = [c – d – e] | 560000 |
Answer (b) (2):
Variable cost of goods sold schedule (For variable costing income statement):
Particulars | Amount |
|
|
Direct Materials [8 *200000] [a] | 1600000 |
Direct Labour [3 * 200000] [b] | 600000 |
Variable Manufacturing Overheads [4 * 200000] [c] | 800000 |
|
|
Cost of goods manufactured [d] = [a+b+c] | 3000000 |
|
|
Add: Opening inventory [e] | 0 |
Less: Closing inventory [3000000 * 30000 / 200000] [f] | (450000) |
|
|
Variable cost of goods sold [g] = [d+e-f] | 2550000 |
Contribution margin income statement (As per variable costing)
Particulars | Amount |
|
|
Sales [30 * 170000] [a] | 5100000 |
Less: Variable cost of goods sold [b] | (2550000) |
Less: Variable selling and administrative cost [2 * 170000] [c] | (340000) |
Contribution Margin [d] = [a – b – c] | 2210000 |
Less: Fixed production costs [e] | (1000000) |
Less: Fixed selling and administrative expenses [f] | (800000) |
Net Operating Income [g] = [d – e – f] | 410000 |
Answer (c) (1):
Cost of goods sold schedule (For absorption costing income statement):
Particulars | Amount |
|
|
Direct Materials [8 *200000] [a] | 1600000 |
Direct Labour [3 * 200000] [b] | 600000 |
Variable Manufacturing Overheads [4 * 200000] [c] | 800000 |
Fixed Production Costs [d] | 1000000 |
|
|
Cost of goods manufactured [e] = [a+b+c+d] | 4000000 |
|
|
Add: Opening inventory [4000000 * 30000 / 200000] [f] | 600000 |
Less: Closing inventory [g] | 0 |
|
|
Cost of goods sold [h] = [e+f-g] | 4600000 |
Traditional income statement (As per absorption costing)
Particulars | Amount |
|
|
Sales [30 * 230000] [a] | 6900000 |
Less: Cost of goods sold [b] | (4600000) |
Gross Margin [c] = [a – b] | 2300000 |
Less: Variable selling and administrative cost [2 * 230000] [d] | (460000) |
Less: Fixed selling and administrative cost [e] | (800000) |
Net Operating Income [f] = [c – d – e] | 1040000 |
Answer (c) (2):
Variable cost of goods sold schedule (For variable costing income statement):
Particulars | Amount |
|
|
Direct Materials [8 *200000] [a] | 1600000 |
Direct Labour [3 * 200000] [b] | 600000 |
Variable Manufacturing Overheads [4 * 200000] [c] | 800000 |
|
|
Cost of goods manufactured [d] = [a+b+c] | 3000000 |
|
|
Add: Opening inventory [3000000 * 30000 / 200000] [e] | 450000 |
Less: Closing inventory [f] | 0 |
|
|
Variable cost of goods sold [g] = [d+e-f] | 3450000 |
Contribution margin income statement (As per variable costing)
Particulars | Amount |
|
|
Sales [30 * 230000] [a] | 6900000 |
Less: Variable cost of goods sold [b] | (3450000) |
Less: Variable selling and administrative cost [2 * 230000] [c] | (460000) |
Contribution Margin [d] = [a – b – c] | 2990000 |
Less: Fixed production costs [e] | (1000000) |
Less: Fixed selling and administrative expenses [f] | (800000) |
Net Operating Income [g] = [d – e – f] | 1190000 |
Answer (d):
In year 1, the net operating income as per absorption costing and variable costing is the same i.e. $800000. The reason for it is that there is no opening or closing inventory in year 1.
In year 2, the net operating income as per absorption costing is $560000 and as per variable costing is $410000. In absorption costing, fixed production cost is a part of cost of goods sold; hence the fixed production cost that relates to closing inventory is deducted from cost of goods sold. In variable costing, fixed production cost is not a part of cost of goods sold; hence the fixed production cost that relates to closing inventory is not deducted from cost of goods sold. Fixed production cost is $1000000. Number of units produced are 200000. Closing inventory is 30000 units. Hence, $150000 [$1000000 * 30000 units / 200000 units] is not deducted from cost of goods sold in variable costing. Hence, the net operating income as per variable costing is lower by $150000 as compared to absorption costing.
In year 3, the net operating income as per absorption costing is $1040000 and as per variable costing is $1190000. In absorption costing, fixed production cost is a part of cost of goods sold; hence the opening inventory includes fixed production cost of previous year that relates to previous year’s closing inventory i.e. current year’s opening inventory. In variable costing, fixed production cost is not a part of cost of goods sold; hence the fixed production cost that relates to previous year’s closing inventory i.e. current year’s opening inventory is not added to cost of goods sold. Fixed production cost is $1000000. Number of units produced are 200000. Opening inventory is 30000 units. Hence, $150000 [$1000000 * 30000 units / 200000 units] is not added to cost of goods sold in variable costing. Hence, the net operating income as per variable costing is higher by $150000 as compared to absorption costing.