Exercise-5 (Variable and absorption costing income statement, reconciliation)

AGA company manufactures and sells a product for $20 per Kg. The data for the year 2016 is given below:

  • Sales in kgs: 75,000 kgs
  • Finished goods inventory at the beginning of the period: 12,000 kgs
  • Finished goods inventory at the closing of the period: 17,000 kgs

Manufacturing costs:

  • Variable cost: $8 per Kg
  • Fixed manufacturing overhead cost: $320,000 per year

Marketing and administrative expenses:

  • Variable expenses: $2 per Kg of sale
  • Fixed expenses: $300,000 per year

Required:

  1. Income statement using absorption and variable costing methods.
  2. Explanation of the cause of difference in net operating income under two concepts.

Solution

(1) Income statements:

(a) Absorption costing income statement:

exercise-5-vaac-img1

*Production for the year 2016:

Units manufactured during 2016 = Units sold + Units in closing inventory – Units in opening inventory

= 75,000 kgs + 17,000 kgs – 12,000 kgs

= 80,000 kgs

**Manufacturing expenses per unit:

Variable expenses + Fixed expenses

= $8 + ($320,000/80,000 kgs)

= $8 + $4

= $12

(b) Variable costing income statement:

exercise-5-vaac-img2

(2) Explanation of the difference in net operating income:

The net operating income under absorption costing is $20,000 more than the net operating income under variable costing. When production is more than sales (as in this exercise), the fixed manufacturing overhead is deferred in inventory that causes a higher net operating income under absorption costing than under variable costing. The reconciliation of net operating income is given below:

exercise-5-vaac-img3

Or

exercise-5-vaac-img4

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14 Thoughts on Exercise-5 (Variable and absorption costing income statement, reconciliation)

  1. deo

    They are very useful as they helped me understand how these differences emerge.

  2. kinjal;

    IT’s nice, but give some sums with explanation.

  3. Joseph Stalin

    Very useful, thank you chief.

    1. Accounting For Management

      Thank you Joseph Stalin.

  4. Amstrong

    Very useful, it helped me understand this chapter.

  5. Gurman Singh

    Calculation under Absorption Costing is not correct ! Please correct it, do not mislead students. Thanks

  6. Mieke

    Useful thank you, but maybe add an example where the costs, closing inventory, and beginning inventory vary?

  7. Mieke

    From year to year, or month to month.

  8. Accounting For Management

    @mieke
    noted.

  9. Susy

    Your post is a timely cotiunbrtion to the debate

  10. Molakeng

    Your site is very helpful and educating. Even bookmarked it. I’ll definitely pass my cost module by the help of this site.

  11. Gowi Path

    Can u plz solve the question where cost are given in amount.

  12. Farhan Khawaja

    can someone tell me where is that 12 for the beginning inventory coming in Absorption costing?

    1. Accounting For Management

      Computation of per unit manufacturing expenses under absorption costing:

      Variable manufacturing expenses per unit: $8
      Fixed manufacturing expenses per unit: $320,000/80,000 kgs = $4
      Total manufacturing expenses per unit per unit: $8 + $4 = $12

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