Absorption costing income statement of a company for the first two years is as follows:

Year-1 Year-2
Sales 2,000,000 3,000,000
Less cost of goods sold:
Beginning inventory 0 340,000
Add cost of goods manufactured 1,700,000 1,700,000
————- ————-
Goods available for sale 1,700,000 2,040,000
Less ending inventory 340,000 0
————- ————-
Cost of goods sold 1,360,000 2,040,000
————- ————-
Gross margin 640,000 480,000
Less selling and administrative expenses* 620,000 680,000
————- ————-
Net operating income 20,000 280,000
————- ————-
*6 per unit variable; $500,000 fixed each year.

The manufacturing cost per unit is computed as follows:

Direct materials $16
Direct labor $20
Variable manufacturing overhead $4
Fixed manufacturing overhead $28
——
$68
——

Sales and production for two years:

Year-1 Year-2
Units produced 25,000 25,000
Units sold 20,000 30,000

Required:

  1. Prepare a variable costing (contribution margin) income statement.
  2. Reconcile net operating income figures.

Solution

(1) Variable costing (contribution margin) income statement:

Year-1 Year-2
Sales 2,000,000 3,000,000
Less variable cost of goods sold:
Beginning inventory 0  200,000
Add variable cost of goods manufactured (25,000 × $40) 1,000,000 1,000,000
————- ————-
Goods available for sale 1,000,000 1,200,000
Less ending inventory (5,000 × $40)  200,000 0
————- ————-
Variable cost of goods sold  800,000  1,200,000
————- ————-
Gross contribution margin 1,200,000  1,800,000
Less variable selling and administrative expenses  120,000 180,000
————- ————-
Contribution margin 1,080,000 1,620,000
 ————- ————-
Less period costs:
Fixed manufacturing costs 700,000 700,000
Fixed selling and administrative expenses 500,000 500,000
————- ————-
Total period costs 1,200,000 1,200,000
————- ————-
Net operating income/(loss) (120,000) 420,000
————- ————-

(2) Reconciliation:

Year-1 Year-2
Net operating income (loss) under variable costing (120,000) 420,000
Fixed manufacturing cost deferred in inventory ($28 × 5000) 140,000
Fixed manufacturing cost released from inventory ($28 × 5000)  (140,000)
———- ———-
Net income under absorption costing 20,000 280,000
———- ———-

For reconciliation of net operating income figures:

When fixed manufacturing overhead cost is deferred in inventory, it is added to the variable costing income figure and when fixed manufacturing cost is released from inventory, it is deducted from the variable costing income figure.

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