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:
- Income statement using absorption and variable costing methods.
- Explanation of the cause of difference in net operating income under two concepts.
Solution
(1) Income statements:
(a) Absorption costing income statement:

*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:

(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:

Or

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