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:

*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