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

By: Rashid Javed | Updated on: July 12th, 2023

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


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


(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:




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