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# Variable and Absorption Costing of Goods

A manufacturer makes a single product. When comparing this year's income statement with last year's, why is net income different for the same level of sales:
Cost have not changed at all, but income has.
What was done right this year?
The statements, both prepared using absorption costing, look like this:
This Year Last Year
Sales revenue(40,000 units each year) \$800,000 \$800,000
Less cost of goods sold 400,000 460,000
Gross margin \$400,000 \$340,000
Less selling and administrative expenses 300,000 300,000
Net Income \$100,000 \$100,000

Last year, the first year of operations, the company produced 40,000 units and sold them all. This year, the company increased production to maintain a margin of safety in its finished goods inventory. Fixed costs are applied to products on the basis of the number of units produced each year. Here is a summary of production results, variable production cost, and fixed manufacturing overhead cost for both years:

This Year Last Year
Production in units 50,000 40,000
Production cost:
Variable cost per unit \$4 \$4

Required
a. Calculate the unit product cost under variable costing and absorption costing.
b. Prepare an income statement for each year using variable costing.
c. Compare the net income figures in the variable-costing income statement (requirement b.) and the absorption-costing income statement for each of the years. Explain any differences.
d. Why did the manufacturer earn more this year than the last year using absorption costing, even though the company sold the same number of units?

#### Solution Preview

Please view the attachment for proper formatting.

Required
a. Calculate the unit product cost under variable costing and absorption costing.

Under variable costing the product costs includes only the variable costs of production. The fixed overhead is taken as a period cost and is expensed in the period. Under absorption costing all manufacturing costs (fixed and variable) are taken as the product cost.
Unit cost under variable costing
Variable cost per unit \$4
This will be the same in both the years
Unit cost under absorption costing
Last year
The fixed manufacturing cost per unit = Total fixed manufacturing cost/units produced
Fixed manufacturing cost per unit = 300,000/40,000=7.50
Unit cost = 4+7.5 = 11.50
This year
The fixed manufacturing cost per unit = Total fixed manufacturing cost/units produced
Fixed manufacturing cost per unit = 300,000/50,000=6.00
Unit cost = 4+6 = 10.00

b. Prepare an income statement for each year using variable costing.

Last Year
Variable costing income statement
Sales (20 X ...

#### Solution Summary

This solution explains the calculations under variable costing and absorption costing in an attached Word document.

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