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    Absorption Versus Contribution Costing Income Statements

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    Far North Telecom, Ltd., of Ontario, has organized a new division to manufacture and sell specialty cellular telephones. The division's monthly costs are shown in the table below. Far North Telecom regards all of its workers as full-time employees and the company has a long-standing no layoff policy. Furthermore, production is highly automated. Accordingly, the company includes its labor costs in its fixed manufacturing overhead. The cellular phones sell for $150 each. During September, the first month of operations, the following activity was recorded: 12,000 units produced, 10,000 units sold.

    Manufacturing costs:
    Variable costs per unit:
    Direct Materials $48
    Variable manufacturing overhead $2
    Fixed manufacturing overhead costs (total) $360,000
    Selling and administration costs:
    Variable 12% of sales
    Fixed (total) $470,000

    1. Compute the unit product cost under:
    o absorption costing
    o variable costing
    2. Prepare an absorption costing income statement for September
    3. Prepare a contribution format income statement for September using variable costing.
    4. Assume that the company must obtain additional financing in order to continue operations. As a member of top management, would you prefer to rely on the statement in (2) above or in (3) above when meeting with a group of prospective investors?

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    Solution Summary

    Using a Word 97-2003 document, this solution illustrates how to prepare absorption and contribution costing income statements based upon the same set of facts, and how to reconcile the statements to each other. It also illustrates how to compute the product cost per unit under each approach. Finally, it discusses which statements management would prefer to show to lenders.