Income statements using variable and absorption costing
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The E-Company
The E-Company manufactures trendy, high-quality moderately priced watches that it sells on the Internet. As the company's senior financial analyst, you are asked to analyze the overall profitability fo the current year. The CFO has heard that there are two different approaches for preparing income statements. You are asked to show the CFO both approaches and explain the advantages or disadvantages of each method. The following data are for the year ended December 31, 2008:
Beginning inventory, January 1, 2008 85,000 units
Ending inventory, December 31, 2008 55,000 units
2008 sales are 345,000 units
Selling price (to distributor) $19.00 per unit
Variable manufacturing cost per unit, including. direct materials 4.90 per unit
Variable operating cost per unit sold $1.20 per unit sold
Fixed manufacturing overhead $1,600,000
Fixed selling & administrative expenses $1,200,000
Assume costs per unit are the same for units in beginning inventory and units produced during the year. Also, assume the prices and unit costs did not change during the year.
Requirement:
Prepare income statements under variable (contribution margin) and traditional (absorption) costing for the year ended December 31, 2008.
What is E's operating income under each costing method (in percentage terms)?
Explain the difference in operating income between the two methods.
Which costing method would you recommend to the CFO? Why?
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The solution explains how to prepare income statements using variable and absorption costing
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Requirement:
Prepare income statements under variable (contribution margin) and traditional (absorption) costing for the year ended December 31, 2008.
Unit Cost under Absorption Costing
Absorption costing:
Variable Manufacturing Cost $4.90
Fixed manufacturing overhead 5.08
Unit product cost $9.98
Units produced = Sales + Ending inventory - Beginning Inventory
345,000 + 55,000-85,000 = 315,000
The total fixed manufacturing overhead is 1,600,000 and the units produced are 315,000. Fixed manufacturing overhead per unit = 1,600,000/315,000=5.08 (rounded)
Income statement under absorption costing
Absorption costing income statement
Sales (345,000 units X $19) $6,555,000
Cost of goods sold:
Beginning inventory (85,000X9.98) $ 848,300
Add cost of goods manufactured (9.98X315,000) 3,143,700
Goods available for sale 3,992,000
Less ending inventory ...
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