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# Managerial accounting/absorption cost: Variable and Absorption Costing

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Managerial accounting

Absorption and Variable Costing; Production Constant, sales fluctuate:

Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc. in order to produce and sell the device. During the first month of operations, the device was very well received on the market, so Ms. Scott looked forward to a healthy profit from sales. For this reason, she was surprised to see a loss for the month on her income statement. This statement was prepared by her accounting services, which takes great pride in providing its clients with timely financial data. The statement follows:

SCOTTS PRODUCTS, INC.
Income Statement

Sales (40,000).....................................................................\$200,000
Less variable expences:
Variable cost of goods sold...................................\$80,000
Variable selling and administrative expenses........... 30,000 110,000

Contribution margin............................................ 90,000
Less fixed expenses:
Fixed selling and administrative expenses.................20,000 95,000

Net operating loss...................................................................(5,000)

Ms. Scott is discouraged over the loss shown for the month, particularly since she had planned to use the statement to encourage investors to purchase stock in the new company. A friend, who is CPA, insists that the company should be using absorption costing rather than variable costing. He argues that if absorption costing had been used, the company would probably have reported a nice profit for the month.

Selected cost data relating to the product and to first month of operations follow:

units produced .........................................................50,000
units sold .................................................................40,000
Variable costs per unit:
Direct materials.......................................................\$1.00
Direct labor...............................................................0.80

1. Complete the following:
A. Compute the units product cost under absorption costing.
B. Redo the company's income statement for the month using absorption costing.
C. Reconcile the variable and absorption costing net operation income figures.

2. Was the CPA correct in suggestion that the company really earned a profit for the month? Explain.

3. During the second month of operations, the company again produced 50,000 unit but sold 60,000 units. (Assume no change in total fixed costs.)
A. Prepare an income statment for the month using variable costing.
B. Prepare an income statment for the month using absorption costing
c. Reconcile the variable costing and absorption costing net operation income figures.