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Variable and Absorption Costing in Accounting

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Maxwell Company manufactures and sells a single product. The following costs were incurred during the company's first year of operations:

Variable costs per unit:
Manufacturing:
Direct materials $ 20
Direct labor $ 7
Variable manufacturing overhead $ 2
Variable selling and administrative $ 4
Fixed costs per year:
Fixed manufacturing overhead $ 210,000
Fixed selling and administrative expenses $ 80,000

During the year, the company produced 21,000 units and sold 16,400 units. The selling price of the company's product is $66 per unit.

Requirement 1:
Assume that the company uses absorption costing:
A) Compute the unit product cost
Unit product cost = $ ____________

B) Prepare an income statement for the year. (Fill in grey area)
Sales $
Cost of goods sold:
Beginning inventory $
Add: Cost of goods manufactured
Goods available for sale
Less: Ending inventory
Gross Profit
Selling and administrative expenses
Net operating income $

Requirement 2:
Assume that the company uses variable costing:
A) Compute the unit product cost.
Unit product cost = $___________

B) Prepare an income statement for the year. (Fill in grey area)
Sales $
Less variable expenses
Variable Cost of goods sold:
Beginning inventory $
Add: Variable manufacturing costs
Goods available for sale
Less: Ending inventory
Variable cost of goods sold
Variable selling expense
Contribution margin
Less fixed expenses:
Fixed manufacturing overhead
Fixed selling and administrative
Net operating income $

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The solution explains some calculations relating to variable and absorption costing

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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 manufacturing overhead ...............................75,000
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
Variable manufacturing overhead................................0.20
Varable selling and administrative expenses.................0.75

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.

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