Answer Class Exercise - 2.

45

Part (A)

Absorption Variable
Costing Costing

Direct Material Cost per unit $ 5 $ 5

Direct Labor Cost per unit 3 3
Variable Overhead Cost per unit 2 2
Fixed Overhead Costs per unit 2 -

Standard Product Cost per unit $ 12 $ 10

Part (B)

Income Statement for 20x0 Income Statement for 20x0

(Absorption Costing) (Variable Costing)

-------$------ -------$------

Sales 2,000,000 Sales 2,000,000

Less: Cost of Goods Sold (1,500,000) Less: Variable Product Cost (1,250,000)
Gross Profit 500,000 Variable Manufacturing Margin 750,000
Less: Selling & Admin Expenses Less: Variable Selling & Admin Expenses (125,000)
Variable Expenses (125,000) Contribution Margin 625,000
Fixed Expenses (50,000) Less: Fixed Overhead (300,000)
Net Income 325,000 Less: Fixed Selling & Admin Expenses (50,000)
Net Income 275,000

Part (C)

Reconciliation of Income under the two methods by listing the two key places where Income Statements Differ

1) Gross Profit vs Conribution Margin (Reconciliation)

-------$------

Gross Profit Margin as per Absorptoin Costing 500,000

Add: Fixed Manufacturing Overheads 125,000

Contribution Margin as per Variable Costing 625,000

2) Net Income Reconciliation

-------$------

Net Income as per Absorptoin Costing 325,000

Adjustment for Fixed Manufacturing Overheads in Stock (50,000)
Net Income as per Variable Costing 275,000

Part (D)

Reconciliation of Income reported under the two methods using the shortcut method
 -------$------

Net Income as per Absorptoin Costing 325,000

Adjustment for Fixed Manufacturing Overheads in Stock (50,000)
Net Income as per Variable Costing 275,000

Important Points:

1) In Variable Costing, closing stocks are valued at marginal production cost. And the fixed costs are charged in full against the profit as a
Period cost.

2) In Absorption Costing, closing stocks are valued at full production cost, and include a share of fixed production costs. Thus the fixed
manufacturing overheads are treated as Product cost.
ents Differ
gainst the profit as a

osts. Thus the fixed

Answer Class Exercise - 2.47
Part (A)

Answer Case 1

Production 11,000 units

Sales 9,000 units

When the units produced exceed units sold, income is higher under Absorption Costing. This is because a part of fixed manufacturing overheads
goes to Closing stock in Absorption Costing, and therefore Cost of Goods sold is reduced. On the other hand Variable Costing treats fixed
manufacturing overheads as period cost, so all the cost is charged to current period. Thus the income under Absorption Costing is higher when
units produced exceed units sold.

Answer Case 2

Production 10,000 units

Sales 10,000 units

When the units produced are equal to units sold, income is under Absorption Costing and Variable Costing are the same. This is because same
amount of fixed manufacturing overheads are included in profit & loss if the Production and Sales are same, and thus income under both
methods remains same.

Answer Case 3

Production 20,000 units

Sales 23,000 units

When the units sold exceed units produced, income is higher under Variable Costing. This is because of the reason that additional fixed cost is

absorbed in Cost of Sales under Absorption Costing. Therefore income under Variable costing is higer if units sold exceed units produced.
When the units sold exceed units produced, income is higher under Variable Costing. This is because of the reason that additional fixed cost is

absorbed in Cost of Sales under Absorption Costing. Therefore income under Variable costing is higer if units sold exceed units produced.

Part (B)

Case 1

Absorption
Variable Costing
Costing

Sale $ 5,670,000 Sale $ 5,670,000

Cost of Goods Sold (4,950,000) Variable Cost (3,150,000)
Income $ 720,000 Contribution Margin $ 2,520,000
FixedCost (2,200,000)
Income $ 320,000

Thus Income under Absorption Costing is higher by $ 400,000.

Case 2

Absorption
Variable Costing
Costing
Sale $ 6,300,000 Sale $ 6,300,000
Cost of Goods Sold (5,700,000) Variable Cost (3,500,000)
Income $ 600,000 Contribution Margin $ 2,800,000
 FixedCost (2,200,000)
Income $ 600,000

Thus Income under Absorption Costing and Variable Costing are same.

Case 3

Absorption
Variable Costing
Costing
Sale $ 14,490,000 Sale $ 14,490,000
Cost of Goods Sold (10,580,000) Variable Cost (8,050,000)
Income $ 3,910,000 Contribution Margin $ 6,440,000
FixedCost (2,200,000)
Income $ 4,240,000

Thus Income under Variable Costing is higher.

ufacturing overheads
Costing treats fixed
sting is higher when

This is because same

income under both

ditional fixed cost is

its produced.