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Hanks Company produces a single product.

Operating data for the


company and its absorption costing income statement for the last year is
presented below:
Units in beginning inventory........................
0 Units
produced...............................................
9,000 Units
sold......................................................
8,000
Sales.........................................................
Less cost of goods sold:
Beginning inventory
0
Add cost of goods manufactured.
54,000
Goods available for sale....
54,000
Less ending inventory...
6,000
Cost of goods sold.........
Gross margin...........................
Less selling & admin. expenses....................
Net operating income................................

80,000

48,000
32,000
28,000
4,000

Variable manufacturing costs are $4 per unit. Fixed factory overhead


totals $18,000 for the year. This overhead was applied at a rate of $2 per
unit. Variable selling and administrative expenses were $1 per unit sold.
Required: Prepare a new income statement for the year using variable
costing. Comment on the differences between the absorption costing and
the variable costing income statements
SUGGESTED ANSWER

workings
Sales
Less : Variable Cost of Goods Sold
Opening Inventory
Cost of Goods Manufactured
Goods Available For Sale
Less : Closing Inventory
Contribution
Less : Variable Selling & Admin Cost
Less Fixed Expenses
Fixed Factory OHD
Fixed Selling & Admin Cost
Net Operating Income

9,000 X $4
1,000 X $4
8,000 X 1

28,000 8,000

($)
0
36,000
36,000
(4,000)

($)
80,000

(32,000)
48,000
(8,000)
40,000
(18,000)
(20,000)
2,000

The difference in the operating profit in both variable costing and absorption costing is
due to the difference in Closing Inventory Valuation. In variable costing method, closing
inventory is values at variable cost only while in absorption costing the inventory is
valued at a higher price because it includes portion of Fixed Cost. When Closing

Inventory is higher, the profit is higher. As such, the profit shown in Absorption costing is
higher that that calculated using variable costing method. Following is the Profit
Reconciliation Statement
Absorbtion Costing Profit
Less : Fixed Cost Element in Closing Inventory
($2 X 1,000)
Variable Costing Profit

4,000
(2,000)
2,000