Question 1 Consider the following information: Q1 Q2 Q3 B ✓ Solved

Question 1 Consider the following information: Q1 Q2 Q3 B

Consider the following information: Q1 Q2 Q3 Beginning inventory (units) 000 Budgeted units to be produced 300,000 Actual units produced 296,000 Units sold 294,000 Variable manufacturing costs per unit produced $40 $40 $40 Variable selling costs per unit sold $10 $10 $10 Fixed manufacturing costs $3,000,000 $3,000,000 $3,000,000 Fixed selling costs $1,000,000 $1,000,000 $1,000,000 Selling price per unit $70 $70 $70 There are no price, efficiency, or spending variances, and any production-volume variance is directly written off to cost of goods in the quarter in which it occurs.

a) Prepare income statements for Q1, Q2, and Q3 using variable costing and absorption costing. b) Explain the differences in operating income between the two costing systems for each quarter. Be specific!

Paper For Above Instructions

Income Statements Preparation

The income statements for Q1, Q2, and Q3 using both variable costing and absorption costing are prepared as follows:

Variable Costing Income Statement

For Quarter 1

Revenue: 294,000 units sold x $70 = $20,580,000

Variable Manufacturing Costs: 296,000 units produced x $40 = $11,840,000

Variable Selling Costs: 294,000 units sold x $10 = $2,940,000

Contribution Margin: Revenue - Variable Manufacturing Costs - Variable Selling Costs = $20,580,000 - $11,840,000 - $2,940,000 = $5,800,000

Fixed Manufacturing Costs: $3,000,000

Fixed Selling Costs: $1,000,000

Operating Income: Contribution Margin - Fixed Manufacturing Costs - Fixed Selling Costs = $5,800,000 - $3,000,000 - $1,000,000 = $1,800,000

For Quarter 2

Revenue: 294,000 units sold x $70 = $20,580,000

Variable Manufacturing Costs: 296,000 units produced x $40 = $11,840,000

Variable Selling Costs: 294,000 units sold x $10 = $2,940,000

Contribution Margin: Revenue - Variable Manufacturing Costs - Variable Selling Costs = $20,580,000 - $11,840,000 - $2,940,000 = $5,800,000

Fixed Manufacturing Costs: $3,000,000

Fixed Selling Costs: $1,000,000

Operating Income: Contribution Margin - Fixed Manufacturing Costs - Fixed Selling Costs = $5,800,000 - $3,000,000 - $1,000,000 = $1,800,000

For Quarter 3

Revenue: 294,000 units sold x $70 = $20,580,000

Variable Manufacturing Costs: 296,000 units produced x $40 = $11,840,000

Variable Selling Costs: 294,000 units sold x $10 = $2,940,000

Contribution Margin: Revenue - Variable Manufacturing Costs - Variable Selling Costs = $20,580,000 - $11,840,000 - $2,940,000 = $5,800,000

Fixed Manufacturing Costs: $3,000,000

Fixed Selling Costs: $1,000,000

Operating Income: Contribution Margin - Fixed Manufacturing Costs - Fixed Selling Costs = $5,800,000 - $3,000,000 - $1,000,000 = $1,800,000

Absorption Costing Income Statements

For Quarter 1

Revenue: 294,000 units sold x $70 = $20,580,000

Cost of Goods Sold (COGS): Total Fixed Manufacturing Costs Allocated = Fixed Costs + Variable Manufacturing Costs + Allocated Fixed Costs in Ending Inventory.

Fixed Manufacturing Costs: $3,000,000

Variable Manufacturing Costs: 296,000 units produced x $40 = $11,840,000

COGS: (Variable Manufacturing Costs + Fixed Manufacturing Costs) for units sold: $11,840,000 + $3,000,000 = $14,840,000

Operating Income: Revenue - COGS = $20,580,000 - $14,840,000 = $5,740,000

For Quarter 2

Revenue: 294,000 units sold x $70 = $20,580,000

COGS: $14,840,000.

Operating Income: Revenue - COGS = $20,580,000 - $14,840,000 = $5,740,000

For Quarter 3

Revenue: 294,000 units sold x $70 = $20,580,000

COGS: $14,840,000.

Operating Income: Revenue - COGS = $20,580,000 - $14,840,000 = $5,740,000.

Differences in Operating Income

The income calculated under variable costing shows a consistent operating income of $1,800,000 for each quarter. In contrast, the absorption costing method presents an operating income of $5,740,000, also consistent across all quarters. The primary difference arises from how fixed manufacturing costs are treated. In absorption costing, fixed costs are absorbed into inventory, inflating the gross margin when inventory levels increase. Conversely, in variable costing, all fixed costs are expensed in the period incurred. Thus, if production equals sales, the two methods yield the same operating income. However, variations in inventory levels impact income under absorption costing, leading to increased operating income whenever production exceeds sales.

Conclusion

In conclusion, while both costing methods have their merits, they present differing pictures of profitability based on inventory behaviors. Understanding these differences is crucial for managerial decision-making.

References

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