Question

Diaz Company reports the following variable costing income statement for its single product. This company’s sales totaled 50,000 units, but its production was 80,000 units. It had no beginning finished goods inventory for the current period.

DIAZ COMPANY

Income Statement (Variable Costing)

Sales (50,000 units × \(60 per unit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \)3,000,000 Variable expenses

Variable manufacturing expense (50,000 units × \(28 per unit) . . . . . . . . . . . . . . . . . . 1,400,000 Variable selling and admin.expense (50,000 units × \)5 per unit) . . . . . . . . . . . . . . . . 250,000

Total variable expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,650,000 Contribution margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,350,000 Fixed expenses

Fixed overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320,000

Fixed selling and administrative expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160,000

Total fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 870,000

1. Convert this company’s variable costing income statement to an absorption costing income statement.

2. Explain the difference in income between the variable costing and absorption costing income statement.

Short answer

1. The net income under variable costing is $990,000.
2. Variable costing shows less income as compared to absorption costing

Step-by-step solution

Step 1:Preparation of income statement under absorption costing

Diaz Company
Absorption costing Income Statement
For the year ended December 31
	Amount ($)	Amount ($)
Sales (50,000 x 60)		3,000,000
Less: Cost of goods sold
Variable Overhead Cost (50,000 x 28)	1,400,000
Fixed Overhead Cost (50,000 x ($320,000 / 80,000))	200,000
Cost of goods sold		1,600,000
Gross Profit		1,400,000
Less: Selling and administrative expenses
Fixed cost	160,000
Variable cost	250,000
Total selling and administrative expenses		410,000
Net Income		$990,000

Step 2:Difference in income between variable costing and absorption costing income statement

The income statement under absorption costing shows the net income of $990,000 and the income under variable costing is $870,000. This difference is because the absorption costing allocates fixed overhead costs to all the units produced when they are soldwhereas variable costing includes all the variable direct costs in the cost of goods sold but excludes direct fixed overhead costs.