Question

Azule Company produces a single product. Its income statements under absorption costing for its first two years of operation follow.

	2016	2017
Sales (\(35 per unit)	\)1,925,000	\(2,275,000
Cost of goods sold (\)26 per unit)	1,430,000	1,690,000
Gross margin	495,000	585,000
Selling and administrative expenses	465,000	495,000
Net income	\(30,000	\)90,000

Additional information

1. Sales and production data for these first two years follow:

	2016	2017
Units produced	60,000	60,000
Units sold	55,000	65,000

1. Its variable cost per unit and total fixed costs are unchanged during 2016 and 2017. Its \(26 per unit product cost consists of the following.

Direct materials	\)4
Direct labor	6
Variable overhead	8
Fixed overhead (\(480,000/60,000 units)	8
Total product cost per unit	\)26

1. Its selling and administrative expenses consist of the following.

	2016	2017
Variable selling and administrative expenses (\(3 per unit)	\)165,000	\(195,000
Fixed selling and administrative expenses	300,000	300,000
Total selling and administrative expenses	\)465,000	$495,000

Required

1. Prepare this company’s income statements under variable costing for each of its first two years.

2. Explain any difference between the absorption costing income and the variable costing income for these two years.

Short answer

The net loss for the year 2016 is$(10,000).

Net income for the year 2017 is$130,000.

Step-by-step solution

Meaning of Absorption Costing

Absorption costing is one of the methods used in the cost accounting branch to determine the price of a product produced. It considers bothdirect and indirect expensesassociated with the production of a product.

Preparation of income statement

Azule Company
Variable Costing Income Statement
For the year ended 2016
Particulars	Details	Amounts ($)
Sales	55000*35	$1,925,000
Less: Variable costs
Direct materials	55000*4	220,000
Direct labor	55000*6	330,000
Variable overheads	55000*8	440,000
Variable selling and administrative expenses		165,000
Contribution margin		$770,000
Less: Fixed costs
Fixed overhead		480,000
Fixed selling and administrative expenses		300,000
Net loss		$(10,000)

Azule Company
Variable Costing Income Statement
For the year ended 2016
Particulars	Details	Amounts ($)
Sales	65000*35	$2,275,000
Less: Variable costs
Direct materials	65000*4	260,000
Direct labor	65000*6	390,000
Variable overheads	65000*8	520,000
Variable selling and administrative expenses		195,000
Contribution margin		$910,000
Less: Fixed costs
Fixed overhead		480,000
Fixed selling and administrative expenses		300,000
Net income		$130,000

Explanation of the difference

The difference between the incomes of 2016 and 2017 is arising due to the fixed manufacturing overheads cost.

For the year 2016:

Reconciliation of variable costing income/(loss)
Particulars	Details	Amounts ($)
Net loss from variable costing		$(10,000)
Add: Fixed overhead cost deferred in ending inventory	5000*8	40,000
Net income from absorption costing		$30,000

For the year 2017:

Reconciliation of variable costing income/(loss)
Particulars	Details	Amounts ($)
Net income from variable costing		$130,000
Less: Fixed overhead cost deferred in beginning inventory	5000*8	(40,000)
Net income from absorption costing		$90,000