Question

: Before you begin this assignment, review the Tying It All Together feature in the chapter. CF Industries Holdings, Inc. is one of the largest manufacturers and distributors of nitrogen fertilizer and other nitrogen products in the world. The corporation often produces and stores large amounts of inventory during periods of low demand to ensure that there is enough product to meet the demand of peak seasons. Assume that one line of fertilizer (with no beginning Finished Goods Inventory) had the following data during a time period of low demand:

Sales price $ 20.00 per case Variable manufacturing costs 4.00 per case Fixed manufacturing costs 100,000 per quarter Variable selling and administrative costs 2.00 per case Fixed selling and administrative costs 45,000 per quarter Given that the time period has low demand, assume the company produced 1,000,000 cases but only sold 250,000 cases.

Requirement

1. Prepare the income statement for the quarter using variable costing.

2. Prepare the income statement for the quarter using absorption costing.

3. Why, if at all, is there a difference between operating income under the two methods?

Short answer

1. The operating income under variable costing is $3,355,000
2. The operating income under absorption costing is $3,430,000
3. There is difference in operating income because of difference in method of allocation of fixed assets.

Step-by-step solution

Income statement as per variable costing (a

Particulars	Amount
Net sales revenue ($20x250,000)	$5,000,000
Less: Variable cost ($4x250,000)	$1,000,000
Less: Variable selling and administrative expenses ($2x250,000)	$500,000
Contribution Margin	$3,500,000
Less: Fixed manufacturing costs	$100,000
Less: Fixed selling and administrative costs	$45,000
Operating income	$3,355,000

Income statement as per absorption costing (b

Unit cost of goods sold (AbsorptionCosting)= Variable Cost Per Unit+Total Fixed Cost / Number of units produced in Quarter

=$4+$100,000/$10,000,000

=$4.10

Particulars	Amount
Net sales revenue ($20x250,000)	$5,000,000
Less: Cost of goods sold ($4.10x250,000)	$1,025,000
Gross profit	$3,975,000
Less: Variable selling and administrative costs ($2x250,000)	$500,000
Less: Fixed selling and administrative costs	$45,000
Operating income	$3,430,000

Profitability Analysis (c)

The operating income under absorption costing ishigher than that in variable costing because under absorption costing manufacturing fixed overheads are not fully absorbed in the current quarter due to short sales.