Question

Preparing variable and absorption costing income statements Linda’s Foods produces frozen meals that it sells for \(7 each. The company computes a new monthly fixed manufacturing overhead allocation rate based on the planned number of meals to be produced that month. Assume all costs and production levels are exactly as planned. The following data are from Linda’s Foods’s first month in business:

January 2018

Units produced and sold:

Sales 1,000 meals

Production 1,200 meals

Variable manufacturing cost per meal \) 3

Sales commission cost per meal 1

Total fixed manufacturing overhead 660

Total fixed selling and administrative costs 500

Requirements:

1. Compute the product cost per meal produced under absorption costing and under variable costing.
2. Prepare income statements for January 2018 using: a. absorption costing. b. variable costing.
3. Is operating income higher under absorption costing or variable costing in January?

Short answer

1. Total unit product cost is $3.55 and $3 under absorption and variable costing respectively.
2. Operating income as per absorption costing and variable costing is $1,950 and $1,840.
3. Operating income is higher under absorption costing in January.

Step-by-step solution

Calculation of unit product cost using variable and absorption costing (a)

Particulars	Absorption costing	Variable Costing
Variable manufacturing overhead	$3	$3
Fixed manufacturing overhead ($660/1,200)	$0.55	-
Total unit product cost	$3.55	$3

Income statement absorption costing format 2(a):

Particulars	Absorption Costing
Net sales revenue ($7x1,000)	$7,000
Less: Cost of goods sold ($3.55x1,000)	$3,550
Gross profit	$3,450
Variable selling and administrative cost ($1x1,000)	$1,000
Fixed selling and administrative cost	$500
Operating Income	$1,950

Income statement variable costing format 2(b)

Particulars	Variable Costing
Net sales revenue ($7x1,000)	$7,000
Less: Cost of goods sold
Variable cost of goods sold ($3x1,000)	$3,000
Variable selling and administrative cost ($1x500)	$1,000
Contribution margin	$3,000
Less: Fixed costs
Fixed costs of goods sold	$660
Fixed selling and administrative cost	$500
Operating Income	$1,840

Profitability Analysis (c):

Operating income is higher under absorption costing.