Question

Question: Preparing variable and absorption costing income statements

Game Store manufactures video games that it sells for \(38 each. The company uses a fixed manufacturing overhead allocation rate of \)3 per game. Assume all costs and production levels are exactly as planned. The following data are from Game Store’s first two months in business during 2018:

October November

Sales 1,500 units 2,900 units

Production 2,800 units 2,800 units

Variable manufacturing cost per game \( 16 \) 16

Sales commission cost per game 8 8

Total fixed manufacturing overhead 8,400 8,400

Total fixed selling and administrative costs 8,000 8,000 Requirements

1. Compute the product cost per game produced under absorption costing and under variable costing.

2. Prepare monthly income statements for October and November, including columns for each month and a total column, using these costing methods:

a. absorption costing.

b. variable costing.

3. Is operating income higher under absorption costing or variable costing in October? In November? Explain the pattern of differences in operating income based on absorption costing versus variable costing.

4. Determine the balance in Finished Goods Inventory on October 31 and November 30 under absorption costing and variable costing. Compare the differences in inventory balances and the differences in operating income. Explain the differences in inventory balances based on absorption costing versus variable costing.

Short answer

Answer

1. Total unit product cost is $19 and $16 under absorption and variable costing respectively.
2. a. gross profit is $28,500 and $55,100 for October and November respectively.

b. Contribution margin is $21,000 and $40,600 for October and November respectively.

3. Operating income is higher under absorption costing in October and lower in November.

4.This difference is due tofixed manufacturing overhead.

Step-by-step solution

Calculation of unit product cost using variable and absorption costing (1)

Particulars	Absorption costing	Variable Costing
Variable manufacturing overhead	$16	$16
Fixed manufacturing overhead ($8,400/2,800)	$3	-
Total unit product cost	$19	$16

 Step 2:  Income statement absorption costing format (2)(a)  

Particulars	October (1,500 Units)	November (2,900 Units)
Net sales revenue	$38x1,500 =$57,000	$38x2,900 =$110,200
Less: Cost of goods sold	$19x1,500 =$28,500	$19x2,900 =$55,100
Gross profit	$28,500	$55,100
Less: Variable selling and administrative cost	$8x1,500 =$12,000	$8x2,900 =$23,200
Less: Fixed selling and administrative cost	$8,000	$8,000
Operating Income	$8,500	$23,900

 Income statement variable costing format (2) (b)

Particulars	October (1,500 Units)	November (2,900 Units)
Net sales revenue	$38x1,500 =$57,000	$38x2,900 =$110,200
Less: Cost of goods sold
Variable cost of goods sold	$16x1,500 =$24,000	$16x2,900 =$46,400
Variable selling and administrative cost	$8x1,500 =$12,000	$8x2,900 =$23,200
Contribution margin	$21,000	$40,600
Less: Fixed costs
Fixed costs of goods sold	$8,400	$8,400
Fixed selling and administrative cost	$8,000	$8,000
Operating Income	$4,600	$24,200

Profitability Analysis (c)

Operating income is higher under absorption costing in October because units are lower than because of proportionate total fixed cost for units sold are charged for determination of operating profit. Operating income in November is higher under variable costing because units sold are higher than the units produced. In November, the operating income is higher under variable costing. Operating income is higher under variable costing because fixed manufacturing overhead that is contained in the in beginning Finished Goods inventory under absorption costing is not contained in beginning Finished Goods inventory (and Cost of Goods Sold) under variable costing.

Calculation of ending inventory (4)

Particulars	October	November
Beginning inventory	0	1,300
(+) Units produced	2,800	2,800
(-) Units sold	1,500	2,900
Ending inventory	1,300	1,200
Amount of ending inventory as per variable costing (Product cost per unit is $16)	$20,800	$19,200
Amount of ending inventory as per absorption costing (Product cost per unit is $19)	$24,700	$22,800

The amount of ending inventory as per variable costing is less than the amount of inventory as per absorption costing. This difference is due to fixed manufacturing overhead. The absorption costing includes fixed manufacturing overhead while calculating unit product cost.