Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 25,800 hats, of which 24,500 were sold. Operating data for the month are summarized as follows:

Sales $171,500

Manufacturing costs:

Direct materials$103,200

Direct labor28,380

Variable manufacturing cost12,900

Fixed manufacturing cost10,320 154,800

Selling and administrative expenses:

Variable$9,800

Fixed7,150 16,950

During August, Head Gear Inc. manufactured 23,200 hats and sold 24,500 hats. Operating data for August are summarized as follows:

Sales $171,500

Manufacturing costs:

Direct materials$92,800

Direct labor25,520

Variable manufacturing cost11,600

Fixed manufacturing cost10,320 140,240

Selling and administrative expenses:

Variable$9,800

Fixed7,150 16,950

Required:

1a. Prepare income statement for July using the absorption costing concept.

Head Gear Inc.

Absorption Costing Income Statement

For the Month Ended July 31

$

Cost of goods sold:

$

$

$

1b. Prepare income statement for August using the absorption costing concept.

Head Gear Inc.

Absorption Costing Income Statement

For the Month Ended August 31

$

Cost of goods sold:

$

$

$

2a. Prepare income statement for July using the variable costing concept.

Head Gear Inc.

Variable Costing Income Statement

For the Month Ended July 31

$

Variable cost of goods sold:

$

$

$

Fixed costs:

$

$

2b. Prepare income statement for August using the variable costing concept.

Head Gear Inc.

Variable Costing Income Statement

For the Month Ended August 31

$

Variable cost of goods sold:

$

$

$

Fixed costs:

$

$

3a. For July, operating income reported under costing is less than costing due to part of manufacturing costs that are expensed.

3b. When large changes in inventory levels occur from one period to the next, it is possible for management to misinterpret such increases (or decreases) in operating income as due to changes in:

costs.

prices.

sales volume.

"sales volume", "prices" and "costs" are correct.

None of these choices is correct.

The correct answer is:

4. Based on your answers to (1) and (2), did Head Gear Inc. operate more profitably in July or in August? Explain.

Head Gear Inc. was under the variable costing concept. The difference in operating income reported under the absorption costing concept is due to allocating to the