Question
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
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:
$
$
$
Feedback
1a. Sales - (cost of goods manufactured - ending inventory*) = Gross profit; gross profit - selling and administrative expenses = operating income *(Manufactured Units - Sold units) x (total manufacturing costs/manufactured units)
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:
$
$
$
Feedback
1b. Sales - (cost of goods manufactured - ending inventory*) = Gross profit; gross profit - selling and administrative expenses = operating income *(Manufactured Units - Sold units) x (total manufacturing costs/manufactured units)
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:
$
$
Feedback
2a. Sales - variable cost of goods sold* = Manufacturing margin; Manufacturing margin - variable selling and administrative expenses = Contribution margin; Contribution margin - (fixed manufacturing costs + fixed selling and administrative expenses) = operating income *Variable cost of goods sold = Variable cost of goods manufactured - [(Manufactured Units - Sold units) x (variable manufacturing costs/manufactured units)]
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:
$
$
Feedback
2b. Sales - variable cost of goods sold* = Manufacturing margin; Manufacturing margin - variable selling and administrative expenses = Contribution margin; Contribution margin - (fixed manufacturing costs + fixed selling and administrative expenses) = operating income *Variable cost of goods sold = Variable cost of goods manufactured - [(Manufactured Units - Sold units) x (variable manufacturing costs/manufactured units)]
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 .
Feedback
3a. Review the effects on operating income when the number of units manufactured differs from the number of units sold and how managers should analyze these situations.
3b. Remember that under absorption costing, both variable and fixed selling and administrative costs are combined and then subtracted from gross profit to obtain operating income.
4. Consider what causing the difference in operating income reported under the two methods. There is a need for management to exercise care in interpreting operating income reported under absorption costing when large changes in inventory levels occur.
Feedback
Partially correct
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