Absorption and Variable Costing Income Statements for Two Months and Analysis During the first month of operations ended July 31, Head Gear Inc. manufactured 28,400 hats, of which 26,400 were sold. Operating data for the month are summarized as follows: 5221,760 Sales Manufacturing costs: Direct materials $136,320 Direct labor 36,920 Variable manufacturing cost 17,040 Fixed manufacturing cost 14,200 204,480 Selling and administrative expenses: Variable $10,560 Fixed 7,710 18,270 During August, Head Gear Inc. manufactured 24,400 hats and sold 26,400 hats. Operating data for August are summarized as follows: Sales Manufacturing costs: 5221,760 Direct materials $117,120 Direct labor 31,720 Variable manufacturing cost 14,640 Fixed manufacturing cost 14,200 177,680 Selling and administrative expenses: Variable Fixed Required: $10,560 7,710 18,270 1a. Prepare income statement for July using the absorption costing concept. Head Gear Inc. Absorption Costing Income Statement For the Month Ended July 31 Sales Cost of goods sold: Cost of goods manufactured Inventory, July 31 Total cost of goods sold Gross profit Selling and administrative expenses Operating income 204,480 221,760 Feedback Check My Work 1a. Sales (cost of goods manufactured ending inventory") Gross profit; gross profit- selling and administrative expenses operating income */Linni fa.chised Hoite Cold unita) v. (total manufacturing costalmanufactured, unital *(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 Sales Cost of goods sold: Inventory, August 1 Cost of goods manufactured Total cost of goods sold Gross profit Selling and administrative expenses Operating income Feedback 10000 Check My Work 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 Sales Variable cost of goods sold: Variable cost of goods manufactured Inventory, July 31 Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income Feedback Check My Work Dadially correct Accounting numeric field 100 Check My Work Partially correct 3a. For July, operating income reported under variable costing is less than absorption costing due to part of fixed 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: a. costs. b. prices. c. sales volume. d. "sales volume", "prices" and "costs" are correct. e. None of these choices is correct. The correct answer is: d 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 equally profitable in July and in August under the variable costing concept. The difference in operating income reported under the absorption costing concept is due to allocating fixed manufacturing cost to the July 31 ending inventory Feedback Check My Work 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. 35. 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