Absorption and Variable Costing Income Statements for Two Months and Analysis During the first month of operations ended July 31, Head Gear Inc. manufactured 21,100 hats, of which 20,000 were sold. Operating data for the month are summarized as follows: Sales Manufacturing costs: $140,000 Direct materials $84,400 Direct labor 23,210 Variable manufacturing cost 10,550 Fixed manufacturing cost 8,440 126,600 Selling and administrative expenses: Variable $8,000 Fixed 5,840 13,840 During August, Head Gear Inc. manufactured 18,900 hats and sold 20,000 hats. Operating data for August are summarized as follows: Sales Manufacturing costs: $140,000 Direct materials $75,600 Direct labor 20,790 Variable manufacturing cost 9,450 Fixed manufacturing cost 8,440 114,280 Variable Fixed Required: $8,000 5,840 13,840 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 Feedback 126,600 -23,210 X 140,000 Check My Work - 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 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 75,600 X 140,000 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 Head Gear Inc. Variable Costing Income Statement For the Month Ended July 31 Variable cost of goods sold: Fixed costs: Feedback Check My Work 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: 0000 Check My Work 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 Feedback 3a. For July, operating income reported under manufacturing costs that are expensed. costing is less than costing due to part of 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: 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 to allocating Feedback under the variable costing concept. The difference in operating income reported under the absorption costing concept is due to the 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. 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