Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 31,600 hats, of which 29,700 were sold. Operating data for the month are summarized as follows:

Sales			$243,540
Manufacturing costs:
Direct materials	$148,520
Direct labor	37,920
Variable manufacturing cost	18,960
Fixed manufacturing cost	15,800		221,200
Selling and administrative expenses:
Variable	$11,880
Fixed	8,670		20,550

During August, Head Gear Inc. manufactured 27,800 designer hats and sold 29,700 hats. Operating data for August are summarized as follows:

Sales			$243,540
Manufacturing costs:
Direct materials	$130,660
Direct labor	33,360
Variable manufacturing cost	16,680
Fixed manufacturing cost	15,800		196,500
Selling and administrative expenses:
Variable	$11,880
Fixed	8,670		20,550

Required:

1a. Prepare an income statement for July using the absorption costing concept. Enter all amounts as positive numbers.

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
Income from operations		$

1b. Prepare an income statement for August using the absorption costing concept. Enter all amounts as positive numbers.

Head Gear Inc.
Absorption Costing Income Statement
For the Month Ended August 31
Sales		$
Cost of goods sold:
	$
Inventory, August 1
		$
		$

2a. Prepare an income statement for July using the variable costing concept. Enter all amounts as positive numbers.

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
Income from operations		$

2b. Prepare an income statement for August using the variable costing concept. Enter all amounts as positive numbers.

Head Gear Inc.
Variable Costing Income Statement
For the Month Ended August 31
Sales		$
Variable cost of goods sold:
Inventory, August 1	$
		$
		$
Fixed costs:
	$
		$

3a. For July, income from operations 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 income from operations 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 income reported under the absorption costing concept is due to allocating to the .