Absorption and Variable Costing Income Statements for Two Months and Analysis During the first month of operations ended July 31, Head Gear Inc. manufactured 26,200 hats, of which 24,900 were sold. Operating data for the month are summarized as follows: Sales $239,040 Manufacturing costs: Direct materials $144,100 Direct labor 36,680 Variable manufacturing cost 18,340 Fixed manufacturing cost 15,720 214,840 Selling and administrative expenses: Variable $12,450 Fixed 9,090 21,540 During August, Head Gear Inc. manufactured 23,600 hats and sold 24,900 hats. Operating data for August are summarized as follows: Sales $239,040 Manufacturing costs: Direct materials $129,800 Direct labor 33,040 Variable manufacturing cost 16,520 Fixed manufacturing cost 15,720 195,080 Selling and administrative expenses: Variable $12,450 Fixed 9,090 21,540Required: la. Prepare income statement for July using the absorption costing concept. Head Gear Inc. Absorption Costing Income Statement For the Month Ended July 31 Sales 239.040 Cost of goods sold: Cost of goods manufactured 199.120 X Inventory, July 31 14.940 X Total cost of goods sold 214.060 X Gross profit 24.980 X Selling and administrative expenses 21.540 Operating income 3.440 X1b. Prepare income statement for August using the absorption costing concept. Head Gear Inc. Absorption Costing Income Statement For the Month Ended August 31 Sales 239.040 Cost of goods sold: Inventory, August 1 179.360 X Cost of goods manufactured 16.500 X Total cost of goods sold 195.860 X Gross profit 43.180 X Selling and administrative expenses 21.540 Operating income 21.640 X2a. Prepare income statement for July using the variable costing concept. Head Gear Inc. Variable Costing Income Statement For the Month Ended July 31 Sales 239.040 Variable cost of goods sold: Variable cost of goods manufactured 180.780 X Inventory, July 31 18,340 X Total variable cost of goods sold 199,120 X Manufacturing margin 39.920 X Variable selling and administrative expenses V 12.450 Contribution margin 27,470 X Fixed costs: Fixed manufacturing costs 15,720 Fixed selling and administrative expenses 9.090 Total fixed costs 24.810 Operating income V 2,660 X2b. Prepare income statement for August using the variable costing concept. Head Gear Inc. Variable Costing Income Statement For the Month Ended August 31 Sales 239.040 Variable cost of goods sold: Inventory, August 1 162.840 X Variable cost of goods manufactured 16.520 X Total variable cost of goods sold 179,360 X Manufacturing margin 59.680 X Variable selling and administrative expenses V 12,450 Contribution margin 47.230 X Fixed costs: Fixed manufacturing costs 15,720 Fixed selling and administrative expenses 9.090 Total fixed costs 24.810 Operating income V 22,420 X3a. For July, operating income reported under variable v costing is less than absorption V costing due to part of fixed V 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 - v to the July 31 ending inventory - v