Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 29,300 hats, of which 27,800 were sold. Operating data for the month are summarized as follows:

Sales			$177,920
Manufacturing costs:
Direct materials	$105,480
Direct labor	29,300
Variable manufacturing cost	11,720
Fixed manufacturing cost	11,720		158,220
Selling and administrative expenses:
Variable	$8,340
Fixed	6,090		14,430

During August, Head Gear Inc. manufactured 26,300 hats and sold 27,800 hats. Operating data for August are summarized as follows:

Sales			$177,920
Manufacturing costs:
Direct materials	$94,680
Direct labor	26,300
Variable manufacturing cost	10,520
Fixed manufacturing cost	11,720		143,220
Selling and administrative expenses:
Variable	$8,340
Fixed	6,090		14,430

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

Contribution marginGross profitInventory, July 31SalesTotal cost of goods soldSales		$Sales
Cost of goods sold:
Contribution marginCost of goods manufacturedDirect laborDirect materialsSelling and administrative expensesCost of goods manufactured	$Cost of goods manufactured
Contribution marginDirect laborGross profitInventory, July 31Selling and administrative expensesInventory, July 31	Inventory, July 31
Contribution marginInventory, August 1Manufacturing marginSalesTotal cost of goods soldTotal cost of goods sold		Total cost of goods sold
Manufacturing marginGross profitInventory, August 1SalesSelling and administrative expensesGross profit		$Gross profit
Contribution marginDirect laborInventory, August 1SalesSelling and administrative expensesSelling and administrative expenses		Selling and administrative expenses
Operating incomeOperating lossOperating income		$Operating income

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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

Contribution marginDirect laborGross profitInventory, July 31SalesSales		$Sales
Cost of goods sold:
Contribution marginDirect laborDirect materialsInventory, August 1Variable cost of goods soldInventory, August 1	$Inventory, August 1
Cost of goods manufacturedFixed manufacturing costsInventory, August 1Manufacturing marginSalesCost of goods manufactured	Cost of goods manufactured
Contribution marginDirect materialsInventory, August 1Selling and administrative expensesTotal cost of goods soldTotal cost of goods sold		Total cost of goods sold
Gross profitInventory, August 1Manufacturing marginSalesSelling and administrative expensesGross profit		$Gross profit
Cost of goods manufacturedDirect laborInventory, August 1Selling and administrative expensesTotal cost of goods soldSelling and administrative expenses		Selling and administrative expenses
Operating incomeOperating lossOperating income		$Operating income

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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

Contribution marginGross profitManufacturing marginInventory, July 31SalesSales		$Sales
Variable cost of goods sold:
Cost of goods soldDirect laborDirect materialsFixed manufacturing costsVariable cost of goods manufacturedVariable cost of goods manufactured	$Variable cost of goods manufactured
Contribution marginCost of goods soldFixed manufacturing costsFixed selling and administrative expensesInventory, July 31Inventory, July 31	Inventory, July 31
Fixed cost of goods soldFixed selling and administrative expensesManufacturing marginSalesTotal variable cost of goods soldTotal variable cost of goods sold		Total variable cost of goods sold
Contribution marginFixed manufacturing costsGross profitInventory, July 31Manufacturing margin		$- Select -
Direct laborDirect materialsFixed selling and administrative expensesInventory, July 31Variable selling and administrative expenses		- Select -
Contribution marginCost of goods manufacturedFixed manufacturing costsInventory, July 31Manufacturing margin		$- Select -
Fixed costs:
Fixed contribution marginFixed manufacturing costsFixed salesTotal variable cost of goods soldVariable cost of goods manufactured	$- Select -
Fixed selling and administrative expensesFixed manufacturing marginTotal variable cost of goods soldVariable cost of goods manufacturedVariable selling and administrative expenses	- Select -
Fixed selling and administrative expensesFixed manufacturing marginTotal fixed costsVariable cost of goods manufacturedVariable selling and administrative expenses		- Select -
Operating incomeOperating loss		$- Select -

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Partially correct

2b. Prepare income statement for August using the variable costing concept.

Head Gear Inc. Variable Costing Income Statement For the Month Ended August 31

Contribution marginGross profitManufacturing marginInventory, July 31Sales		$- Select -
Variable cost of goods sold:
Contribution marginDirect laborFixed selling and administrative expensesInventory, August 1Total variable cost of goods sold	$- Select -
Direct laborInventory, August 1Manufacturing marginFixed selling and administrative expensesVariable cost of goods manufactured	- Select -
Contribution marginFixed selling and administrative expensesSalesTotal variable cost of goods soldVariable selling and administrative expenses		- Select -
Direct laborDirect materialsInventory, August 1Manufacturing marginSales		$- Select -
Contribution marginFixed selling and administrative expensesInventory, August 1Variable cost of goods manufacturedVariable selling and administrative expenses		- Select -
Contribution marginDirect laborDirect materialsInventory, August 1Sales		$- Select -
Fixed costs:
Fixed contribution marginFixed manufacturing costsFixed salesTotal variable cost of goods soldVariable cost of goods manufactured	$- Select -
Fixed selling and administrative expensesFixed manufacturing marginTotal variable cost of goods soldVariable cost of goods manufacturedVariable selling and administrative expenses	- Select -
Fixed selling and administrative expensesFixed manufacturing marginTotal fixed costsVariable cost of goods manufacturedVariable selling and administrative expenses		- Select -
Operating incomeOperating loss		$- Select -

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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

absorptionvariablevariable

costing is less than

absorptionvariableabsorption

costing due to part of

fixedvariablefixed

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:

1. costs.
2. prices.
3. sales volume.