Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 32,600 hats, of which 30,600 were sold. Operating data for the month are summarized as follows:

Sales			$201,960
Manufacturing costs:
Direct materials	$123,880
Direct labor	32,600
Variable manufacturing cost	16,300
Fixed manufacturing cost	13,040		185,820
Selling and administrative expenses:
Variable	$9,180
Fixed	6,700		15,880

During August, Head Gear Inc. manufactured 28,600 designer hats and sold 30,600 hats. Operating data for August are summarized as follows:

Sales			$201,960
Manufacturing costs:
Direct materials	$108,680
Direct labor	28,600
Variable manufacturing cost	14,300
Fixed manufacturing cost	13,040		164,620
Selling and administrative expenses:
Variable	$9,180
Fixed	6,700		15,880

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		$

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1a. & b. Sales - (cost of goods manufactured - ending inventory*) = Gross profit; gross profit - selling and administrative expenses = income from operations *(Manufactured Units - Sold units) x (total manufacturing costs/manufactured units) a & b. 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) = income from operations *Variable cost of goods sold = Variable cost of goods manufactured - [(Manufactured Units - Sold units) x (variable manufacturing costs/manufactured units)]

Learning Objective 1 and Learning Objective 2.

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	$
Cost of goods manufactured
Total cost of goods sold
Gross profit		$
Selling and administrative expenses
Income from operations		$

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Learning Objective 1 and Learning Objective 2.

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		$

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2a. & b. Sales - (cost of goods manufactured - ending inventory*) = Gross profit; gross profit - selling and administrative expenses = income from operations *(Manufactured Units - Sold units) x (total manufacturing costs/manufactured units) a & b. 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) = income from operations *Variable cost of goods sold = Variable cost of goods manufactured - [(Manufactured Units - Sold units) x (variable manufacturing costs/manufactured units)]

Learning Objective 1 and Learning Objective 2.

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	$
Variable cost of goods manufactured
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		$

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Learning Objective 1 and Learning Objective 2.

3a. For July, income from operations 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 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: 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 income reported under the absorption costing concept is due to allocating fixed manufacturing costs to the July 31 ending inventory .

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3a. Review the effects on income from operations 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 income from operations.

Learning Objective 1 and Learning Objective 2.

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Partially correct