Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 21,800 hats, of which 20,700 were sold. Operating data for the month are summarized as follows:

Sales			$198,720
Manufacturing costs:
Direct materials	$119,900
Direct labor	30,520
Variable manufacturing cost	15,260
Fixed manufacturing cost	13,080		178,760
Selling and administrative expenses:
Variable	$10,350
Fixed	7,560		17,910

During August, Head Gear Inc. manufactured 19,600 hats and sold 20,700 hats. Operating data for August are summarized as follows:

Sales			$198,720
Manufacturing costs:
Direct materials	$107,800
Direct labor	27,440
Variable manufacturing cost	13,720
Fixed manufacturing cost	13,080		162,040
Selling and administrative expenses:
Variable	$10,350
Fixed	7,560		17,910

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
		$
Cost of goods sold:
	$
		$
		$

1b. Prepare income statement for August using the absorption costing concept.

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

2a. Prepare income statement for July using the variable costing concept.

Head Gear Inc.
Variable Costing Income Statement
For the Month Ended July 31
		$
Variable cost of goods sold:
	$
		$
		$
Fixed costs:
	$
		$

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:
	$
		$

3a. For July, operating income 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 operating income as due to changes in:

1. costs.
2. prices.
3. sales volume.
4. "sales volume", "prices" and "costs" are correct.
5. 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 operating income reported under the absorption costing concept is due to allocating to the .