Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 22,600 hats, of which 21,200 were sold. Operating data for the month are summarized as follows:

Sales			$186,560
Manufacturing costs:
Direct materials	$113,000
Direct labor	29,380
Variable manufacturing cost	13,560
Fixed manufacturing cost	11,300		167,240
Selling and administrative expenses:
Variable	$8,480
Fixed	6,190		14,670

During August, Head Gear Inc. manufactured 19,800 hats and sold 21,200 hats. Operating data for August are summarized as follows:

Sales			$186,560
Manufacturing costs:
Direct materials	$99,000
Direct labor	25,740
Variable manufacturing cost	11,880
Fixed manufacturing cost	11,300		147,920
Selling and administrative expenses:
Variable	$8,480
Fixed	6,190		14,670

Required:

Question Content Area

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 sold		$- Select -
Cost of goods sold:
Contribution marginCost of goods manufacturedDirect laborDirect materialsSelling and administrative expenses	$- Select -
Contribution marginDirect laborGross profitInventory, July 31Selling and administrative expenses	- Select -
Contribution marginInventory, August 1Manufacturing marginSalesTotal cost of goods sold		- Select -
Manufacturing marginGross profitInventory, August 1SalesSelling and administrative expenses		$- Select -
Contribution marginDirect laborInventory, August 1SalesSelling and administrative expenses		- Select -
Operating incomeOperating loss		$- Select -

Question Content Area

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 31Sales		$- Select -
Cost of goods sold:
Contribution marginDirect laborDirect materialsInventory, August 1Variable cost of goods sold	$- Select -
Cost of goods manufacturedFixed manufacturing costsInventory, August 1Manufacturing marginSales	- Select -
Contribution marginDirect materialsInventory, August 1Selling and administrative expensesTotal cost of goods sold		- Select -
Gross profitInventory, August 1Manufacturing marginSalesSelling and administrative expenses		$- Select -
Cost of goods manufacturedDirect laborInventory, August 1Selling and administrative expensesTotal cost of goods sold		- Select -
Operating incomeOperating loss		$- Select -

Question Content Area

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 31Sales		$- Select -
Variable cost of goods sold:
Cost of goods soldDirect laborDirect materialsFixed manufacturing costsVariable cost of goods manufactured	$- Select -
Contribution marginCost of goods soldFixed manufacturing costsFixed selling and administrative expensesInventory, July 31	- Select -
Fixed cost of goods soldFixed selling and administrative expensesManufacturing marginSalesTotal variable cost of goods sold		- Select -
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 -	blank
Fixed selling and administrative expensesFixed manufacturing marginTotal fixed costsVariable cost of goods manufacturedVariable selling and administrative expenses	blank	- Select -
Operating incomeOperating loss		$- Select -

Question Content Area

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 -	blank
Fixed selling and administrative expensesFixed manufacturing marginTotal fixed costsVariable cost of goods manufacturedVariable selling and administrative expenses	blank	- Select -
Operating incomeOperating loss		$- Select -

Question Content Area

3a. For July, operating income reported under

absorptionvariable

costing is less than

absorptionvariable

costing due to part of

fixedvariable

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:

costs.

prices.

sales volume.

"sales volume", "prices" and "costs" are correct.

None of these choices is correct.

The correct answer is:

abcde

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 Augustmore profitable in July than Augustmore profitable in July than August

under the variable costing concept. The difference in operating income reported under the absorption costing concept is due to allocating

fixed manufacturing costvariable cost

to the

July 31 ending inventoryAugust 31 ending inventory

.