Estimated Income Statements, using Absorption and Variable Costing

Prior to the first month of operations ending October 31 Marshall Inc. estimated the following operating results:

Sales (30,400 x $106)	$3,222,400
Manufacturing costs (30,400 units):
Direct materials	1,939,520
Direct labor	459,040
Variable factory overhead	215,840
Fixed factory overhead	255,360
Fixed selling and administrative expenses	69,500
Variable selling and administrative expenses	84,000

The company is evaluating a proposal to manufacture 33,600 units instead of 30,400 units, thus creating an Inventory, October 31 of 3,200 units. Manufacturing the additional units will not change sales, unit variable factory overhead costs, total fixed factory overhead cost, or total selling and administrative expenses.

a. 1. Prepare an estimated income statement, comparing operating results if 30,400 and 33,600 units are manufactured in the absorption costing format. If an amount box does not require an entry leave it blank or enter 0.

Marshall Inc.
Absorption Costing Income Statement
For the Month Ending October 31
	30,400 Units Manufactured	33,600 Units Manufactured
Sales	$	$
Cost of goods sold:
Cost of goods manufactured	$	$
Inventory, October 31
Total cost of goods sold	$	$
Gross profit	$	$
Selling and administrative expenses
Income from operations	$	$

Feedback

a. 1. Recall that under absorption costing, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead. To obtain direct materials for this exercise, calculate unit cost for direct materials as $1,939,520 30,400 units. Calculate unit cost for direct labor as $459,040 30,400 units. Calculate unit cost for variable factory overhead as $215,840 30,400 units. Calculate unit cost for fixed factory overhead as $255,360 30,400 units. Add together to get total unit cost for under 30,400 units manufactured. For 33,600 units, use the same unit costs for direct materials, direct labor, and variable overhead, but instead recalculate the fixed factory overhead as $255,360 33,600 units and add this to obtain the unit cost at the 33,600 unit level. Sales - (cost of goods manufactured - Inventory, October 31) = Gross profit; gross profit - selling and administrative expenses = income from operations. Remember that the Inventory, October 31 adjustment will only be necessary at the 33,600 level.

Learning Objective 1 and Learning Objective 2.

a. 2. Prepare an estimated income statement, comparing operating results if 30,400 and 33,600 units are manufactured in the variable costing format. If an amount box does not require an entry leave it blank or enter 0.

Marshall Inc.
Variable Costing Income Statement
For the Month Ending October 31
	30,400 Units Manufactured	33,600 Units Manufactured
Sales	$	$
Variable cost of goods sold:
Variable cost of goods manufactured	$	$
Inventory, October 31
Total variable cost of goods sold	$	$
Manufacturing margin	$	$
Variable selling and administrative expenses
Contribution margin	$	$
Fixed costs:
Fixed factory overhead	$	$
Fixed selling and administrative expenses
Total fixed costs	$	$
Income from operations	$	$

Feedback

a. 2. Recall that under variable costing, fixed factory overhead costs are not a part of the cost of goods manufactured. Instead, fixed factory overhead costs are treated as a period expense. Therefore, recast the income statement such that Net sales - variable cost of products 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. Remember that the variable cost of manufacturing will be the same at both levels after adjusting for Inventory, October 31. Thus manufacturing margin should also be the same for both levels.

Learning Objective 1 and Learning Objective 2.

b. What is the reason for the difference in income from operations reported for the two levels of production by the absorption costing income statement?

The increase in income from operations under absorption costing is caused by the allocation of fixed factory overhead cost over a larger number of units. Thus, the cost of goods sold is less . The difference can also be explained by the amount of fixed factory overhead cost included in the ending inventory.