Estimated Income Statements, using Absorption and Variable Costing

Prior to the first month of operations ending January $31,$ Lemke Inc. estimated the following operating results:

Line Item Description Amount

Sales $(23,200\backslash$times $$81)$ $$1,879,200$

Manufacturing costs $(23,200$ units$)$:

Direct materials $1,127,520$

Direct labor $266,800$

Variable factory overhead $125,280$

Fixed factory overhead $148,480$

Fixed selling and administrative expenses $40,400$

Variable selling and administrative expenses $48,800$

The company is evaluating a proposal to manufacture $25,600$ units instead of $23,200$ units, thus creating an ending inventory of $2,400$ 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.

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a$.1.$ Prepare an estimated income statement, comparing operating results if $23,200$ and $25,600$ units are manufactured in the absorption costing format. If an amount box does not require an entry leave it blank.

Lemke Inc.

Absorption Costing Income Statement

For the Month Ending January $31$

Line Item Description $23,200$ Units

Manufactured $25,600$ Units

Manufactured

Sales

$Sales

$1,879,200$

$Sales

$1,879,200$

Cost of goods sold:

Cost of goods manufactured

$Cost of goods manufactured

$1,668,080$

$Cost of goods manufactured

Inventory, January $31$

Inventory, January $31$

$0$

Inventory, January $31$

$2,400$

Total cost of goods sold

$Total cost of goods sold

$1,668,080$

$Total cost of goods sold

Gross profit

$Gross profit

$211,120$

$Gross profit

Selling and administrative expenses

Selling and administrative expenses

$89,200$

Selling and administrative expenses

Operating income

$Operating income

$121,920$

$Operating income

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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. Calculate unit cost for direct materials, direct labor, variable factory overhead, fixed factory overhead. Add together to get total unit cost. For $25,600$ units, use the same unit costs for direct materials, direct labor, and variable overhead, but instead recalculate the fixed factory overhead and add this to obtain the unit cost at the $25,600$ unit level. Sales $-($Cost of goods manufactured $-$ Inventory, January $31)=$ Gross profit; Gross profit $-$ Selling and administrative expenses $=$ Income from operations. Remember that the Inventory, January $31$ adjustment will only be necessary at the $25,600$ level.

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a$.2.$ Prepare an estimated income statement, comparing operating results if $23,200$ and $25,600$ units are manufactured in the variable costing format. If an amount box does not require an entry leave it blank.

Lemke Inc.

Variable Costing Income Statement

For the Month Ending January $31$

Line Item Description $23,200$ Units

Manufactured $25,600$ Units

Manufactured

Sales

$Sales

$Sales

Variable cost of goods sold:

Variable cost of goods manufactured

$Variable cost of goods manufactured

$Variable cost of goods manufactured

Inventory, January $31$

Inventory, January $31$

Inventory, January $31$

Total variable cost of goods sold

$Total variable cost of goods sold

$Total variable cost of goods sold

Manufacturing margin

$Manufacturing margin

$Manufacturing margin

Variable selling and administrative expenses

Variable selling and administrative expenses

Variable selling and administrative expenses

Contribution margin

$Contribution margin

$Contribution margin

Fixed costs:

Fixed factory overhead

$Fixed factory overhead

$Fixed factory overhead

Fixed selling and administrative expenses

Fixed selling and administrative expenses

Fixed selling and administrative expenses

Total fixed costs $Total fixed costs

$Total fixed costs

Operating income

$Operating income

$Operating income

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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, January $31.$ Thus manufacturing margin should also be the same for both levels.

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

The increase in operating income under absorption costing is cau