Income statements under absorption and variable costing

Gallatin County Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1 and operated at 100% of capacity during the first month. The following data summarize the results for July:

Sales (3,500 units)				$2,450,000
Production costs (4,000 units):
Direct materials		$1,204,000
Direct labor		517,600
Variable factory overhead		84,400
Fixed factory overhead		132,400		1,938,400
Selling and administrative expenses:
Variable selling and administrative expenses		$60,100
Fixed selling and administrative expenses		25,200		85,300

This information has been collected in the Microsoft Excel Online file. Open the spreadsheet, perform the required analysis, and input your answers in the questions below.

Open spreadsheet

a. Prepare an income statement according to the absorption costing concept.

Gallatin County Motors Inc.
Absorption Costing Income Statement
For the Month Ended July 31
		$
		$
		$

b. Prepare an income statement according to the variable costing concept.

Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31
					$
					$
					$
Fixed costs:
		$
					$

c. What is the reason for the difference in the amount of Operating income reported in (a) and (b)?

Under the method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the income statement will have a higher Operating income than will the variable costing income statement.