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 (3,000 units)				$2,340,000
Production costs (3,000 units):
Direct materials		$1,006,200
Direct labor		432,600
Variable factory overhead		70,500
Fixed factory overhead		110,700		1,620,000
Selling and administrative expenses:
Variable selling and administrative expenses		$50,200
Fixed selling and administrative expenses		21,100		71,300

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
Cost of goods soldDirect laborDirect materialsFixed factory overhead costsSales		$ fill in the blank 3
Cost of goods soldGross profitSalesSelling and administrative expensesVariable factory overhead costs		fill in the blank 5
Direct laborDirect materialsGross profitFixed factory overhead costsSales		$ fill in the blank 7
Cost of goods soldFixed factory overhead costsSalesSelling and administrative expensesVariable factory overhead costs		fill in the blank 9
Operating incomeLoss from operations		$ fill in the blank 11

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
Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expenses					$ fill in the blank 13
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expenses					fill in the blank 15
Contribution marginManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expenses					$ fill in the blank 17
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expenses					fill in the blank 19
Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expenses					$ fill in the blank 21
Fixed costs:
Contribution marginFixed factory overhead costsManufacturing marginSalesVariable cost of goods sold		$ fill in the blank 23
Fixed selling and administrative expensesManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expenses		fill in the blank 25
Contribution marginManufacturing marginOperating incomeSalesTotal fixed costs					fill in the blank 27
Operating incomeLoss from operations					$ fill in the blank 29

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

Under the

absorption costingvariable costing

method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under

absorption costingvariable costing

, 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

absorption costingvariable costing

income statement will have a higher Operating income than will the variable costing income statement.