Income Statements under Absorption Costing 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 (12,500 units)		$1,375,000
Production costs (16,000 units):
Direct materials	$651,200
Direct labor	312,000
Variable factory overhead	156,800
Fixed factory overhead	104,000		1,224,000
Selling and administrative expenses:
Variable selling and administrative expenses	$189,700
Fixed selling and administrative expenses	73,400		263,100

If required, round interim per-unit calculations to the nearest cent.

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

Cost of goods soldDirect laborDirect materialsFixed factory overhead costsSales	$- Select -
Cost of goods soldGross profitSalesSelling and administrative expensesVariable factory overhead	- Select -
Direct laborDirect materialsGross profitFixed factory overhead costsSales	$- Select -
Cost of goods soldFixed factory overhead costsSalesSelling and administrative expensesVariable factory overhead	- Select -
Operating incomeLoss from operations	$- Select -

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

Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expenses		$- Select -
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expenses		- Select -
Contribution marginManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expenses		$- Select -
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expenses		- Select -
Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expenses		$- Select -
Fixed costs:
Contribution marginFixed factory overhead costsManufacturing marginSalesVariable cost of goods sold	$- Select -
Fixed selling and administrative expensesManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expenses	- Select -
Contribution marginOperating incomeManufacturing marginSalesTotal fixed costs		- Select -
Operating incomeLoss from operations		$- Select -

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.

On April 30, the end of the first month of operations, Joplin Company prepared the following income statement, based on the absorption costing concept:

Joplin Company Absorption Costing Income Statement For the Month Ended April 30
Sales (2,700 units)		$86,400
Cost of goods sold:
Cost of goods manufactured (3,100 units)	$71,300
Inventory, April 30 (400 units)	(9,200)
Total cost of goods sold		(62,100)
Gross profit		$24,300
Selling and administrative expenses		(14,370)
Operating income		$9,930

If the fixed manufacturing costs were $16,399 and the fixed selling and administrative expenses were $7,040, prepare an income statement according to the variable costing concept. Round all final answers to whole dollars.

Contribution marginInventoryManufacturing marginSalesVariable cost of goods manufacturedVariable selling and administrative expenses		$- Select -
Variable cost of goods sold:
Contribution marginFixed manufacturing costsVariable cost of goods manufacturedVariable cost of goods soldVariable selling and administrative expenses	$- Select -
Fixed manufacturing costsInventory, April 30Fixed selling and administrative expensesManufacturing marginSales	- Select -
InventorySalesTotal variable cost of goods manufacturedTotal variable cost of goods soldTotal variable selling and administrative expenses		- Select -
Contribution marginFixed manufacturing costsInventoryManufacturing marginSales		$- Select -
Manufacturing marginSalesVariable cost of goods manufacturedVariable cost of goods soldVariable selling and administrative expenses		- Select -
Contribution marginFixed selling and administrative expensesInventoryManufacturing marginSales		$- Select -
Fixed costs:
Fixed manufacturing costsFixed inventoryVariable cost of goods manufacturedVariable cost of goods soldVariable selling and administrative expenses	$- Select -
Fixed selling and administrative expensesFixed inventoryFixed salesVariable cost of goods soldVariable selling and administrative expenses	- Select -
Contribution marginOperating incomeManufacturing marginSalesTotal fixed costs		- Select -
Operating incomeLoss from operations		$- Select -

Product Profitability Analysis

Galaxy Sports Inc. manufactures and sells two styles of All Terrain Vehicles (ATVs), the Conquistador and Hurricane, from a single manufacturing facility. The manufacturing facility operates at 100% of capacity. The following per-unit information is available for the two products:

	Conquistador	Hurricane
Sales price	$5,600		$3,600
Variable cost of goods sold	(3,530)		(2,410)
Manufacturing margin	$2,070		$1,190
Variable selling expenses	(838)		(578)
Contribution margin	$1,232		$612
Fixed expenses	(580)		(240)
Operating income	$652		$372

In addition, the following sales unit volume information for the period is as follows:

	Conquistador	Hurricane
Sales unit volume	2,700		2,000

a. Prepare a contribution margin by product report. Compute the contribution margin ratio for each product as a whole percent.

	Conquistador	Hurricane
Contribution marginCost of goods soldDirect laborGross profitSales	$- Select -	$- Select -
Fixed cost of goods soldFixed selling expensesManufacturing marginSalesVariable cost of goods sold	- Select -	- Select -
Contribution marginCost of goods soldFixed manufacturing costsGross profitManufacturing margin	$- Select -	$- Select -
Fixed cost of goods soldFixed selling expensesManufacturing marginSalesVariable selling expenses	- Select -	- Select -
Contribution marginCost of goods manufacturedFixed manufacturing costsFixed salesManufacturing margin	$- Select -	$- Select -
Contribution margin ratioFixed manufacturing costsFixed salesManufacturing marginVariable cost of goods sold	- Select -%	- Select -%

b. What advice would you give to the management of Galaxy Sports Inc. regarding the profitability of the two products?

The

ConquistadorHurricane

line provides the largest total contribution margin and the largest contribution margin ratio. If the sales mix were shifted more toward the

ConquistadorHurricane

line, the overall profitability of the company would increase.