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 (10,500 units)				$1,260,000
Production costs (14,000 units):
Direct materials		$621,600
Direct labor		298,200
Variable factory overhead		149,800
Fixed factory overhead		99,400		1,169,000
Selling and administrative expenses:
Variable selling and administrative expenses		$181,200
Fixed selling and administrative expenses		70,100		251,300

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

Question Content Area

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	$- 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 -

Question Content Area

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		$- 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 -

Question Content Area

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.