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 (18,000 units)		$1,620,000
Production costs (23,000 units):
Direct materials	$765,900
Direct labor	368,000
Variable factory overhead	184,000
Fixed factory overhead	121,900		1,439,800
Selling and administrative expenses:
Variable selling and administrative expenses	$223,200
Fixed selling and administrative expenses	86,400		309,600

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 costsSalesSales	$Sales
Cost of goods soldGross profitSalesSelling and administrative expensesVariable factory overheadCost of goods sold	Cost of goods sold
Direct laborDirect materialsGross profitFixed factory overhead costsSalesGross profit	$Gross profit
Cost of goods soldFixed factory overhead costsSalesSelling and administrative expensesVariable factory overheadSelling and administrative expenses	Selling and administrative expenses
Operating incomeLoss from operations	$- Select -

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a. 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.

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 -

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b. Under variable costing, the cost of goods manufactured includes only variable manufacturing costs.

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.

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