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 (11,500 units)				$1,610,000
Production costs (15,000 units):
Direct materials		$777,000
Direct labor		373,500
Variable factory overhead		186,000
Fixed factory overhead		124,500		1,461,000
Selling and administrative expenses:
Variable selling and administrative expenses		$226,500
Fixed selling and administrative expenses		87,700		314,200

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

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
Sales	$fill in the blank c3696b049fec053_2
Cost of goods sold	fill in the blank c3696b049fec053_4
Gross profit	$fill in the blank c3696b049fec053_6
Selling and administrative expenses	fill in the blank c3696b049fec053_8
Operating income	$fill in the blank c3696b049fec053_10

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
Sales		$fill in the blank ce456bfc9fdcf85_2
Variable cost of goods sold		fill in the blank ce456bfc9fdcf85_4
Manufacturing margin		$fill in the blank ce456bfc9fdcf85_6
Variable selling and administrative expenses		fill in the blank ce456bfc9fdcf85_8
Contribution margin		$fill in the blank ce456bfc9fdcf85_10
Fixed costs:
Fixed factory overhead costs	$fill in the blank ce456bfc9fdcf85_12
Fixed selling and administrative expenses	fill in the blank ce456bfc9fdcf85_14
Total fixed costs		fill in the blank ce456bfc9fdcf85_16
Operating income		$fill in the blank ce456bfc9fdcf85_18

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

Under the variable costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under absorption 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 costing income statement will have a higher operating income.