1. 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 (17,000 units)				$2,210,000
   Production costs (22,000 units):
   Direct materials		$1,058,200
   Direct labor		508,200
   Variable factory overhead		253,000
   Fixed factory overhead		169,400		1,988,800
   Selling and administrative expenses:
   Variable selling and administrative expenses		$308,300
   Fixed selling and administrative expenses		119,300		427,600

   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 f2cee406fff9041_2
   Cost of goods sold	fill in the blank f2cee406fff9041_4
   Gross profit	$fill in the blank f2cee406fff9041_6
   Selling and administrative expenses	fill in the blank f2cee406fff9041_8
   Operating income	$fill in the blank f2cee406fff9041_10

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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.

   Gallatin County Motors Inc.
   Variable Costing Income Statement
   For the Month Ended July 31
   Sales		$fill in the blank 9e1ffc019020017_2
   Variable cost of goods sold		fill in the blank 9e1ffc019020017_4
   Manufacturing margin		$fill in the blank 9e1ffc019020017_6
   Variable selling and administrative expenses		fill in the blank 9e1ffc019020017_8
   Contribution margin		$fill in the blank 9e1ffc019020017_10
   Fixed costs:
   Fixed factory overhead costs	$fill in the blank 9e1ffc019020017_12
   Fixed selling and administrative expenses	fill in the blank 9e1ffc019020017_14
   Total fixed costs		fill in the blank 9e1ffc019020017_16
   Operating income		$fill in the blank 9e1ffc019020017_18

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

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   c. Consider what causing the difference in operating income reported under the two methods. There is a need for management to exercise care in interpreting operating income reported under absorption costing when significant changes in inventory levels occur.

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   Partially correct

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