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)				$1,870,000
Production costs (22,000 units):
Direct materials		$895,400
Direct labor		429,000
Variable factory overhead		215,600
Fixed factory overhead		143,000		1,683,000
Selling and administrative expenses:
Variable selling and administrative expenses		$260,900
Fixed selling and administrative expenses		101,000		361,900

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 costsSalesDirect labor	$Direct labor
Cost of goods soldGross profitSalesSelling and administrative expensesVariable factory overheadCost of goods sold	Cost of goods sold
Direct laborDirect materialsGross profitFixed factory overhead costsSalesDirect labor	$Direct labor
Cost of goods soldFixed factory overhead costsSalesSelling and administrative expensesVariable factory overheadCost of goods sold	Cost of goods sold
Operating incomeLoss from operationsOperating income	$Operating income

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 expensesFixed selling and administrative expenses		$Fixed selling and administrative expenses
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expensesFixed selling and administrative expenses		Fixed selling and administrative expenses
Contribution marginManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expensesContribution margin		$Contribution margin
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expensesFixed selling and administrative expenses		Fixed selling and administrative expenses
Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expensesContribution margin		$Contribution margin
Fixed costs:
Contribution marginFixed factory overhead costsManufacturing marginSalesVariable cost of goods soldFixed factory overhead costs	$Fixed factory overhead costs
Fixed selling and administrative expensesManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expensesFixed selling and administrative expenses	Fixed selling and administrative expenses
Contribution marginOperating incomeManufacturing marginSalesTotal fixed costsOperating income		Operating income
Operating incomeLoss from operationsOperating income		$Operating income

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 costing / variable costing

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

absorption costing / 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 / variable costing

income statement will have a higher operating income.