Inventory Valuation under Absorption Costing and Variable Costing

At the end of the first year of operations, 6,600 units remained in the finished goods inventory. The unit manufacturing costs during the year were as follows:

Direct materials	$36.70
Direct labor	20.80
Fixed factory overhead	5.30
Variable factory overhead	4.70

Determine the cost of the finished goods inventory reported on the balance sheet under (a) the absorption costing concept and (b) the variable costing concept.

Absorption costing	$
Variable costing	$

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Product Profitability Analysis

PowerTrain Sports Inc. manufactures and sells two styles of All Terrain Vehicles (ATVs), the Mountain Monster and Desert Dragon, from a single manufacturing facility. The manufacturing facility operates at 100% of capacity. The following per-unit information is available for the two products:

	Mountain Monster		Desert Dragon
Sales price	$4,800		$2,800
Variable cost of goods sold	3,020		1,880
Manufacturing margin	$1,780		$920
Variable selling expenses	964		304
Contribution margin	$816		$616
Fixed expenses	380		250
Income from operations	$436		$366

In addition, the following sales unit volume information for the period is as follows:

	Mountain Monster		Desert Dragon
Sales unit volume	2,900		2,100

a. Prepare a contribution margin by product report. Calculate the contribution margin ratio for each product as a whole percent.

PowerTrain Sports Inc.
Contribution Margin by Product
	Mountain Monster	Desert Dragon
	$	$
	$	$
	$	$
	%	%

b. What advice would you give to the management of PowerTrain Sports Inc. regarding the relative profitability of the two products?

The line provides the largest total contribution margin and the largest contribution margin ratio. If the sales mix were shifted more toward the line, the overall profitability of the company would increase.

Estimated Income Statements, using Absorption and Variable Costing

Prior to the first month of operations ending October 31 Marshall Inc. estimated the following operating results:

Sales (19,200 x $68)	$1,305,600
Manufacturing costs (19,200 units):
Direct materials	787,200
Direct labor	186,240
Variable factory overhead	86,400
Fixed factory overhead	103,680
Fixed selling and administrative expenses	28,200
Variable selling and administrative expenses	34,100

The company is evaluating a proposal to manufacture 21,600 units instead of 19,200 units, thus creating an Inventory, October 31 of 2,400 units. Manufacturing the additional units will not change sales, unit variable factory overhead costs, total fixed factory overhead cost, or total selling and administrative expenses.

a. 1. Prepare an estimated income statement, comparing operating results if 19,200 and 21,600 units are manufactured in the absorption costing format. If an amount box does not require an entry leave it blank or enter 0.

Marshall Inc.
Absorption Costing Income Statement
For the Month Ending October 31
	19,200 Units Manufactured	21,600 Units Manufactured
	$	$
Cost of goods sold:
	$	$
	$	$
	$	$
Income from operations	$	$

a. 2. Prepare an estimated income statement, comparing operating results if 19,200 and 21,600 units are manufactured in the variable costing format. If an amount box does not require an entry leave it blank or enter 0.

Marshall Inc.
Variable Costing Income Statement
For the Month Ending October 31
	19,200 Units Manufactured	21,600 Units Manufactured
	$	$
Variable cost of goods sold:
	$	$
	$	$
	$	$
	$	$
Fixed costs:
	$	$
Total fixed costs	$	$
	$	$

b. What is the reason for the difference in income from operations reported for the two levels of production by the absorption costing income statement?

The increase in income from operations under absorption costing is caused by the allocation of overhead cost over a number of units. Thus, the cost of goods sold is . The difference can also be explained by the amount of overhead cost included in the inventory.

Variable Costing Income Statement

The following data were adapted from a recent income statement of Bluth Company:

	(in millions)
Sales	$292,290
Operating costs:
Cost of products sold	$140,300
Marketing, administrative, and other expenses	93,530
Total operating costs	$233,830
Income from operations	$58,460

Assume that the variable amount of each category of operating costs is as follows:

			(in millions)
Cost of products sold			$78,920
Marketing, administrative, and other expenses			38,000

a. Based on the data given, prepare a variable costing income statement for Bluth Company, assuming that the company maintained constant inventory levels during the period.

Bluth Company
Variable Costing Income Statement (assumed)
(in millions)
		$
		$
		$
Fixed costs:
	$
		$

b. If Bluth Company reduced its inventories during the period, what impact would that have on the income from operations determined under absorption costing?

If Bluth Company reduced its inventories during the period, then the cost of products sold would fixed costs allocated to the beginning inventories. Thus, the total fixed costs of products sold on the absorption costing income statement would be , and the income from operations would be .