Nicky's Entrees produces frozen meals, which it sells for $ 9 each. The company uses the FIFO inventory costing method, and it computes a new monthly fixed manufacturing overhead rate based on the actual number of meals produced that month. All costs and production levels are exactly as planned. The following data are from the company's first two months in business: Requirements 1. Compute the product cost per meal produced under absorption costing and under variable costing. Do this first for January and then for February. 2. Prepare separate monthly income statements for January and for February, using the following: a. Absorption costing b. Variable costing. 3. Is operating income higher under absorption costing or variable costing in January? In February? Explain the pattern of differences in operating income based on absorption costing versus variable costing. Requirement 1. Compute the product cost per meal produced under absorption costing and under variable costing. Do this first for January and then for February. January Absorption Variable costing costing Total product cost 3.50 3 February Absorption Variable costing costing 3.70 3 Requirement 2a. Prepare separate monthly income statements for January and for February, using absorption costing. Nicky's Entrees Income Statement (Absorption Costing) Month Ended January 31 Sales revenue 9000 Less: Cost of goods sold Less: Operating income February 28 10800 Requirement 2b. Prepare Nicky's Entrees' January and February income statements using variable costing. Nicky's Entrees Contribution Margin Income Statement (Variable Costing) Month Ended January 31 February 28 Sales revenue Less: Less: Requirement 3. Is operating income higher under absorption costing or variable costing in January? In February? Explain the pattern of differences in operating income based on absorption costing versus variable costing. In January, absorption costing operating income equals exceeds is less than variable costing income. This is because units produced were equal to greater than less than units sold. Absorption costing defers some of January's February's fixed manufacturing overhead nonmanufacturing variable manufacturing overhead costs in the units of ending inventory. These costs will not be capitalized expensed paid for in cash until those units are sold. Deferring these fixed manufacturing overhead nonmanufacturing variable manufacturing overhead costs to the future increases decreases January's absorption costing income. In February, absorption costing operating income equals exceeds is less than variable costing operating income. This is because units produced were equal to greater than less than units sold for the month. As inventory increases declines , as was the case in this February, January's fixed manufacturing overhead nonmanufacturing variable manufacturing overhead costs that absorption costing assigned to that inventory are expensed in January February . This increases decreases February's absorption costing income.

Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

meals

1,200

meals

Production. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,400

meals

1,000

meals

Variable manufacturing expense per meal. . . . . . . . . . . .

$3

$3

Sales commission expense per meal. . . . . . . . . . . . . . . .

$2

$2

Total fixed manufacturing overhead. . . . . . . . . . . . . . .

$700

$700

Total fixed marketing and administrative expenses. . . . .

$600

$600