Prepare income statements under variable costing and absorption costing and reconcile the differences when sales and production levels change; discuss the usefulness of absorption costing versus variable costing.

The Daniels Tool & Die Corporation has been in existence for a little over three years. The company's sales have been increasing each year as it builds a reputation. The company manufactures dies to its customers' specifications and therefore uses a job-order cost system. Factory overhead is applied to the jobs based on direct labour hoursthe absorption-costing (full) method. Overapplied or underapplied overhead is treated as an adjustment to cost of goods sold. The company's income statements and other data for the last two years are as follows:

DANIELS TOOL & DIE CORPORATION 2015-2016 Comparative Income Statements
		2015		2016
Sales		$840,000		$1,015,000
Cost of goods sold
Finished goods, January 1		25,000		18,000
Cost of goods manufactured		548,000		657,600
Total available		573,000		675,600
Finished goods, December 31		18,000		14,000
Cost of goods sold before overhead adjustment		555,000		661,600
Underapplied factory overhead		36,000		14,400
Cost of goods sold		591,000		676,000
Gross profit		249,000		339,000
Selling expenses		82,000		95,000
Administrative expenses		70,000		75,000
Total operating expenses		152,000		170,000
Operating income		$97,000		$169,000
	Daniels Tool & Die Corporation Inventory Balances
	January 1, 2015		December 31, 2016			December 31, 2017
Raw material	$22,000		$30,000			$10,000
Work in process	$40,000		$48,000			$64,000
Direct labour hours (used in WIP)	1,335		1,600			2,100
Finished goods	$25,000		$18,000			$14,000
Direct labour hours (used in FG)	1,450		1,050			820

Daniels used the same predetermined overhead rate in applying overhead to its production orders in both 2015 and 2016. The rate was based on the following estimates:

Fixed factory overhead	$25,000
Variable factory overhead	$155,000
Direct labour hours	25,000
Direct labour costs	$150,000

In 2015 and 2016, the actual direct labour hours used were 20,000 and 23,000, respectively. Raw materials put into production were $292,000 in 2015 and $370,000 in 2016. The actual fixed overhead was $42,300 for 2015 and $37,400 for 2016, and the planned direct labour rate was the direct labour achieved.

For both years, all of the administrative costs were fixed. The variable portion of the selling expenses results from a 5% commission that is paid as a percentage of the sales revenue.

Instructions

(a)

For the year ended December 31, 2016, prepare a revised income statement for Daniels Tool & Die Corporation using the variable-costing method.

Operating income $168,730

(b)

Reconcile the difference in operating income between Daniels Tool & Die Corporation's 2016 absorption-costing income statement and the revised 2016 income statement prepared under variable costing.

(c)

Describe both the advantages and disadvantages of using variable costing.

(adapted from CMA Canada, now CPA Canada)

Please Note: There is a textbook typo:

On page 342, Question 35A, the labels for the inventory balances near the bottom of the page are wrong.

They Show:
January 1, 2015	December 31, 2016	December 31, 2017
They should show:
January 1, 2015	December 31, 2015	December 31, 2016