Federal Mixing (FM) is a division of Federal Chemicals, a large diversified chem
ID: 2435255 • Letter: F
Question
Federal Mixing (FM) is a division of Federal Chemicals, a large diversified chemical company. FM provides mising services for both outside customers and other Federal divisions. FM buys or receives liquid chemicals and combines and packages them according to the customers specifications. FM computes its divisional net income on both a fully absorbed and variable costing basis. For the year just ending it reportedNet Income
Absorption costing $13,800,000
Variable Costing $12,600,000
Difference $1,200,000
Overhead is assigned to products using machine hours. There is no finished goods inventory at FM, only work-in-progress (WIP) inventory. As soon as a product is completed, it is shipped to the customer. The beginning inventory was valued at $6.3 Million and contained 70,000 machine hours. The ending WIP inventory was valued at $9.9 Million and contained 90,000 machine hours.
Need a short nontechnical note to senior management explaining why variable costing and absortion costing net income amounts differ.
Explanation / Answer
Absorption Costing makes no difference between Fixed and Variable Costs.
According to Absorption Costing , the beginning and Ending Inventory would be valued at 6.3 and 9.9 M respectively.
However, Variable Costing considers only variable Costs.
Hence, it would consider only the variable portion of the 6.3 M and 9.9M .
Hence , the difference.
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