Variable and Absorption Costing Valux manufactures a single product and sells it
ID: 2565545 • Letter: V
Question
Variable and Absorption Costing
Valux manufactures a single product and sells it for $10 per unit. At the beginning of the year there were 1,000 units in inventory. Upon further investigation, you discover that units produced last year had $3.00 of fixed manufacturing cost and $2.00 of variable manufacturing cost. During the year Valux produced 10,000 units of product. Each unit produced generated $3.00 of variable manufacturing cost. Total fixed manufacturing cost for the current year was $40,000. There were no inventories at the end of the year.
Required:
a. Prepare two income statements for the current year, one on a variable cost basis and the other on an absorption cost basis.
b. Explain any difference between the two net income numbers and provide calculations supporting your explanation of the difference.
Explanation / Answer
Valux
Income Statement under Absorption Costing Method:
Income Statement under Absorption Costing
Sales
$110,000
(11,000 units x $10)
Less: Cost of goods sold:
Beginning inventory
$5,000
Cost of goods manufactured
$70,000
Less: Ending inventory
$0
Cost of goods sold
$75,000
Gross profit
$35,000
Notes:
Variable cost = $3, total cost of goods produced = 10,000 x ($3 + $4)
Variable Costing income statement:
Variable Costing Income Statement
Units
Unit price/cost
Amount
Sales
11,000
$10
$110,000
variable cost of goods sold:
Beginning inventory
1,000
$2
$2,000
variable production cost
10,000
$3
$30,000
Cost of goods available for sale
$32,000
Less: Ending inventory
0
$0
Contribution margin
$78,000
Fixed manufacturing costs
$40,000
Net Income
38,000
Explanation for difference in net incomes under the two methods:
Absorption costing income = $35,000
Variable costing income = $38,000
Difference =$3,000
The variation in net incomes is due to the difference in the method of valuing beginning inventory of 1,000 units. Deferral in fixed overhead charged to ending inventory causes the difference the net incomes under the two methods.
Under absorption costing income statement, the value of ending inventory includes a portion of allocated fixed manufacturing cost of the units produced in the current year.
Hence, the beginning inventory under absorption costing is valued at $5 (including the $3, the fixed portion of previous year), which inflated the costs of goods available for sale in current year.
Consequently, the net income in current year is decreased by $3,000 (1,000 x $3).
Alternatively, under variable costing system, the produced units are assigned only direct costs or variable costs, while the fixed manufacturing costs are treated as period cost and expensed in the accounting period in which they are incurred. Fixed costs are not charged to the units produced.
Hence, the beginning inventory of 1,000 units is valued at the variable cost of $2 per unit. This caused an increase in net income by $3,000 (1,000 x $3). Since, no fixed manufacturing cost of previous year is charged to the beginning inventory in current year.
Income Statement under Absorption Costing
Sales
$110,000
(11,000 units x $10)
Less: Cost of goods sold:
Beginning inventory
$5,000
Cost of goods manufactured
$70,000
Less: Ending inventory
$0
Cost of goods sold
$75,000
Gross profit
$35,000
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