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Variable vs Absorption Costing Analysis

Great Outdoze Company manufactures sleeping bags, which sells for $65 each. The sails people commission is $1 per unit sold and the variable production costs are as follows: Direct material: $20 Direct labor: $11 Variable manufacturing overhead: $8 Fixed manufacturing overhead in 20x1 was $200,000. Fixed administrative overhead in 20x1 was $30,000. The year’s actual production was 25,000 units, of which 22,000 were sold.

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2K views2 pages

Variable vs Absorption Costing Analysis

Great Outdoze Company manufactures sleeping bags, which sells for $65 each. The sails people commission is $1 per unit sold and the variable production costs are as follows: Direct material: $20 Direct labor: $11 Variable manufacturing overhead: $8 Fixed manufacturing overhead in 20x1 was $200,000. Fixed administrative overhead in 20x1 was $30,000. The year’s actual production was 25,000 units, of which 22,000 were sold.

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anon_590039258
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PROBLEM 8-25 - Great Outdoze

Required:
1. Calculate the product cost per sleeping bag under Variable Costing
Direct material $ 20.00
Direct labor $ 11.00
Variable manufacturing overhead $ 8.00
Unit product cost $ 39.00

2. Calculate the 20x1 operating income under Variable Costing.


Great Outdoze Company
Variable-Costing Income Statement (20x1)
Sales revenue (at $65 per unit) $ 1,430,000
Less: Variable expenses:
Variable manufacturing costs (at variable cost of $39 per unit) (858,000)
Variable selling cost (at $1 per unit) (22,000)
Contribution margin $ 550,000
Less: Fixed expenses:
Fixed manufacturing overhead (200,000)
Fixed administrative overhead (30,000)
Net income $ 320.000

3. Calculate the product cost per sleeping bag under Absorption Costing.
Direct material $ 20.00
Direct labor $ 11.00
Variable manufacturing overhead $ 8.00
Fixed manufacturing overhead* $ 8.00
Unit product cost $ 47.00
* Fixed manufacturing overhead rate
Fixed manufacturing overhead = Budgeted annual fixed overhead / Planned annual production =
$200,000 / 25,000 = $8.00

4. Calculate the 20x1 operating income for tax purposes.


Great Outdoze Company
Operating Income Statement (20x1)
Sales revenue (at $65 per unit) $ 1,430,000
Less: Costs of goods sold (at absorption cost of $47 per unit) (1,034,000)
Gross margin $ 396,000
Less: Selling and adminsistrative expenses:
Variable (at $1 per unit) (22,000)
Fixed (30,000)
Net income $ 344,000

5. Explain the differences (if any) between the income under both methods.
The difference between the net income under both methods is created because
there are 3000 sleeping bags there were not sold (they still are part of the inventory). The
absorption cost method consists in dividing the fixed manufacturing costs among the total
production, therefore, if everything produced is not sold, there will still be part of the
fixed cost value incorporated in the inventory. In Great Outdoze's case, as only 22000
units were sold and 25000 were produced, there are 3000 that still part of the inventory.
The absorbed cost per unit is $8, thus there are $24,000 that are related to the fixed cost
and are now attributed to the inventory. This value is not represented in the operating
income statement, and it is the exact difference between the net income under both
methods.

6. Explain the possible effects on these calculations if Great Outdoze had


implemented a JIT inventory and FMS at the beginning of 20x1.
If the company had implemented a JIT inventory and FMS, the inventory would be
very low and flexible, thus the income difference when comparing both methods (variable
costing and absorption) should be almost insignificant.

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