1). Income statement using absorption costing method: -
Revenues: $100 * 35,000
cost of goods sold:
Direct Materials ($75 * 35,000)
Direct Labor costs ($50 * 35,000)
Variable manufacturing overheads ($20
*35,000)
Fixed Manufacturing overhead ($7.5 *35,000)
cost of goods sold
Gross margin
operating costs:
Variable selling expenses ($15*35,000)
Fixed selling and administrative expenses
Total operating costs
operating income
$3,500,000
$2,625,000
$1,750,000
$700,000
262500
$5,337,500
-$1,837,500
$525,000
$200,000
$725,000
-$2,562,500
Calculation of Fixed Manufacturing overhead applied:
Fixed Manufacturing overhead cost per unit = Total Fixed Manufacturing overhead cost / total units
produced
= $300,000 / 40,000
=$7.5 per unit
Fixed Manufacturing overhead applied = unit sold × cost per unit
= 35,000 × $7.5
= $262,500
Total unit product cost = Direct Materials + Direct Materials + Variable manufacturing overheads + Fixed
Manufacturing overhead
Total unit product cost = $75 +$50 +$20 +$7.5 = $152.5
2). Income statement using variable costing method: -
Revenues: $100 * 35,000
variable costs:
Direct Materials ($75 * 35,000)
$3,500,000
$2,625,000
Direct Labor costs ($50 * 35,000)
Variable manufacturing overheads ($20 *35,000)
Variable selling expenses ($15*35,000)
Total variable costs
contribution margin
Fixed costs:
Fixed Manufacturing overhead
Fixed selling and administrative expenses
Total fixed costs
operating income
$1,750,000
$700,000
$525,000
$5,600,000
-$2,100,000
$300,000
$200,000
$500,000
-$2,600,000
Total unit product cost = Direct Materials + Direct Materials + Variable manufacturing overheads
Total unit product cost = $75 +$50 +$20 = $145
3.)
The ending inventory under variable costing = 5,000 × $145 = $725,000
The ending inventory under absorption costing = 5,000 × $152.5 = $762,500
Difference = $37,500 ($762,500 - $725,000) OR (5000 × $7.5)
The reason behind the difference between the ending inventory balances using absorption costing and
variable costing is that, in absorption costing fixed manufacturing overhead is treated as product cost
and in variable costing it is treated as a non- product cost. Therefore, in absorption costing only the
portion corresponding to the units sold is treated as cost and the balance goes to the ending inventory,
but in the case of variable costing the whole fixed manufacturing overhead is treated as cost in the
current period and no fixed manufacturing overhead goes to the ending inventory. This creates a
difference in the ending inventories calculated under the two methods.
The fixed manufacturing overhead cost is fully included in variable costing and
partially in absorption costing. This makes the cost in current period higher in variable costing than
absorption costing. Therefore, the operating income calculated using absorption will be higher than that
of calculated using variable costing in the current period.