Question

Whitman Company has just completed its first year of operations. The company’s absorption costing income statement for the year follows: Whitman Company Income Statement Sales (40,000 units × $42.60 per unit) $ 1,704,000 Cost of goods sold (40,000 units × $21 per unit) 840,000 Gross margin 864,000 Selling and administrative expenses 460,000 Net operating income $ 404,000 The company’s selling and administrative expenses consist of $300,000 per year in fixed expenses and $4 per unit sold in variable expenses. The $21 unit product cost given above is computed as follows: Direct materials $ 11 Direct labor 3 Variable manufacturing overhead 3 Fixed manufacturing overhead ($196,000 ÷ 49,000 units) 4 Absorption costing unit product cost $ 21 Required: 1. Redo the company’s income statement in the contribution format using variable costing. 2. Reconcile any difference between the net operating income on your variable costing income statement and the net operating income on the absorption costing income statement above.

Answer 1

Answer:

1. Preparing Contribution Income statement

Sales = 40,000 units X $42.60 =                                                $1,704,000

Less: Variable Costs

Direct Material = $11 X 40,000 =                                 $440,000

Direct Labor = $3 X 40,000 =                                      $120,000

Variable Manufacturing Overhead = $3 X 40,000 = $120,000

Variable Selling Expenses = $4 X 40,000 =                $160,000

Total Variable Costs =                                                                    ($840,000)

Contribution Margin =                                                                      $864,000

Less: Fixed Costs

Selling & Administrative =                                           $300,000

Manufacturing Overheads =                                       $196,000

Total Fixed Cost =                                                                           ($496,000)

Net Operating Income =                                                                  $368,000

2. Now we have net income as per Contribution statement = $368,000 and net income as per Absorption Costing = $404,000

This difference is because of Fixed Manufacturing Overheads

Under Absorption costing Fixed Manufacturing Overheads charged = $196,000  ÷ 49,000 units = $4 per unit X 40,000 units = $160,000 whereas in contribution statement it is charged fully.

Under absorption costing even fixed costs are charged based on the number of units produced, whereas in income statement is it charged completely irrespective of the units produced as that value is fixed and cannot be avoided on per unit basis.

Difference = $404,000 - $368,000 = $36,000

Manufacturing cost for 9,000 units (49,000 - 40,000) = at the rate of $4 = $36,000

In case cost of fixed manufacturing overhead is reduced by $36,000 then profit will be increased to $368,000 + $36,000 = $404,000 same as of absorption costing.