Exercise-1 (Unit product cost under

variable and absorption costing)

Posted in: Variable and absorption costing exercises

Super Bike Manufacturing Company presents the following data for 2011:

Opening inventory 0 Units

Sales 8,000 Units
Production 10,000 Units
Closing inventory 2,000 Units
Direct materials $240
Direct labor $280
Variable manufacturing overhead expenses $100
Variable selling and administrative expenses $40
Fixed manufacturing overhead expenses $1200,000
Fixed selling and administrative expenses $800,000

Required: Compute the unit product cost of one bike under:

1. Absorption costing system.

2. Variable costing system.

Solution:

Computation of unit product cost:

Absorption costing Variable costing

Direct materials $240 $240
Direct labor $280 $280
Variable manufacturing overhead $100 $100
Fixed manufacturing overhead $120* —
———- ———-
Unit product cost $740 $620
———- ———-
*1,200,000 / 10,000 = $120

Notice that the fixed manufacturing overhead cost has not been included while computing
the cost of one bike under variable costing system.
Note: Selling and administrative expenses (both variable and fixed) are not relevant for
the computation of unit product cost.

Exercise-2 (Variable costing income

statement, Reconciliation of net operating
income)
Posted in: Variable and absorption costing exercises

The following is the absorption costing income statement of a manufacturing company:

Sales (40,000 units @ $67.50) $2,700,000

Less cost of goods sold:
Opening inventory 0
Add cost of goods manufactured (50,000 ×
2,100,000
42)
———-
Available for use 2,100,000
Less closing inventory 420,000 1,680,000
———- ———-
Gross margin 1,020,000
Less selling and administrative expenses 840,000
———-
Net operating income 180,000
———-
Fixed selling and administrative expenses are $600,000. Variable selling and
administrative expenses are $6 per unit sold. The unit product cost under
absorption costing is computed as follows:
Direct materials $20
Direct labor 8
Variable manufacturing overhead 4
Fixed manufacturing overhead
10
($500,000/50,000)
——-
Total cost per unit $42
——-

Required:
 1. Prepare a contribution margin income statement using variable costing system.
2. Reconcile any difference between net operating income figure under variable
costing income statement and net operating income figure under absorption
costing income statement.

Solution
(1) Income Statement:

Sales (40,000 units @ $67.50) 2,700,000

Less variable cost of goods sold:
Opening inventory 0
Add v. cost of goods manufactured (50,000 units ×
1,600,000
$32)
———-
Available for sale 1,600,000
Less closing inventory (10,000 units × $32) 320,000 1,280,000
———- ———-
Gross contribution margin 1,420,000
Less variable selling and administrative expenses 240,000
———-
Contribution margin 1,180000
Less fixed expenses:
Manufacturing 500,000
Selling and admin. 600,000 1,100,000
———- ———-
Net operating income 80,000
———-

(2) Reconciliation of net operating income:

Net operating income under variable costing 80,000

Fixed manufacturing overhead deferred in inventory (10,000 units
100,000
× $10)
——–
Net operating income under absorption costing 180,000
——–
Exercise-3 (Unit product cost under
variable costing, break-even point)
Posted in: Variable and absorption costing exercises

A company manufactures and sells large size tables to be used in the offices of the
executives. One table is sold for $400. The data for 2010 is as follows:

Manufacturing costs:
Direct materials per unit $120
Direct labor per unit $60
Variable manufacturing overhead per unit $20
Fixed manufacturing overhead per year $600,000
Non-manufacturing costs:
Variable selling administrative per unit $40
Fixed selling administrative $900,000
Inventory:
Opening 0
Production during 2010 10,000
———
Units available for sale 10,000
Sales 9,000
———
Closing inventory 1,000
———

Required:

1. Compute cost of one table under variable costing.

2. Prepare income statement if variable costing is used.
3. Compute breakeven point in units.
4. Calculate net operating income of the company under absorption costing by
preparing a reconciliation schedule.

Solution

(1) Computation of the cost of one office table:

Direct materials $120

Direct labor $60
Variable manufacturing over head $20
——
Cost of one table under variable costing $200
——

(2) Income statement

Sales (9,000 units @ $400) 3,600,000

Less variable cost of goods sold:
Opening inventory 0
Add v. cost of goods manufactured (10,000 units ×
2,000,000
$200)
———-
Available for sale 2,000,000
Less closing inventory (1,000 units × $200) 200,000 1,800,000
———- ———-
Gross contribution margin 1,800,000
Less variable selling and administrative expenses 360,000
———-
Contribution margin 1,440,000
Less fixed expenses:
Manufacturing 600,000
Selling and admin. 900,000 1,500,000
———- ———-
Net operating loss (60,000)
———-

(3). Break-even point:

We can easily calculate break-even point using contribution margin method:

= Total fixed expenses / Contribution margin per unit

= $1,500,000 / $160*

= 9,375 Units

*$1,440,000 / 9,000 Units

(4) Net operating income under absorption costing:

Net operating income (loss) if variable costing is used $(60,000)
Fixed manufacturing overhead cost deferred in inventory (1000 units
$60,000
× $60*)
———-
Net operating income if absorption costing is used 0
———-
*$600,000/10,000 units = $60

Exercise-4 (Variable and absorption

costing ending inventory, external
reports)
Posted in: Variable and absorption costing exercises

The production and sales data of Albari company for the year 2011 is as follows:

Variable costs per unit:

Direct materials $20
Direct labor $10
Variable manufacturing overhead $4
Variable selling and administrative
$8
expenses
Fixed costs per year:
Fixed manufacturing overhead $180,000
Fixed selling and administrative expenses $600,000

During 2011, Albari company manufactured 30,000 units out of which 25,000 units were
sold. At the end of 2011, the finished goods inventory account showed a balance of
$170,000.

Required:

1. What costing method is used by Albari to compute finished goods inventory?

2. Should company use $170,000 finished goods inventory figure for external
reports? if not what is correct amount in dollars that the company should use for
external reporting purpose?

Solution:

(1) Costing method used:

The ending inventory figure of $170,000 shows that the company is using variable
costing for finished goods inventory because the company has not included fixed
manufacturing cost in its ending inventory. The following calculation proves that:

Variable cost per unit:

Direct materials $20

Direct labor $10
Variable manufacturing overhead $4
——–
Total variable cost per unit $34
——–
Ending inventory under variable costing:
$34 × 5,000 = $170,000

(2) Finished goods inventory figure for external reports:

For external reporting purposes, company must use finished goods inventory figure
computed on the basis of absorption costing system. It is computed as follows:

Absorption cost per unit:

Direct materials $20

Direct labor $10
Variable manufacturing overhead $4
Fixed manufacturing overhead $6*
——–
Total absorption cost per unit $40
——–
Ending inventory under absorption costing:
$40 × 5,000 = $200,000

* $180,000/30,000 units = $6.00

Exercise-5 (Variable and absorption

costing income statement, reconciliation)
Posted in: Variable and absorption costing exercises

AGA company manufactures and sells a product for $20/Kg. The data for the last year is
given below:
Sales 75,000 Kg
Finished goods inventory at the beginning of the
12,000 Kg
period
Finished goods inventory at the closing of the period 17,000 Kg
Manufacturing costs:
Variable cost $8 per Kg
$320,000 per
Fixed manufacturing overhead cost
year
Marketing and administrative expenses:
Variable expenses $2 per Kg of sale
$300,000 per
Fixed expenses
year

Required:

1. Income statement using absorption and variable costing methods.

2. Explanation of the cause of difference in operating income under two concepts.

Solution
(1) Income statements:

(a) Absorption costing:

Sales 1,500,000
Less cost of goods sold:
Beginning inventory (12000Kg × $12) 144,000
Cost of goods manufactured (80,000* Kg × $12**) 960,000
———
Cost of goods available for sale 1,104,000
Closing inventory (17,000Kg × 12 ) 204,000 900,000
——— ———
Gross profit 600,000
Less marketing and administrative expenses:
Variable expenses (75,000Kg × $2) 150,000
Fixed expenses 300,000 450,000
——— ———
Net operating income 150,000
———
*Production for last year: **Manufacturing cost per
 unit
Sales 75,000Kg Variable $8
Closing inventory 17,000Kg Fixed (320,000 / 80,000) $4
———- ——
Total inventory available for
92,000Kg $12
sale
Opening inventory 12,000Kg ——
———-
Production for the period 80,000Kg
———-

(b)Variable costing:

Sales 1,500,000
Less variable cost of goods sold:
Beginning inventory (12000Kg × $8) 96,000
Variable cost of goods manufactured (80,000 Kg × $8) 640,000
———
Variable cost of goods available for sale 736,000
Closing inventory (17,000Kg × 8 ) 136,000 600,000
——— ———
Gross contribution margin 900,000
Variable marketing and admin. expenses (75,000Kg ×
150,000
$2)
———
750,000
Less period costs:
Marketing and administrative 300,000
Manufacturing 320,000 620,000
——— ———
Net operating income 130,000
———

(2) Explanation of the difference in net operating income:

The net operating income under absorption costing is $20,000 more than the net
operating income under variable costing. When production is more than sales (as in this
exercise), the fixed manufacturing overhead is deferred in inventory that causes a higher
net operating income under absorption costing than under variable costing. The
reconciliation of net operating income is as follows:
Operating income under absorption costing 150,000
Operating income under variable costing 130,000
———
Difference in net operating income 20,000
———
Change in inventory (17,000Kg – 12,000Kg) 5,000Kg
———
Fixed cost deferred in inventory (5,000Kg ×
20,000
$4.00)
———

or

Net operating income under variable costing 130,000

Add fixed manufacturing overhead cost deferred in inventory (5,000Kg
20,000
× $4.00)
———
$150,000
———

Problem-1 (Variable costing income

statement and reconciliation)
Posted in: Variable and absorption costing problems

Absorption costing income statement of a company for the first two years is as follows:

Year-1 Year-2
Sales 2,000,000 3,000,000
Less cost of goods sold:
Beginning inventory 0 340,000
Add cost of goods manufactured 1,700,000 1,700,000
————- ————-
Goods available for sale 1,700,000 2,040,000
Less ending inventory 340,000 0
————- ————-
Cost of goods sold 1,360,000 2,040,000
————- ————-
Gross margin 640,000 480,000
Less selling and administrative expenses* 620,000 680,000
————- ————-
Net operating income 20,000 280,000
————- ————-
*6 per unit variable; $500,000 fixed each year.

The manufacturing cost per unit is computed as follows:

Direct materials $16

Direct labor $20
Variable manufacturing overhead $4
Fixed manufacturing overhead $28
——
$68
——

Sales and production for two years:

Year-1 Year-2
Units produced 25,000 25,000
Units sold 20,000 30,000

Required:

1. Prepare a variable costing (contribution margin) income statement.

2. Reconcile net operating income figures.

Solution
(1) Variable costing (contribution margin) income statement:

Year-1 Year-2
Sales 2,000,000 3,000,000
Less variable cost of goods sold:
Beginning inventory 0 200,000
Add variable cost of goods manufactured (25,000 ×
1,000,000 1,000,000
$40)
 ————
————-
-
Goods available for sale 1,000,000 1,200,000
Less ending inventory (5,000 × $40) 200,000 0
————
————-
-
Variable cost of goods sold 800,000 1,200,000
————
————-
-
Gross contribution margin 1,200,000 1,800,000
Less variable selling and administrative expenses 120,000 180,000
————
————-
-
Contribution margin 1,080,000 1,620,000
———— ————
- -
Less period costs:
Fixed manufacturing costs 700,000 700,000
Fixed selling and administrative expenses 500,000 500,000
————
————-
-
Total period costs 1,200,000 1,200,000
————
————-
-
Net operating income/(loss) (120,000) 420,000
————
————-
-

(2) Reconciliation:

Year-1 Year-2
Net operating income (loss) under variable costing (120,000) 420,000
Fixed manufacturing cost deferred in inventory ($28 ×
140,000
5000)
Fixed manufacturing cost released from inventory ($28 ×
(140,000)
5000)
———- ———-
Net income under absorption costing 20,000 280,000
———- ———-
For reconciliation of net operating income figures:

When fixed manufacturing overhead cost is deferred in inventory, it is added to the

variable costing income figure and when fixed manufacturing cost is released from
inventory, it is deducted from the variable costing income figure.

Problem-2 (Variable and absorption

costing unit product costs and income
statements)
Posted in: Variable and absorption costing problems

A company manufactures a unique device that is used to boost Wi-Fi signals. The
following data relates to the first month of operation:

Beginning inventory 0
Units produced 40,000
Units sold 35,000
Selling price per unit $120
Selling and administrative expenses:
Variable per unit $4
Fixed (total for the month) $1,120,000
Manufacturing costs:
Direct materials cost per unit $30
Direct labor cost per unit $14
Variable manufacturing overhead cost per unit $4
Fixed manufacturing overhead cost $1,280,000

Management is anxious to see the profitability of newly designed unique booster.

Required:

1. Calculate unit product cost and prepare income statement under variable costing
system and absorption costing system.
2. Prepare income statement under two costing system.
 3. Prepare a schedule to reconcile the net operating income under variable and
absorption costing system.

Solution:
(1) Calculation of unit product cost:

Variable costing Absorption costing

Direct materials $30 $30
Direct labor $14 $14
Variable manufacturing overhead $4 $4
Fixed manufacturing overhead — $32*
———- ———-
production cost per unit $48 $80
———- ———-

*1,280,000/40,000

(2) Income statements:

Absorption costing:

Sales (35,000 Units × $120) 4,200,000

Less cost of goods sold:
Beginning inventory 0
Add cost of goods manufactured (40,000 Units ×
3,200,000
$80)
———-
Cost of goods available for sale 3,200,000
Less ending inventory (5,000 Units × $80) 400,000 2,800,000
———- ———-
Gross profit 1,400,000
Less selling and administrative expenses
Fixed 1,120,000
Variable (35,000 Units × $4) 140,000 1,260,000
———- ———-
140,000
———-
Variable costing:

Sales (35,000 Units × $120) 4,200,000

Less variable cost of goods sold:
Beginning inventory 0
Add v. cost of goods manufactured (40,000 Units ×
1,920,000
$48)
———-
Cost of goods available for sale 1,920,000
Less ending inventory (5,000 Units × $48) 240,000 1,680,000
———- ———-
Gross contribution margin 2,520,000
Less variable selling and administrative expenses 140,000
———-
Contribution margin 2,380,000
Less fixed costs:
Fixed manufacturing overhead 1,280,000
Fixed selling and administrative expenses 1,120,000 2,400,000
———- ———-
Net operating loss (20,000 )
———-

(3) Reconciliation schedule:

Net operating income (loss) under variable costing $(20,000)

Fixed manufacturing overhead cost deferred in inventory (5,000 units
$160,000
× $32)
———–
Net operating income under absorption costing $140,000
———–

Problem-3 (Impact of change in

production on variable and absorption
costing)
Posted in: Variable and absorption costing problems

AJX company manufactures and sells a single product. Company sold the same number
of units this year as it did last year but generated different profit for two years. The
president asks for the explanation of difference in net operating income for two years.

The income statements of two years are as follows:

Year 1 Year 2
Sales (40,000 units) $2,500,000 $2,500,000
Less cost of goods sold $1,680,000 $1,440,000
————- ————-
Gross margin 820,000 1,060,000
Less selling and administrative expenses 700,000 700,000
————- ————-
Net operating income 120,000 360,000
————- ————-

Sales, production and production for two years are as follows:

Year 1 Year 2
Production in units 40,000 50,000
Sales in units 40,000 40,000
Variable production cost per unit $12 $12
Fixed manufacturing overhead cost $1,200,000 $1,200,000

Variable selling and administrative expenses of AJX are $4.00 per unit sold. A new
manufacturing overhead rate is computed each year.

Required:

1. Calculate unit product cost for both the years under absorption costing and direct
costing (variable costing).
2. Prepare a contribution margin format income statement for two years.
3. Reconcile the net operating income figures for each year under two costing
methods.
4. Explain how operations would have different in year 2 if the company had been
using just in time (JIT) manufacturing and inventory control methods.

Solution:
(1) Computation of unit product cost:
 Year 1 Year 2
Unit product cost under variable costing $12 $12
Unit product cost under absorption costing $12+$30*=$42 $12+$24**=$36
*1,200,000 / 40,000
**1,200,000 / 50,000

(2) Variable costing income statement:

Year 1 Year 2
Sales 2,500,000 2,500,000
——— ———-
Less variable cost of goods sold:
Beginning inventory 0 0
Variable cost of goods manufactured 480,000 600,000
———- ———-
Cost of goods available for sale 480,000 600,000
Less ending inventory 0 120,000
———- ———-
Cost of goods sold 480,000 480,000
———- ———-
Gross contribution margin 2,020,000 2,020,000
Less variable selling and administrative expenses 160,000 160,000
———- ———-
Contribution margin 1,860,000 1,860,000
———- ———-
Less fixed costs:
Fixed manufacturing overhead expenses 1,200,000 1,200,000
Fixed selling and administrative expenses 540,000 540,000
———- ———-
Total fixed expenses 1,740,000 1,740,000
———- ———-
120,000 120,000
———- ———-

(3) Reconciliation of net operating income:

Year 1 Year 2
Variable costing income statement 120,000 120,000
Fixed manufacturing overhead deferred in inventory 0 240,000
 ———- ———-
120,000 360,000
———- ———-

(4) Just in time manufacturing method:

If the company had been using just in time manufacturing and inventory control methods
in year 2 the difference in net operating income under variable costing and absorption
costing would have been very little to zero. The central idea of just in time manufacturing
is to eliminate inventories. For better understanding of the impact of JIT read our article
variable and absorption costing with just in time (JIT) manufacturing system.

Problem-4 (Constant production and

change in sales – variable and absorption
costing)
Posted in: Variable and absorption costing problems

Fine Producers Inc. suffered a loss for the first month of operations. Following is the
income statement prepared by the accounting service providers of Fine Producers.

Sales $400,000
Less variable cost of goods sold $160,000
————
Gross contribution margin $240,000
Less variable selling and administrative expenses $60,000
————
Contribution margin $180,000
Less fixed expenses:
Fixed manufacturing overhead $150,000
Fixed selling and administrative expenses $40,000 $190,000
———— ————
Net operating loss $(10,000)
————
The loss created a serious problem because company was planning to use the statement to
encourage investors to purchase the stock of the company. Other relevant data is given
below:

Units produced during the first month of operation 50,000

Units sold during the first month of operation 40,000
Variable unit cost:
Direct materials $2.00
Direct labor 1.60
Variable manufacturing overhead expenses 0.40
Variable selling and administrative expenses 1.50

Required:

1. What costing method was used by the accounting service providers to prepare
income statement of Fine Producers Inc? Can an absorption costing income
statement show a profit rather than loss? Support your answer with computations.
2. Prepare company’s income statement using variable costing and absorption
costing for the second month if 60,000 units were sold in the second month and
there were no closing inventories.
3. Reconcile the second month’s net operating income under both the costing
approaches.

Solution:
(1) Costing method:

Accounting service providers used variable costing method to prepare income statement
of Fine Producers.

Yes, an income statement prepared on the basis of absorption costing can show a profit
rather than loss because a portion of fixed manufacturing overhead cost would be
absorbed by ending finished goods inventory. Under absorption costing, this absorbed
fixed cost would be deferred to the next period and would reduce the burden of current
period.

The net operating loss for the first month of operation under variable costing is $10,000
and the cost to be absorbed under absorption costing system is $30,000*. It results in a
net operating profit of $20,000 (30,000 – $10,000). The computations are shown below:

Net profit (loss) under variable costing method $(10,000)

Fixed manufacturing overhead to be deferred in inventory under
$30,000*
absorption costing system.
 ———
Net operating income if absorption costing is adopted $20,000
———

*10,000 units × $3.00

(2) Income statements for second month:

Absorption costing:

Sales (60,000 Units × $10) $600,000

Less cost of goods sold:
Beginning finished goods inventory 70,000
Direct materials 100,000
Direct labor 80,000
Manufacturing overhead 170,000
———-
Cost of goods manufactured 350,000
———-
Cost of goods available for sale 420,000
Less ending finished goods inventory 0 420,000
———- ———-
Gross profit $180,000
Add selling and administrative expenses:
Fixed 40,000
Variable (60,000 × 1.50 ) 90,000 $130,000
———- ———-
Net operating income $50,000
———-

Variable costing:

Sales (60,000 Units × $10) $600,000

Less cost of goods sold:
Beginning finished goods inventory 40,000
Direct materials 100,000
Direct labor 80,000
Variable manufacturing overhead 20,000
———-
Cost of goods manufactured 200,000
 ———-
Cost of goods available for sale 240,000
Less ending finished goods inventory 0 240,000
———- ———-
Gross contribution margin 360,000
Less variable selling and admin. expenses 90,000
———-
Contribution margin 270,000
Less fixed costs:
Manufacturing overhead 150,000
Selling and administrative 40,000 190,000
———- ———-
Net operating loss 80,000
———-

(3) Reconciliation:

If the company sells 60,000 units in second month, the sales of the second month will be
more than production. In that case, the fixed manufacturing overhead cost deferred in
inventory in first month will be released from inventory in the second month and the net
operating income under absorption costing will be less than the net operating income
under variable costing.

Net operating income under variable costing $80,000

Less fixed manufacturing overhead released from inventory $30,000*
———
Net operating income under absorption costing $50,000
———

*10,000 units × $3.00