1. Approximately how busy (relative to a normal month) was the factory in August?

The factory in the month of August was relatively lesser busy than the normal month. The

reason behind this is that it’s clearly mentioned in the case study that the company had

reduced its production levels below normal which states that the men and machine was not

involved much in the production and thus the factory was idle more of the time due to lesser

production.

2. Can you construct an income statement for a "normal" month under both absorption
costing and direct costing? Analyze the profit variance for August versus a normal month.

Income Statement Absorption Costing Direct Costing Variances

Sales 11,32,112 11,32,112 -

Cost of Sales 6,10,416 4,18,648 1,91,768
Gross Margin 5,21,696 7,13,464 -1,91,768
Less: Manufacturing Overhead
Labour -21,704 -21,704 -
Material 20,324 20,324 -
Overhead 6,904.00 8,692 -1,788
Fixed Factory Overhead - 2,63,448 -2,63,448

Profit Before S&A 5,16,172 4,42,704 73,468

Selling Expenses 3,41,928 3,41,928 -
Administrative Expenses 1,60,208 1,60,208 -
Profit or losses 14,036 -59,432 73,468

3. be prepared to explain the profit differences shown in Exhibits 1 and 2 ($-22928 vs.
$34272) and in Exhibits 3($14036 vs. -59432)

The difference in the profits was mainly attributed to the two systems where the difference

equals the difference in the amount of fixed manufacturing overhead charged in the income

statement. Thus, the underlying condition is the treatment of manufacturing cost in both the

profits.
4. Could the problem in the case arise with respect to annual income statements?

No such problems won’t arise with the annual statements as they are prepared as per GAAP and

hence the principles followed are independent of the cost records and the differences arising over

here will be self reconciled and the totality approach is followed and thus no under absorption

would be recorded I the firm decides to follow direct costing technique but if absorption is followed

there will be an effect in these statements as well.

5. From a managerial perspective, how does graham inc. earn a profit? Which costing system
best reflects the basic economics of the business?

Provided the direct costing, in this the income statement of each of the period includes the

actual fixed manufacturing overhead incurred in that month whereas provided the absorption

costing is used, the income statement will include that part of the manufacturing cost only

which is attributed solely to the standard cost of goods sold variance for that month.

However, the income statement will again include the production variance for that month

itself. Thus, the difference between the profits under the present two systems is always equal

to the difference arising in the fixed cost of that month. Thus looking into the whole scenario,

we would recommend Graham Inc. for Direct Costing.

6. What do you recommend? 

This is always difficult to judge whether the company should use which costing since both

the systems are right and correct in their own statement. However, the answer is solely based

on what the motive of the company is. Looking into the case study, we can resolve that the

company is keener to determine profits out of their production which therefore suggests

going for absorption costing as the company would eventually have profits in their statement.

But if they are looking for deriving profits out of level of sales, then direct costing is more

suitable.