Reconciliation of absorptionvariable costing

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Reconciliation of absorption/variable costing operating incomes 2008 2009 2010 (1) Absorption costing operating income (ACOI) $0 $240,000 $ 40,000 (2) Variable costing operating income (VCOI) 0 0 280,000 (3) Difference (ACOI – VCOI) $0 $240,000 $(240,000 ) (4) Fixed mfg. costs in ending inventory under absorption costing (ending inventory in units × $24 per unit) $0 $240,000 $ 0 (5) Fixed mfg. costs in beginning inventory under absorption costing (beginning inventory in units × $24 per unit) 0 0 240,000 (6) Difference = (4) – (5) $0 $240,000 $(240,000 ) In the table above, row (3) shows the difference between the operating income under absorption costing and the operating income under variable costing, for each of the three years. In 2008, the difference is $0; in 2009, absorption costing income is greater by $240,000; and in 2010, it is less by $240,000. Row (6) above shows the difference between the fixed costs in ending inventory and the fixed costs in beginning inventory under absorption costing, which is $0 in 2008, $240,000 in 2009 and -$240,000 in 2010. Row (3) and row (6) explain and reconcile the operating income differences between absorption costing and variable costing. Stuart Weil is surprised at the non-zero, positive net income (reported under absorption costing) in 2009, when sales were at the ‘breakeven volume’ of 50,000; further, he is concerned about the drop in operating income in 2010, when, in fact, sales increased to 60,000 units. In 2009, starting with zero inventories, 60,000 units were produced, 50,000 were sold, i.e., at the end of the year, 10,000 units remained in inventory. These 10,000 units had each absorbed $24 of fixed costs (total of $240,000), which would remain as assets on Headsmart’s balance sheet until they were sold. Cost of goods sold, representing only the costs of the 50,000 units sold in 2009, was accordingly reduced by $240,000, the production volume variance, resulting in a positive operating income even though sales were at breakeven levels. The following year, in 2010, production was 50,000 units, sales were 60,000 units i.e., all of the fixed costs that were included in 2009 ending inventory, flowed through COGS in 2010. Contribution margin in 2010 was $1,680,000 (60,000 units × $28), but, in absorption costing, COGS also contains the allocated fixed manufacturing costs of the units sold, which were $1,440,000 (60,000 units × $24), resulting in an operating income of $40,000 = 1,680,000 – $1,440,000 – $200,000 (fixed sales and admin.) Hence the drop in operating income under absorption costing, even though sales were greater than the computed breakeven volume: inventory levels decreased sufficiently in 2010 to cause 2010’s operating income to be lower than 2009 operating income. Note that beginning and ending with zero inventories during the 2008–2010 period, under both costing methods, Headsmart’s total operating income was $280,000. 9-18
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9-25 (10 min.) Capacity management, denominator-level capacity concepts. 1. a, b 2. a 3. d 4. c, d 5. c 6. d 7. a 8. b (or a) 9. b 10. c, d 11. a, b 9-26 (25 min.) Denominator-level problem.
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