Operating income under absorption costing 1573150

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Operating income under absorption costing $1,573,150 Operating income under variable costing 1,543,150 Difference in operating income under absorption versus variable costing $ 30,000 Under absorption costing: Fixed mfg. costs in ending inventory (500 units $60 per unit) $ 30,000 Fixed mfg. costs in beginning inventory (0 units $60 per unit) 0 Change in fixed mfg. costs between ending and beginning inventory $ 30,000 4. Relative to the alternative of using contribution margin (from variable costing), the absorption-costing based gross margin has some pros and cons as a performance measure for Regina’s supervisors. It takes into account both variable costs and fixed costs—costs that the supervisors should be able to control in the long run—and therefore is a more complete measure than contribution margin, which ignores fixed costs (and may cause the supervisors to pay less attention to fixed costs). The downside of using absorption-costing-based gross margin is the supervisor’s temptation to use inventory levels to control the gross margin—in particular, to shore up a sagging gross margin by building up inventories. This can be offset by specifying, or limiting, the inventory build-up that can occur, charging the supervisor a carrying cost for holding inventory, and using nonfinancial performance measures such as the ratio of ending to beginning inventory. 9- 20
9-23 (40 min.) Variable and absorption costing, sales, and operating-income changes. Note: In some print versions of the text, the adjustment for production-volume variance for 2014 is listed as (260,600) rather than (260,000) and the gross margin is listed as 468,600 rather than 468,000. 1. Smart Safety’s annual fixed manufacturing costs are $1,300,000. It allocates $25 of fixed manufacturing costs to each unit produced. Therefore, it must be using $1,300,000 $25 = 52,000 units (annually) as the denominator level to allocate fixed manufacturing costs to the units produced. We can see from Smart Safety’s income statements that it disposes of any production volume variance against cost of goods sold. In 2014, 62,400 units were produced instead of the budgeted 52,000 units. This resulted in a favorable production volume variance of $260,000 F [(62,400 – 52,000) units $25 per unit], which, when written off against cost of goods sold, increased gross margin by that amount. 2. The breakeven calculation, same for each year, is shown below: Calculation of breakeven volume 201 3 201 4 2015 Selling price ($2,236,00052,000; $2,236,000 59,000; $2,683,000 62,400) $43 $43 $43 Variable cost per unit (all manufacturing) 14 14 14 Contribution margin per unit $29 $29 $29 Total fixed costs (fixed mfg. costs + fixed selling & admin. costs) $1,508,00 0 $1,508,00 0 $1,508,000 Breakeven quantity = Total fixed costs contribution margin per unit 52,000 52,000 52,000 3. Variable Costing 2013 2014 2015 Sales (units) 52,00 0 52,000 62,400 Revenues $2,236,00 0 $2,236,000 $2,683,000 Variable cost of goods sold Beginning inventory $14 0; 0; 10,400 0 0 145,600 Variable manuf. costs $14 52,000; 62,400; 52,000 728,000 873,600 728,000 Deduct ending inventory $14 0; 10,400; 0 0 (145,600 ) 0 Variable cost of goods sold 728,00 0 728,00 0 873,600 Contribution margin $1,508,00 0 $1,508,00 0 $1,809,600 Fixed manufacturing costs $1,300,00 $1,300,00 $1,300,000 9- 21
0 0 Fixed selling and administrative expenses 208,00 0 208,00 0 208,000 Operating income $ 0 $ 0 $ 301,600 Explaining variable costing operating income Contribution margin ($26 contribution margin per unit sales units) $1,508,00 0 $1,508,00 0 $1,809,600

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