1 Absorption Costing Mavis Company Income Statement For the Year Ended December

# 1 absorption costing mavis company income statement

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1.Absorption Costing:Mavis Company Income StatementFor the Year Ended December 31, 2007Revenues (540,000 × \$5.00)\$2,700,000Cost of goods sold:Beginning inventory (30,000 × \$3.70a)\$ 111,000Variable manufacturing costs (550,000 × \$3.00)1,650,000Allocated fixed manufacturing costs (550,000 × \$0.70)385,000Cost of goods available for sale2,146,000Deduct ending inventory (40,000 × \$3.70)(148,000)Add adjustment for prod.-vol. variance (50,000b× \$0.70)35,000UCost of goods sold2,033,,000Gross margin667,000Operating costs:Variable operating costs (540,000 × \$1)540,000Fixed operating costs120,000Total operating costs660,000Operating income\$ 7,000a\$3.00 + (\$7.00 ÷ 10) = \$3.00 + \$0.70 = \$3.70b[(10 units per mach. hr. × 60,000 mach. hrs.) – 550,000 units)] = 50,000 units unfavorable9-25
2.Variable Costing: Mavis Company Income Statement For the Year Ended December 31, 2007Revenues\$2,700,000Variable cost of goods sold:Beginning inventory (30,000 × \$3.00)\$ 90,000Variable manufacturing costs (550,000 × \$3.00)1,650,000Cost of goods available for sale1,740,000 Deduct ending inventory (40,000 × \$3.00)(120,000)Variable cost of goods sold1,620,000Variable operating costs540,000Contribution margin540,000Fixed costs:Fixed manufacturing overhead costs420,000Fixed operating costs120,000Total fixed costs540,000Operating income\$ 03.The difference in operating income between the two costing methods is:= \$7,000 – \$0=[(40,000 × \$0.70) – (30,000 × \$0.70)]\$7,000=\$28,000 – \$21,000\$7,000=\$7,000The absorption-costing operating income exceeds the variable costing figure by \$7,000 becauseof the increase of \$7,000 during 2007 of the amount of fixed manufacturing costs in endinginventory vis-a-vis beginning inventory.4.Total fixed manufacturing costs \$420,000 \$385,000 Actual and budget line Unfavorable production-volume variance{Allocated line @ \$7.00 55,000 60,000 Machine-hours }Favorable production-volume variance 5.Absorption costing is more likely to lead to buildups of inventory than does variable costing.Absorption costing enables managers to increase reported operating income by building upinventory which reduces the amount of fixed manufacturing overhead included in the currentperiod’s cost of goods sold.9-26
Ways to reduce this incentive include(a)Careful budgeting and inventory planning.(b)Change the accounting system to variable costing or throughput costing.(c)Incorporate a carrying charge for carrying inventory.(d)Use a longer time period to evaluate performance than a quarter or a year.(e) Include nonfinancial as well as financial measures when evaluating managementperformance.9-31(10–20 min.)Breakeven under absorption costing (chapter appendix). Refer toProblem 9-30.1.The unit contribution margin is \$5 – \$3 – \$1 = \$1. Total fixed costs (\$540,000) dividedby the unit contribution margin (\$1.00) equals 540,000 units. Therefore, under variable costing540,000 units must be soldto break even.2.If there are no changes in inventory levels, the breakeven point can be the same, 540,000units, under both variable costing and absorption costing. However, as the chapter demonstrates,under absorption costing, the breakeven point is not unique; operating income is a function ofboth sales and production. Some fixed overhead is “held back” when inventories rise (10,000units × \$0.70 = \$7,000), so operating income is positive even though sales are at the breakevenlevel as commonly conceived.

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