Preparing variable and absorption costing income statements

Game Source manufactures video games that it sells for \(43 each. The company uses a fixed manufacturing overhead allocation rate of \)5 per game. Assume all costs and production levels are exactly as planned. The following data are from Game Store’s first two months in business during 2018:

October November Sales 1,500 units 2,900 units Production 2,500 units 2,500 units Variable manufacturing cost per game \( 17 \) 17Sales commission cost per game 7 7Total fixed manufacturing overhead12,500 12,500

Total fixed selling and administrative costs 11,500 11,500 Requirements

1. Compute the product cost per game produced under absorption costing and under variable costing.

2. Prepare monthly income statements for October and November, including columns for each month and a total column, using these costing methods:

a. absorption costing.

b. variable costing.

3. Is operating income higher under absorption costing or variable costing in October? In November? Explain the pattern of differences in operating income based on absorption costing versus variable costing.

4. Determine the balance in Finished Goods Inventory on October 31 and November 30 under absorption costing and variable costing. Compare the differences in inventory balances and the differences in operating income. Explain the differences in inventory balances based on absorption costing versus variable costing.

Step by step solution

01

Calculation of unit product cost using variable and absorption costing 

Particulars	Absorption costing	Variable Costing
Variable manufacturing overhead	$17	$17
Fixed manufacturing overhead ($12,500/2,500)	$5	-
Total unit product cost	$22	$17

02

Income statement absorption costing format 

Particulars	October (1,500 Units)	November (2,900 Units)
Net sales revenue	$43x1,500 =$64,500	$43x2,900 =$124,700
Less: Cost of goods sold	$22x1,500 =$33,000	$22x2,900 =$63,800
Gross profit	$31,500	$60,900
Variable selling and administrative cost	$7x1,500 =$10,500	$7x2,900 =$20,300
Fixed selling and administrative cost	$11,500	$11,500
Operating Income	$9,500	$29,100

03

Income statement variable costing format

Particulars	October (1,500 Units)	November (2,900 Units)
Net sales revenue	$43x1,500 =$64,500	$43x2,900 =$124,700
Less: Cost of goods sold
Variable cost of goods sold	$17x1,500 =$25,500	$17x2,900 =$49,300
Variable selling and administrative cost	$7x1,500 =$10,500	$7x2,900 =$20,300
Contribution margin	$28,500	$55,100
Less: Fixed costs
Fixed costs of goods sold	$12,500	$12,500
Fixed selling and administrative cost	$11,500	$11,500
Operating Income	$4,500	$31,100

04

 Step 4: Profitability Analysis

Operating income is higher under absorption costing in October because units produced are higher than the units sold. Operating income in November is higher under variable costing because units sold are higher than the units produced

05

Calculation of ending inventory 

Particulars	October	November
Beginning inventory	0	1,000
(+) Units produced	2,500	2,500
(-) Units sold	1,500	2,900
Ending inventory	1,000	600[SS1]

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