Absorption Costing and Variable Costing Archives - EP Online Study

Absorption Costing | Variable Costing | Exam Based Q&A | Brief | Descriptive | Analytical

Manju@2050 — Sat, 05 Feb 2022 12:41:59 +0000

Absorption Costing and Variable Costing Exam Based Questions and Answers

It includes Brief Question, Descriptive Questions and Analytical Questions with answers in details

Absorption Costing | External Costing | Traditional Costing

Absorption costing is a traditional costing system.

It is also called full absorption, conventional costing or traditional costing and external costing.

It includes variable cost and fixed cost manufacturing.

Absorption costing includes direct materials, direct labour, variable manufacturing cost and fixed manufacturing cost in product cost.

It includes administrative cost, selling and distribution cost in period cost.

But it does not include fixed manufacturing cost in period cost.

The main object of the business company is to earn more and more profit.

Success or failure of the company is depended on profit.

The income statement measures profit or loss of the company.

There are two types of methods to find out profit and loss from income statement.

Absorption costing and variable costing are two methods to prepare income statement.

Absorption costing is suitable for internal as well as external users but variable costing is suitable for internal users with management decision.

Direct materials, direct labour, variable manufacturing cost and fixed manufacturing cost = Production units × Cost per unit

Period cost under absorption costing = Administrative cost + Selling and distribution cost

Total variable, selling and distribution cost = Sales units × Cost per unit

Income Statement under Absorption Costing

For ….. units

Particulars			Amount
Sales Revenue (sales units @ $)			xxxx
(A)			xxxx
Manufacturing cost:
	Direct materials (production units @ $)
	Direct labour (production units @ $)
	Variable production overhead (production units @ $)
	Fixed production cost (production units @ $*)
	Total manufacturing cost or Cost of production		xxxx
Add:	Beginning inventory (opening stock @ $)		xxxx
Less:	Ending inventory (closing stock @ $)		(xxx)
	COGS before adjustment		xxxx
Add:	Under absorption^# manufacturing cost (compare with actual)		xxxx
Less:	Over absorption manufacturing cost (compare with actual)		(xxx)
	COGS after adjustment (B)		xxxx
	Gross profit (A–B)		xxxx
Less:	Variable administrative cost (production units x $)	xxxx
	Variable S&D cost (sales units x $)	xxxx
Less:	Fixed administrative cost (production units x $)	xxxx
	Fixed S & D cost (sales units x $)	xxxx	xxxx
Net Income			$xxxx

Fixed cost per unit (FCPU*) = Fixed manufacturing cost ÷ Normal output

Either over absorption^# or under absorption

Variable Costing | Internal Costing | Direct Costing

Variable costing is also known as internal costing, direct costing and marginal costing.

Variable cost helps to administrator to solve the problem about production planning.

Under this method, production cost is calculated on variable basis.

Variable costing includes direct materials, direct labour and variable manufacturing cost in product cost.

It includes fixed manufacturing cost, administrative, selling and distribution cost in period cost.

Direct materials, direct labour, variable manufacturing cost:

= Production units x Cost per unit

Period costing under variable costing = Fixed manufacturing cost + Administrative cost + S&D cost

Total variable, selling and distribution cost = Sales units × Cost per unit

Sold units = Opening stock + Production – Closing stock

Income Statement under Variable Costing

Particulars				Amount $
Sales revenue (sales units @ $)				xxxx
(A)				xxxx
Variable cost:
	Direct materials	(production units @ $)		xxxx
	Direct labour	(production units @ $)		xxxx
	Variable production overhead	(production units @ $)		xxxx
		Total variable cost or Cost of production		xxxx
Add:	Beginning inventory	(opening stock @ $)		xxxx
Less:	Ending inventory	(closing stock @ $)		xxxx
		COGS (B)		xxxx
		Gross contribution (A – B)		xxxx
Less:	Variable administrative cost	(production units x $)		xxxx
Less:	Variable S&D cost	(sales units x $)		xxxx
		Net contribution		xxxx
Less:	Fixed production cost	( ± absorption, if any)	xxxx
Fixed administrative cost		(production units x $)	xxxx
Fixed S&D cost		(sales units x $)	xxxx
Net Income				$xxxx

Note: If there is under absorption in absorption costing, it is added with fixed manufacturing cost in variable costing

If there is over absorption in absorption costing, it is deducted from fixed manufacturing cost in variable costing

Reconciliation of Difference in Net Cost

If there is no difference in the size of opening stock and closing stock, in such a condition net income of absorption costing and variance costing is same.

The difference between opening stock, closing stock and fixed manufacturing overhead are the main cause of difference in net income.

These differences can be solved by reconciliation.

Where:

Difference in stock units	= Difference in income ÷ Fixed cost per unit
According to variable costing, Opening stock in units	= Closing stock in units − Difference in stock units
According to absorption costing, Opening stock in units	= Closing stock in units + Difference in stock units

According to variable costing, Closing stock– Opening stock	= Difference
According to absorption costing, Opening stock – Closing stock	= Difference

Reconciliation Statement

Particulars	Amount
Net income as per variable costing	xxxx
Add: Closing stock (units @ FCPU)	xxxx
Less: Opening stock (units @ FCPU)	(xxx)
Net income as per absorption costing	xxxx

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	xxxx
Add: Opening stock (units @ FCPU)	xxxx
Less: Closing stock (units @ FCPU)	(xxx)
Net income as per variable costing	xxxx

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Brief Questions

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 1

The extracted data are given to you:

Opening stock 10,000 units

Sales 60,000 units

Closing stock 20,000 units

Required: Production units

[Answer: 70,000 units]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 2

The extracted data are given to you:

Production 20,000 units

Sales 25,000 units

Required: Stock

[Answer: Opening stock = 5,000 units]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 3

The extracted data are taken from ABC Manufactures Company:

Sales units 9,000 units

Production units 12,000 units

Cost data:

Direct materials 60

Direct labor 40

Variable factory overheads 30

Fixed manufacturing overheads $180,000

Required: Cost of production under variable costing

[Answer: COP = $15,60,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 4

The extracted data are taken from BC Manufactures Company:

Production units 12,000 units

Normal output 9,000 units

Cost data:

Direct materials 60

Direct labor 40

Variable factory overheads 30

Fixed manufacturing overheads $180,000

Required: Cost of production under absorption costing

[Answer: COP = $18,00,000] * FCPU or SFOR = $20

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 5

ABC Manufacturing Company has following extracted data:

Normal output 35,000 units

Production 30,000 units

Opening stock 5,000 units

Closing stock 10,000 units

Cost data per unit:

Direct materials $260,000

Direct labour $350,000

Variable factory overheads $275,000

Factory manufacturing overheads $200,000

Required: Cost of goods sold under variable costing

[Answer: COGS = $735,500]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 6

ABC Manufacturing Company has following extracted data:

Standard fixed overhead rate (SFOR) $7

Production 30,000 units

Sales 35,000 units

Opening stock 10,000 units

Cost data per unit:

Direct materials $260,000

Direct labour $350,000

Variable factory overheads $275,000

Required: Cost of goods sold under absorption costing

[Answer: COGS = $12,77,500] *Closing stock = 5,000 units

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 7

The following extracted information is available:

Net income as per absorption costing $450,000

Opening stock 10,000 units

Closing stock 20,000 units

Normal output was 40,000 units

Fixed manufacturing cost $200,000

Required: Reconciliation statement

[Answer: Net profit as per variable costing = $400,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 8

The following extracted information is available:

Net income as per variable costing $450,000

Opening stock 10,000 units

Closing stock 20,000 units

Normal output was 40,000 units

Fixed manufacturing cost $200,000

Required: Reconciliation statement

[Answer: Net profit as per absorption costing = $500,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 9

Following extracted information is given to you:

Cost of goods sold before adjustment $500,000

Fixed manufacturing cost $125,000

Normal output 25,000 units

Output for the period 30,000 units

Required: Cost of goods sold after adjustment

[Answer: $475,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

BQ: 10

Following extracted information is given to you:

Cost of goods sold before adjustment $500,000

Fixed manufacturing cost $125,000

Normal output 25,000 units

Output for the period 22,000 units

Required: Cost of goods sold after adjustment

[Answer: $515,000]

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Descriptive Questions

VARIABLE COSTING

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 1

Following are data pertaining to month of December of operation for ABC Textile Company related to school dress:

Opening stock 2,000 units	Administrative expenses:
Units produced 6,000 units	Fixed $250,000
Normal output 5,000 units	Variable $250,000
Units sold 7,000 units
Selling price per unit $300	Selling and distribution expenses:
Fixed manufacturing cost $200,000	Variable (per unit) $20
Variable cost per unit:	Fixed (per unit) $15
Direct materials 50
Direct labor 40
Factory overheads 30

Required: (a) Income statement under variable costing; (b) Reconciliation statement

[Answer :(1) Net income = $315,000; (2) $275,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 2

AK Manufacturing Company has reported its income statement under absorption costing technique as under:

Particulars		Amount	Amount
Sales revenue (10,000 units x $45)			450,000
Less:	Cost of goods sold:
	Beginning inventory (2,000 x $27)	54,000
	Variable cost (9,000 x $23)	207,000
	Fixed mfg. cost (9,000 x $4)	36,000
	Ending inventory (1,000 x $27)	(27,000)	(270,000)
	Gross margin before adjustment		180,000
Less:	Fixed manufacturing cost under absorbed		4,000
	Gross margin after adjustment		176,000
Less:	Other variable cost		50,000
Net income before tax			$126,000

Required: Income statement under variable costing technique

[Answer: Net income under variable costing = $130,000;

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 3

Following extracted details are given to you by EP Industries:

Normal capacity 200,000 units per year

Standard variable manufacturing expenses $20 per unit

Fixed manufacturing overhead $300,000 per year

Variable selling expenses $2 per unit

Fixed selling expenses $100,000

Unit sale price $25

The operating results for the year ending December of the last year were as follows

Sales 150,000 units

Production 180,000 units

Required: (a) variable costing income statement; (b) Reconciled profit under absorption costing

[Answers: Income under VC = $50,000, under AC = $95,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 4

XYZ Manufacturing Company with normal capacity of 50,000 units supplied you with the following particular:

Production	55,000 units
Sale	60,000 units
Closing stock	5,000 units
Unit variable manufacturing cost	$6
Unit fixed manufacturing overhead	$3
Unit variable selling and administrative cost	$2
Fixed selling & administrative cost	$90,000
Unit selling price	$15

Required: (1) Variable costing income statement; (2) Reconciled profit under absorption costing

[Answers: (1) $180,000; (2) $165,000]

ABSORPTION COSTING

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 5

The extracted cost abstract of EP Manufacturing Company was as follows:

Particulars	Units cost	The operations of the year ended December 2021 were:
Direct materials	$12	Opening stock	10,000 units
Direct labour	$3	Production	90,000 units
Variable manufacturing cost	$2	Sales	80,000 units
Variable selling & distribution expenses	$1	Sales price per unit	$30

Budgeted normal output was 100,000 units with $200,000 fixed manufacturing cost. The fixed selling and distribution expenses were $50,000

Required: (1) Income statement under absorption costing; (2) Reconciled profit under variable costing

[Answer: Net profit: A.C = $730,000; V.C = $710,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 6

The summarized data of AM Manufacturing Concern for a capacity output of 50,000 units for a year is reported as:

Items	Units Cost	Items	Units Cost
Direct materials	$14	Fixed manufacturing overhead	$75,000 annual
Direct labour	$6	Fixed selling expenses	$50,000 annual
Variable manufacturing overhead	$4	Production	45,000 units
Variable selling expenses	$2	Sales	40,000 units
Sales price per unit	$30

Required: (1) Absorption costing income statement; (2) Reconciled profit under variable costing

[Answers: (1) Net income = $42,500; (2) $35,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 7

ABC Manufacturing Company with normal capacity of 20,000 units furnished you the following information:

Beginning inventory units	3,000	Standard variable cost	$6.50
Units produced during the year	18,000	Fixed factory overhead at normal capacity	$50,000
Units sold during the year	20,000	Fixed selling and distribution cost	$5,000
		Unit selling price	$12

Required: (1) Income statement under absorption costing; (2) Reconciled profit under variable costing

[Answers: (1) $50,000; (2) $55,000] *Under absorption = $5,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 8

Following are the references data of month June of operation for XYZ Company:

Opening stock	15,000 units	Variable cost:
Units produced	45,000 units	Direct materials per unit	$4
Units sold	50,000 units	Direct labour per unit	$2
Normal output	50,000 units	Factory overheads per unit	$1
Selling price per unit	$20	Administrative	$50,000
Fixed manufacturing cost	$150,000	Selling and distribution per unit	$1
		Fixed cost:
		Manufacturing	$150,000
		Administrative	$40,000
		Selling and distribution	$30,000

Required: (1) Income statement under absorption costing; (2) Reconciliation statement

[Answer: (1) Net income = $315,000; (2) $330,000]

ABSORPTION AND VARIABLE COSTING

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

DQ: 9

Max Company uses direct costing for internal control purchase and absorption costing for external reporting purpose. The following differences are located while comparing the two statements.

Items	Variable Costing	Absorption Costing
Variable manufacturing cost	$60,000	$60,000
Fixed manufacturing cost charged	$25,000	$30,000
Fixed selling and administrative cost	$40,000	$40,000
Variable selling cost per unit	$2	$2
Selling price per unit	$30	$30

Management also projected the following data for the inventory:

Beginning inventory units 1,000	Sales units 5,000
Production units 6,000	Closing stock units 2,000

Cost of beginning inventory is the same as the cost of production in the period.

Required: Income statement by using absorption costing and variable costing approach

[Answers: Net profit = $30,000; $25,000]

*Over absorption $5,000]

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Analytical Questions

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 1

Fame Readymade Garment has given following data at the end of December 2020; it was anticipated that sales would rise 20% in year 2021. Therefore, production was increased from 20,000 units to meet this expected demand.

Particulars	Amount
Sales units during year	20,000
Selling price per unit	300
Direct materials	45
Direct labors	75
Variable manufacturing overheads	30
Variable administrative expenses	2,50,000
Variable selling and distribution expenses	1,00,000
Fixed manufacturing cost for the year	9,60,000
Fixed administrative cost	6,00,000
Fixed selling and distribution cost	4,00,000

All taxes are to be ignored. The beginning inventory of the year was nil.

You are required to prepare profit statement for the year ending December 2021

(1) Net income as per variable costing; (2) Net income as per absorption costing

[Answer: (1) V.C. = $690,000 (2) A.C. = $10,90,000;

* Over absorption = $240,000; Production = 24,000 units]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 2

XYZ Ltd uses direct costing for internal control purposes and absorption costing for external reporting purposes. The company uses the following unit costs for the one product it manufactures:

Projected cost per unit:
Direct materials	$60
Direct labour	$38
Variable manufacturing	$12
Fixed manufacturing cost	$10 (Based on 10,000 units per month)
Variable selling and administrative cost	$8
Fixed selling and administrative cost	$5.60 (Based on 10,000 units per month)

The projected selling price is $160 per unit. The fixed costs remain fixed within the relevant range of 4,000 to 16,000 units of production.

Management has also projected the following data for the month:

Opening stock 2,000 units

Production 9,000 units

Sales 7,500 units

Required: projected income statement under direct costing and absorption costing.

[Answer: Variable costing: $1,59,000, Absorption costing: $1,74,000;

* Under absorption cost =100,000 – 90,000 = 10,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 3

ABC Manufacturing Company has following data:

Income Statement under Absorption Costing

[For 14,000 units]

Particulars				Amount
Sales		[16,000 @ $80] [A]		12,80,000
Manufacturing of goods sold:
	Direct materials	[14,000 units @ $20]		280,000
	Direct labour	[14,000 units @ $10]		140,000
	Variable production cost	[14,000 units @ $15]		210,000
	Fixed manufacturing cost	[14,000 units @ $5]		70,000
		Manufacturing cost @ $50]		700,000
Add:	Opening stock	[3,000 units @ $50]		150,000
Less:	Closing Stock	[1,000 units @ $50]		(50,000)
		COGS before adjustment		800,000
Add:	Under absorption of fixed mfg cost			50,000
		COGS after adjustment (B)		850,000
		Gross profit [A –B]		430,000
Less:	Administrative and selling cost:
	Fixed		80,000
	Variable		50,000	130,000
Net income				300,000

Required: (a) Income statement under variable costing;

(b) Reconciliation of profit between absorption costing and variable costing.

[Answer: Net income under V.C. = $3,10,000;

* Fixed Manufacturing cost in V.C = $120,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 4

MS Tech (P) Ltd produces and assembles computer components. The following internal data is available:

Income Statement under Variable Costing

For 20,000 units

Particulars				Amount
Sales revenue		[21,000 units @ $100]		21,00,000
		(A)		21,00,000
Variable cost:
	Direct materials	[20,000 units @ $30]		6,00,000
	Direct labour	[20,000 units @ $15]		3,00,000
	Variable manufacturing cost	[20,000 units @ $10]		2,00,000
		Cost of production @ $55)		11,00,000
Add:	Beginning inventory	[2,000 units @ $55]		1,10,000
Less:	Ending Inventory	[1,000 units @ $55]		55,000
		COGS (B)		11,55,000
		Gross contribution (A – B)		9,45,000
Less:	Variable selling administrative cost			1,05,000
		Net contribution		8,40,000
Less:	Fixed manufacturing cost		420,000
	Fixed selling and administrative cost		+ 350,000	7,70,000
Net income				70,000

Normal capacity for the period is 20,000 units.

Required: (1) Net income under external period; (2) Reconciliation statement for the period

[Answer: Net income under A.C. = $49,000; * FCPU = $21]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 5

The following information is given by DT Manufacturing Company:

Income Statement under Variable Costing

For 27,000 units

Particulars				Amount
Sales revenue		[28,000 units @ $30]		840,000
		(A)		840,000
Variable cost:				–
	Direct materials	[27,000 units @ $5]		135,000
	Direct labour	[27,000 units @ $8]		216,000
	Variable manufacturing cost	[27,000 units @ $5]		135,000
		Cost of production @ $18)		486,000
Add:	Beginning inventory	[3,000 units @ $18]		54,000
Less:	Ending Inventory	[2,000 units @ $18]		36,000
		COGS (B)		504,000
		Gross contribution (A – B)		336,000
Less:	Variable administrative and selling cost			86,000
		Net contribution		250,000
Less:	Fixed manufacturing cost		100,000
	Fixed selling and administrative cost		+ 50,000	150,000
Net income				100,000

Normal capacity for the period is 25,000 units.

Required: (1) Conversion the income statement into absorption costing statement; (2) Reconciliation statement

[Answer: (1) $96,000; (2) $100,000;

* Over absorption = $8,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 6

The following information is available from Nepal Polymers (P) Ltd:

Particulars	January	February
Selling price per unit	$100	$100
Direct materials and labour per unit	$25	$25
Variable manufacturing cost per unit	$15	$15
Variable selling and administrative cost per unit	$10	$10
Fixed manufacturing cost	$140,000	$140,000
Fixed selling and administrative cost	10% of sales	10% of sales
Units	January	February
Production units	6,000	8,000
Sales units	5,500	7,000

Normal output is 7,000 units per month

Required: (1) Income statement under variable costing; (2) Income statement under absorption costing

[Answer: (1) V.C. = $80,000 and $140,000;

(2) A.C. = $90,000 and $160,000;

* Closing stock in Jan = 500 units; Feb = 1,500 units;

*Under absorption in January = $20,000;

Over absorption in February = $20,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

AQ: 7

A manufacturing company provides you the following data for three accounting periods:

Standard capacity is 10,000 units per month. Fixed manufacturing costs budgeted per month $400,000

Production, sales and inventory changes were as follows:

Period	Standard capacity	Produced units	Sold units
January	90%	9,000	9,000
February	110%	11,000	9,000
March	85%	8,500	10,000

Standard capacity utilized by 10,000 units

Other information:

Administrative and selling expenses were:	Variable cost per unit was as following:
Variable $20 per unit	Materials $40
Fixed selling price per period $300,000	Direct labour $40
	Manufacturing $20
	Selling price per unit $200

Determine the income under:

(1) Absorption costing for three months; (2) Marginal costing for three months

(3) Reconciliation of the difference between the net incomes reported under two concepts.

[Answer: (1) $20,000, $100,000, $40,000 (2) $20,000, $20,000, $100,000]

* Absorption: Under in January = $40,000; Over in February = $40,000;

Under in March = $60,000]

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Absorption costing | Variable costing | Reconciliation Statement | Problems and solutions

Manju@2050 — Sat, 05 Feb 2022 06:31:42 +0000

Absorption Costing | External Costing | Traditional Costing

Absorption costing is a traditional costing system.

It is also called full absorption, conventional costing or traditional costing and external costing.

It includes variable cost and fixed cost manufacturing.

Absorption costing includes direct materials, direct labour, variable manufacturing cost and fixed manufacturing cost in product cost.

It includes administrative cost, selling and distribution cost in period cost.

But it does not include fixed manufacturing cost in period cost.

The main object of the business company is to earn more and more profit.

Success or failure of the company is depended on profit.

The income statement measures profit or loss of the company.

There are two types of methods to find out profit and loss from income statement.

Absorption costing and variable costing are two methods to prepare income statement.

Absorption costing is suitable for internal as well as external users but variable costing is suitable for internal users with management decision.

Direct materials, direct labour, variable manufacturing cost and fixed manufacturing cost = Production units × Cost per unit

Period cost under absorption costing = Administrative cost + Selling and distribution cost

Total variable, selling and distribution cost = Sales units × Cost per unit

Variable Costing | Internal Costing | Direct Costing

Variable costing is also known as internal costing, direct costing and marginal costing.

Variable cost helps to administrator to solve the problem about production planning.

Under this method, production cost is calculated on variable basis.

Variable costing includes direct materials, direct labour and variable manufacturing cost in product cost.

It includes fixed manufacturing cost, administrative, selling and distribution cost in period cost.

Direct materials, direct labour, variable manufacturing cost:

= Production units x Cost per unit

Period costing under variable costing = Fixed manufacturing cost + Administrative cost + S&D cost

Total variable, selling and distribution cost = Sales units × Cost per unit

Sold units = Opening stock + Production – Closing stock

Reconciliation of Difference in Net Cost

If there is no difference in the size of opening stock and closing stock, in such a condition net income of absorption costing and variance costing is same.

The difference between opening stock, closing stock and fixed manufacturing overhead are the main cause of difference in net income.

These differences can be solved by reconciliation.

Where:

Difference in stock units	= Difference in income ÷ Fixed cost per unit
According to variable costing, Opening stock in units	= Closing stock in units − Difference in stock units
According to absorption costing, Opening stock in units	= Closing stock in units + Difference in stock units

According to variable costing, Closing stock– Opening stock	= Difference
According to absorption costing, Opening stock – Closing stock	= Difference

Reconciliation Statement

Particulars	Amount
Net income as per variable costing	xxxx
Add: Closing stock (units @ FCPU)	xxxx
Less: Opening stock (units @ FCPU)	(xxx)
Net income as per absorption costing	xxxx

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	xxxx
Add: Opening stock (units @ FCPU)	xxxx
Less: Closing stock (units @ FCPU)	(xxx)
Net income as per variable costing	xxxx

Reconciliation Statement

Particulars	Year 1	Year 2
Net income as per variable costing	xxxx	xxxx
Net income as per absorption costing	xxxx	xxxx
Different in income	xxxx	xxxx
Opening stock in units	xxxx	xxxx
Closing stock in units	xxxx	xxxx
Different stock in units (A)	xxxx	xxxx
Fixed cost per unit (B)	x	x
Different in income (A x B)	xxxx	xxxx

Keep in Mind (KIM)

FMC = fixed manufacturing cost per unit
FCPU = fixed cost per unit	= Fixed manufacturing cost ÷ Normal output
SFOR = standard fixed overhead rate

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Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3A

Nepal Beverages Limited produces mineral water. It sales its product in 10 liter’s pet jar.

The normal annual level of operations is 36,000 units. Data for the last financial years 2020 was as follows:

Production	40,000 units
Sales	32,000 units
Selling price per units	$60
Costs per units:
Direct materials	$14
Direct labors	$12
Variable manufacturing overheads	$8
Fixed manufacturing overheads	$2,16,000 (based on normal output)
Administrative costs:
Fixed	$50,000
Variable	5% of sales revenue
Selling and distribution overhead:
Fixed	$30,000
Variable	5% of selling price per unit

There was no opening stock of finished goods and the work-in-progress.

You are required to: (i) Prepare an income statement based on direct costing for the year ended 2021

(ii) Prepare an income statement based on absorption costing for the year ended 2021

(iii) Reconciliation statement

[Answer: (i) $320,000 (ii) $368,000]

SOLUTION:

Given and working note:

Sold units	=	Opening stock + Production – Closing stock
32,000	=	Nil + 40,000 – Closing stock
Closing stock	=	8,000 units
Again,
Fixed cost per unit [FCPU]	=	Factory overhead ÷ Normal output
	=	$216,000 ÷ 36,000 units
	=	$6

Income Statement under Variable Costing

For 40,000 cases

Particulars				Amount
Sales revenue		[32,000 units @ $60]		19,20,000
		(A)		19,20,000
Variable cost:
	Direct materials	[40,000 units @ $12]		4,80,000
	Direct labour	[40,000 units @ $14]		5,60,000
	Variable manufacturing cost	[40,000 units @ $8]		3,20,000
		Cost of production @ $34)		13,60,000
Add:	Beginning inventory	[0 units @ $34]		–
Less:	Ending inventory	[8,000 units @ $34]		2,72,000
		COGS (B)		10,88,000
		Gross contribution (A – B)		8,32,000
Less:	Variable administrative cost	[sales @5% = 19,20,000@5%]		(96,000)
Less:	Variable S&D cost	[40,000 x 60@5%]		(1,20,000)
		Net contribution		6,16,000
Less:	Fixed manufacturing cost	[given]	216,000
	Fixed administrative cost	[given]	50,000
	Fixed S&D cost	[given]	30,000	(2,96,000)
Net Income				$3,20,000

Income Statement under Absorption Costing

For 40,000 cases

Particulars				Amount
Sales revenue		[32,000 units @ $60]		19,20,000
		(A)		19,20,000
Manufacturing cost:
	Direct materials	[40,000 units @ $12]		4,80,000
	Direct labour	[40,000 units @ $14]		5,60,000
	Variable production cost	[40,000 units @ $8]		3,20,000
	Fixed manufacturing cost	[40,000 units @ $6]		2,40,000
		Cost of production @ 40)		16,00,000
Add:	Beginning inventory	[0 units @ $40]		Nil
Less:	Ending inventory	[8,000 units @ $40]		3,20,000
		COGS before adjustment		12,80,000
Add:	Under absorption			–
Less:	Over absorption	[$240,000 A.C. – $216,000 V.C.]		24,000
		COGS after adjustment (B)		12,56,000
		Gross profit (A–B)		6,64,000
Less:	Variable administrative cost		96,000
	Variable S&D cost		120,000
Less:	Fixed administrative cost		50,000
	Fixed S&D cost		30,000	(2,96,000)
Net Income				$3,68,000

Reconciliation Statement

Particulars	Amount
Net income as per variable cost	320,000
Add: Closing stock (8,000 units @ $6)	48,000
Less: Opening stock (0 units @ $6)	Nil
Net income as per absorption cost	$368,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3B

ABC Manufacturing Company has following information related to a product:

Year	Production	Sales	Sales price per unit
2019	170,000	140,000	$25
2020	140,000	160,000	$25

Other information:

Normal production 150,000 units	Variable cost per unit:	Administrative and selling cost:
Fixed production cost $750,000	Direct materials $5	Variable 5% of sales
	Direct labour $6	Fixed $325,000
	Production cost $4

Required: (1) Income statement under variable costing for 2020 and 2021

(2) Income statement under absorption costing for 2020 and 2021;

(3) Reconciliation statement

[Answer: Variable costing 150,000 and 325,000;

Absorption costing 300,000 and 225,000]

SOLUTION:

Given and working note:

Sold units	=	Opening stock + Production – Closing stock
140,000	=	Nil + 170,000 – Closing stock
Closing stock	=	30,000

Closing stock of last year becomes opening stock of current year

Sold units	=	Opening stock + Production – Closing stock
140,000	=	30,000 + 140,000 – Closing stock
Closing stock	=	10,000

Fixed cost per unit [FCPU]

= Factory overhead old ÷ Normal output

= $750,000 ÷ 150,000 units

= $5

Income Statement under Variable Costing

170,000 and 140,000 units

Particulars			Year 2020	Year 2021
Sales revenue		[sold units @ $25]	35,00,000	40,00,000
		(A)	35,00,000	40,00,000
Variable cost:			–
	Direct materials	[production @ $5]	8,50,000	7,00,000
	Direct labour	[production @ $6]	10,20,000	8,40,000
	Variable production cost	[production @ $4]	6,80,000	5,60,000
		Cost of production (amount ÷ units = $15)	25,50,000	24,00,000
Add:	Beginning inventory	[units @ $15]	–	4,50,000
Less:	Ending inventory	[units @ $15]	(450,000)	(150,000)
		COGS (B)	21,00,000	24,00,000
		Gross contribution (A – B)	14,00,000	16,00,000
Less:	Variable selling and admt cost	[sales@5%]	(175,000)	(200,000)
		Net contribution	12,25,000	14,00,000
Less:	Fixed production cost		(750,000)	(750,000)
	Fixed selling and admt cost		(325,000)	(325,000)
Net Income			$1,50,000	$3,25,000

Income Statement under Absorption Costing

170,000 and 140,000 units

Particulars			Year 2020	Year 2021
Sales revenue		[sold units @ $25]	35,00,000	40,00,000
		(A)	35,00,000	40,00,000
Manufacturing cost:			–
	Direct materials	[production @ $5]	8,50,000	7,00,000
	Direct labour	[production @ $6]	10,20,000	8,40,000
	Variable production cost	[production @ $4]	6,80,000	5,60,000
	Fixed production cost	[production @ $5]	8,50,000	7,00,000
		Cost of production (amount ÷ units = $20)	34,00,000	28,00,000
Add:	Beginning inventory	[units @ $20]	–	6,00,000
Less:	Ending inventory	[units @ $20]	(600,000)	(200,000)
		COGS before adjustment	28,00,000	32,00,000
Add:	Under absorption	[compare with variable costing]	–	50,000
Less:	Over absorption	[compare with variable costing]	1,00,000	–
		COGS after adjustment (B)	27,00,000	32,50,000
		Gross profit (A–B)	8,00,000	7,50,000
Less:	Variable selling and admt cost	[sales@5%]	(175,000)	(200,000)
Less:	Fixed selling and admt cost		(325,000)	(325,000)
Net Income			$3,00,000	$2,25,000

Reconciliation Statement

Particulars				Year 2020	Year 2021
Net income as per variable costing				150,000	325,000
Add: Closing stock	30,000	10,000	@ $5	150,000	50,000
Less: Opening stock	Nil	30,000	@ $5	Nil	(150,000)
Net income as per absorption costing				$300,000	$225,000

Closing stock of year 1 becomes opening stock of year 2, here $30,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3C

ABC Manufacturing Company has following information related to a product:

Year	Production	Sales	Sales price per unit
2019	6,000	4,000	$300
2020	4,000	5,000	$300
2021	5,000	6,000	$300

Other information:

Normal production 5,000 units	Variable cost per unit:		Administrative and selling cost:
Fixed production cost $500,000	Direct materials	$60	Variable 5% of sales
	Direct labour	$30	Fixed $100,000
	Variable production cost	$10
	Total	$100

Required: (1) Income statement under variable costing for 2019, 2020 and 2021

(2) Income statement under absorption costing for 2019, 2020 and 2021

(3) Reconciliation statement

[Answer: Variable costing: 2019= $140,000; 2020 = $325,000; 2021 = $510,000;

Absorption costing: 2019 = $340,000; 2020 = $225,000; 2021 = $410,000]

SOLUTION:

Given and working note:

Year 2019

Sold units	=	Opening stock + Production – Closing stock
4,000	=	Nil + 6,000 – Closing stock
Closing stock	=	2,000

Closing stock of last year becomes opening stock of current year

Year 2020

Sold units	=	Opening stock + Production – Closing stock
5,000	=	2,000 + 4000 – Closing stock
Closing stock	=	1,000

Year 2021

Sold units	=	Opening stock + Production – Closing stock
6,000	=	1,000 + 5000 – Closing stock
Closing stock	=	Nil

Fixed cost per unit [FCPU]

= Factory overhead old ÷ Normal output

= $500,000 ÷ 50,000 units

= $100

Income Statement under Variable Costing

6,000; 4,000 and 5,000 units

Particulars			Year 2019	Year 2020	Year 2021
Sales revenue		[sold units @ $200]	12,00,000	15,00,000	18,00,000
		(A)	12,00,000	15,00,000	18,00,000
Variable cost:
	Direct materials	[production @ $60]	3,60,000	2,40,000	3,00,000
	Direct labour	[production @ $30]	1,80,000	1,20,000	1,50,000
	Variable production cost	[production @ $10]	60,000	40,000	50,000
		Cost of production ($ ÷ units = $100)	$6,00,000	$4,00,000	$5,00,000
Add:	Beginning inventory	[units @ $100]	–	2,00,000	1,00,000
Less:	Ending inventory	[units @ $100]	(200,000)	(100,000)	Nil
		COGS (B)	4,00,000	500,000	6,00,000
		Gross contribution (A – B)	800,000	10,00,000	12,00,000
Less:	Variable selling and admt cost	[sales@5%]	(60,000)	(75,000)	(90,000)
		Net contribution	7,40,000	9,25,000	11,10,000
Less:	Fixed production cost		(500,000)	(500,000)	(5,00,000)
	Fixed selling and admt cost		(100,000)	(100,000)	(100,000)
Net Income			1,40,000	3,25,000	5,10,000

Income Statement under Absorption Costing

6,000; 4,000 and 5,000 units

Particulars			Year 2019	Year 2020	Year 2021
Sales revenue		[sold units @ $25]	12,00,000	15,00,000	18,00,000
		(A)	12,00,000	15,00,000	18,00,000
Manufacturing cost:
	Direct materials	[production @ $60]	3,60,000	2,40,000	3,00,000
	Direct labour	[production @ $30]	1,80,000	1,20,000	1,50,000
	Variable production cost	[production @ $10]	60,000	40,000	50,000
	Fixed production cost	[production @ $100]	6,00,000	4,00,000	5,00,000
		Cost of production (amount ÷ units = $200)	12,00,000	8,00,000	10,00,000
Add:	Beginning inventory	[units @ $200]	–	4,00,000	2,00,000
Less:	Ending inventory	[units @ $200]	(400,000)	(200,000)	–
		COGS before adjustment	8,00,000	10,00,000	12,00,000
Add:	Under absorption	[compare with variable costing]		1,00,000
Less:	Over absorption	[compare with variable costing]	1,00,000
		COGS after adjustment (B)	7,00,000	11,00,000	12,00,000
		Gross profit (A–B)	5,00,000	4,00,000	6,00,000
Less:	Variable admt and selling cost	[sales@5%]	(60,000)	(75,000)	(90,000)
Less:	Fixed admt and selling cost		(100,000)	(100,000)	(100,000)
Net Income			3,40,000	2,25,000	4,10,000

Reconciliation Statement

Particulars					Year 2019	Year 2020	Year 2021
Net income as per variable costing					1,40,000	3,25,000	5,10,000
Add: Closing stock	2,000	1,000	Nil	@ $100	2,00,000	1,00,000	Nil
Less: Opening stock	Nil	2,000	1,000	@ $100	Nil	(200,000)	(100,000)
Net income as per absorption costing					3,40,000	2,25,000	4,10,000

Closing stock of year 1 becomes opening stock of year 2, here $2,000 and 1,000

WHEN QUESTION IS GIVEN IN VARIABLE OR ABSORPTION COSTING

Sometime variable costing or absorption costing is given in the question.

In such a condition, you can be asked to calculate:

When question is given in variable costing you are asked to calculate absorption costing and reconciliation statement.

When question is given in absorption costing you are asked to calculate variable costing and reconciliation statement.

The Relationships between Production, Sales and Profit

Conditions	Result	Reason
Sales = Production	Profit of variable costing = Profit of absorption costing	No change in inventory
Sales > Production	Profit of variable costing > Profit of absorption costing	Decrease in inventory
Sales < Production	Profit of variable costing < Profit of absorption costing	Increase in inventory

Profit of variable costing = Profit of absorption costing	No change in inventory	No opening , no closing stock*
Profit of variable costing > Profit of absorption costing	Decrease in inventory	Opening stock > Closing stock
Profit of variable costing < Profit of absorption costing	Increase in inventory	Opening stock < Closing stock

*Sometime opening stock and closing stock may be equal.

Keep in Mind (KIM)

If production = sales, net income will be same for variable costing and absorption costing.

If there are not opening stock and closing stock, net income of variable costing = absorption costing.

If sales > production, net income of variable costing will be more than absorption costing.

If sales < production, net income of variable costing will be less than absorption costing.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3D [production = sales]

Rupandehi Biscuits (P) Ltd keeps its accounting under variable costing system. Following data is available on 31^st December:

Income Statement under Variable Costing

For 10,000 units

Particulars				Amount
Sales revenue		[10,000 units @ $20]		200,000
		(A)		200,000
Variable cost:
	Direct materials	[10,000 units @ $2]		20,000
	Direct labour	[10,000 units @ $3]		30,000
	Variable manufacturing cost	[10,000 units @ $1.5]		15,000
		Cost of production		65,000
Add:	Beginning inventory	[0 units @ $6.5]		Nil
Less:	Ending inventory	[0 units @ $6.5]		Nil
		COGS (B)		65,000
		Gross contribution (A – B)		135,000
Less:	Variable administrative cost	[10,000 @ $1]		(10,000)
Less:	Variable S&D cost	[10,000 @ $0.50]		(5,000)
		Net contribution		120,000
Less:	Fixed manufacturing cost		20,000
	Fixed administrative cost		10,000
	Fixed selling and distribution cost		+20,000	(50,000)
Net Income				$70,000

Additional information:

Normal output is 20,000 units.

Production is 10,000 units and sales are 10,000 units.

Required: (1) Absorption Costing; (1) Reconciliation Statement

[Answer: Absorption costing = $70,000]

SOLUTION:

Fixed cost per unit [FCPU]

= Factory overhead ÷ Normal output

= $20,000 ÷ 20,000 unit

= $1

Income Statement under Absorption Costing

For 10,000 units

Particulars				Amount
Sales revenue		[10,000 units @ $20]		200,000
		(A)		200,000
Manufacturing cost:
	Direct materials	[10,000 units @ $2]		20,000
	Direct labour	[10,000 units @ $3]		30,000
	Variable production cost	[10,000 units @ $1.5]		15,000
	Fixed manufacturing cost	[10,000 units @ $1]		10,000
		Cost of production @ $7.5)		75,000
Add:	Beginning inventory	[0 units @ $7.5]		Nil
Less:	Ending inventory	[0 units @ $7.5]		Nil
		COGS before adjustment		75,000
Add:	Under absorption	[$20,000 in V.C. – $10,000 A.C.]		10,000
Less:	Over absorption			–
		COGS after adjustment (B)		85,000
		Gross profit (A–B)		115,000
Less:	Variable administrative cost		10,000
	Variable S&D cost		5,000
Less:	Fixed administrative cost		20,000
	Fixed S&D cost		10,000	(45,000)
Net Income				70,000

Reconciliation Statement

Particulars	Amount
Net income as per variable cost	70,000
Add: Closing stock (0 units @ $1)
Less: Opening stock (0 units @ $1)
Net income as per absorption cost	70,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3E [production < sales]

Duggar Snacks (P) Ltd manufactures brand Kurmure in three sizes: big, medium and small. It keeps its accounting in variable costing. The following information is related to medium size on 31^st December:

Income Statement under Variable Costing

For 45,000 units

Particulars				Amount
Sales revenue		[50,000 units @ $20]		10,00,000
		(A)		10,00,000
Variable cost:
	Direct materials	[45,000 units @ $3]		135,000
	Direct labour	[45,000 units @ $2]		90,000
	Variable manufacturing cost	[45,000 units @ $1]		45,000
		Cost of production		270,000
Add:	Beginning inventory	[15,000 units @ $6]		90,000
Less:	Ending inventory	[10,000 units @ $6]		(60,000)
		COGS (B)		300,000
		Gross contribution (A – B)		700,000
Less:	Variable administrative cost	[45,000 @ $0]		Nil
Less:	Variable S&D cost	[50,000 @ $1]		(50,000)
		Net contribution		650,000
	Fixed manufacturing cost		150,000
	Fixed administrative cost		50,000
	Fixed selling and distribution		200,000	(400,000)
Net Income				250,000

Additional information:

· Normal output is 50,000 units.

· Production is 45,000 units and sales are 50,000 units.

Required: (a) Absorption costing; (b) Reconciliation statement

[Answer: Absorption costing = $235,000]

SOLUTION:

Fixed cost per unit [FCPU]

= Fixed overhead ÷ Normal output

= $150,000 ÷ 50,000 units

= $3

Income Statement under Absorption Costing

For 45,000 units

Particulars				Amount
Sales revenue		[50,000 units @ $20]		10,00,000
		(A)		10,00,000
Manufacturing cost:				–
	Direct materials	[45,000 units @ $3]		1,35,000
	Direct labour	[45,000 units @ $3]		90,000
	Variable production cost	[45,000 units @ $1]		45,000
	Fixed manufacturing cost	[45,000 units @ $3]		1,35,000
		Cost of production @ $9)		4,05,000
Add:	Beginning inventory	[15,000 units @ $9]		1,35,000
Less:	Ending inventory	[10,000 units @ $9]		(90,000)
		COGS before adjustment		4,50,000
Add:	Under absorption	[150,000 in VC – 135,000 AC]		15,000
Less:	Over absorption			–
		COGS after adjustment (B)		4,65,000
		Gross profit (A–B)		5,35,000
Less:	Variable administrative cost		Nil
	Variable S&D cost		50,000
Less:	Fixed administrative cost		50,000
	Fixed S&D cost		200,000	(300,000)
Net Income				235,000

Reconciliation Statement

Particulars	Amount
Net income as per Variable Cost	250,000
Add: Closing stock (10,000 units @ $3)	30,000
Less: Opening stock (15,000 units @ $3)	(45,000)
Net income as per Absorption Cost	235,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3F [production > sales]

Cello Writing Instrument (P) Ltd manufactures different kinds of ball pens. The following information is obtained for particular ball pen on 31^st December:

Income Statement under Absorption Costing

For 50,000 units

Particulars				Amount
Sales revenue		[45,000 units @ $20]		900,000
		(A)		900,000
Manufacturing cost:
	Direct materials	[50,000 units @ $3]		150,000
	Direct labour	[50,000 units @ $2]		100,000
	Variable production cost	[50,000 units @ $1]		50,000

	Fixed manufacturing cost	[50,000 units @ $3]		150,000
		Cost of production @ $9		450,000
Add:	Beginning inventory	[15,000 units @ $9]		135,000
Less:	Ending inventory	[10,000 units @ $9]		(90,000)
		COGS before adjustment		495,000
Add:	Under absorption			15,000
		COGS after adjustment (B)		510,000
		Gross profit (A–B)		390,000
Less:	Variable administrative cost		30,000
	Variable S & D cost	[45,000 units @ $1]	45,000
Less:	Fixed administrative cost		50,000
	Fixed selling and distribution cost		100,000	(225,000)
Net Income				$165,000

Required: (1) Variable costing; (2) Reconciliation statement

[Answer: (1) $180,000; (2) $Different of stock value (45,000 – 30,000) = $15,000;

Hints: Fixed manufacturing cost = $165,000]

SOLUTION:

Income Statement under Variable Costing

For 50,000 units

Particulars				Amount
Sales revenue		[45,000 units @ $20]		900,000
		(A)		900,000
Variable cost:
	Direct materials	[50,000 units @ $3]		150,000
	Direct labour	[50,000 units @ $2]		100,000
	Variable manufacturing cost	[50,000 units @ $1]		50,000
		Cost of production @ $6)		300,000
Add:	Beginning inventory	[15,000 units @ $6]		90,000
Less:	Ending inventory	[10,000 units @ $6]		(60,000)
		COGS (B)		330,000
		Gross contribution (A – B)		570,000
Less:	Variable administrative cost	[given]		(30,000)
Less:	Variable S&D cost	[45,000 @ $1]		(45,000)
		Net contribution		495,000
Less:	Fixed manufacturing cost	[$150,000 AC + $15,000 under absorbed]	165,000
	Fixed administrative cost	[given]	50,000
	Fixed S&D cost	[given]	100,000	(315,000)
Net Income				180,000

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	165,000
Add: Opening stock (15,000 units @ $3)	45,000
Less: Closing stock (10,000 units @ $3)	(30,000)
Net income as per variable costing	180,000

Fixed manufacturing cost per unit given in the question $3

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#####

Problems and Answers of Absorption and Variable Costing

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3A

Max Company uses direct costing for internal control purchase and absorption costing for external reporting purpose. The following differences are located while comparing the two statements.

Items	Variable Costing	Absorption Costing
Variable manufacturing cost	$60,000	$60,000
Fixed manufacturing cost charged	$25,000	$30,000
Fixed selling and administrative cost	$40,000	$40,000
Variable selling cost per unit	$2	$2
Selling price per unit	$30	$30

Management also projected the following data for the inventory:

Beginning inventory units 1,000	Sales units 5,000
Production units 6,000	Closing stock units 2,000

Cost of beginning inventory is the same as the cost of production in the period.

Required: Income statement by using absorption costing and variable costing approach

[Answers: Net profit = $30,000; $25,000]

*Over absorption $5,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 3B

XYZ Ltd uses direct costing for internal control purposes and absorption costing for external reporting purposes. The company uses the following unit costs for the one product it manufactures:

Projected cost per unit:

Direct materials $60

Direct labour $38

Variable manufacturing $12

Fixed manufacturing cost $10 (Based on 10,000 units per month)

Variable selling and administrative cost $8

Fixed selling and administrative cost $5.60 (Based on 10,000 units per month)

The projected selling price is $160 per unit.

The fixed costs remain fixed within the relevant range of 4,000 to 16,000 units of production.

Management has also projected the following data for the month:

Opening stock 2,000 units

Production 9,000 units

Sales 7,500 units

Required: projected income statement under direct costing and absorption costing.

[Answer: Variable costing: $1,59,000, Absorption costing: $1,74,000;

* Under absorption cost =100,000 – 90,000 = 10,000]

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Variable Costing | Absorption vs Variable | Problems and Solutions

Manju@2050 — Sat, 05 Feb 2022 03:55:25 +0000

Variable Costing | Internal Costing | Direct Costing

Variable costing is also known as internal costing, direct costing and marginal costing.

Variable cost helps to administrator to solve the problem about production planning.

Under this method, production cost is calculated on variable basis.

Variable costing includes direct materials, direct labour and variable manufacturing cost in product cost.

It includes fixed manufacturing cost, administrative, selling and distribution cost in period cost.

Direct materials, direct labour, variable manufacturing cost:

= Production units x Cost per unit

Period costing under variable costing = Fixed manufacturing cost + Administrative cost + S&D cost

Total variable, selling and distribution cost = Sales units x Cost per unit

Sold units = Opening stock + Production – Closing stock

Variable costing | Cost allocation

Keep in Mind (KIM)

There are three types of question:

If question is given, you can be asked to calculate variable costing as well as absorption costing and reconciliation statement.

If variable costing is given in question, you are asked to calculate absorption costing and reconciliation statement.

If absorption costing is given in question, you are asked to calculate variable costing and reconciliation statement.

Income Statement under Variable Costing

Particulars				Amount $
Sales revenue (sales units @ $)				xxxx
(A)				xxxx
Variable cost:
	Direct materials	(production units @ $)		xxxx
	Direct labour	(production units @ $)		xxxx
	Variable production overhead	(production units @ $)		xxxx
		Total variable cost or Cost of production		xxxx
Add:	Beginning inventory	(opening stock @ $)		xxxx
Less:	Ending inventory	(closing stock @ $)		xxxx
		COGS (B)		xxxx
		Gross contribution (A – B)		xxxx
Less:	Variable administrative cost	(production units x $)		xxxx
Less:	Variable S&D cost	(sales units x $)		xxxx
		Net contribution		xxxx
Less:	Fixed production cost	( ± absorption, if any)	xxxx
	Fixed administrative cost	(production units x $)	xxxx
	Fixed selling and distribution cost	(sales units x $)	xxxx
Net Income				xxxx

Note: If there is under absorption in absorption costing, it is added with fixed manufacturing cost in variable costing

If there is over absorption in absorption costing, it is deducted from fixed manufacturing cost in variable costing

Advantage of Variable Costing

The main advantage of variable costing are:

It is simple to understand and easy to apply.

It is useful to managerial decision for profit planning, decision making, and control.

It does not effect to calculate predetermined fixed cost.

It does not have problem relating to over or under absorption manufacturing cost.

It is suitable for standard costing and budgeting.

Breakeven point or cost volume profit analysis is totally depended on variable costing.

Disadvantage or Limitation of Variable Costing

The main disadvantage of variable costing are:

Inventory is valuation variable cost in variable costing.

That is not accepted by tax authority department.

Variable costing insists on selling function.

Manufacturing is also important function.

Variable costing impose/force for variable cost.

But segregation of variable cost from semi variable cost is not easy.

It is suitable only for short term run.

Difference between Absorption Costing and Variable Costing

Bases	Absorption Costing	Variable Costing
Cost	Fixed manufacturing overhead is considered as product cost.	Fixed manufacturing overhead is considered as period cost.
Inventory	Inventory includes the fixed manufacturing overhead. Therefore, the value of inventory will be higher	Inventory does not include fixed manufacturing overhead because it is considered as period cost. Therefore the value of inventory will be lower.
Profit	Higher the units of ending inventory, higher the profit	Lower the unit of ending inventory, lower will be the profit.
Reporting	It is suitable for external reporting purpose.	It is suitable for internal reporting purpose
Over or under absorption	Under this costing, there may be over or under absorption of fixed manufacturing.	Under this costing, there will not be over or under absorption of fixed manufacturing.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

ABC Manufactures Company produces a single product; the operating data for February 2020 is given below:

Sales units 1,000 units

Production units 1,000 units

Selling price per unit $500

Materials cost per unit:		Fixed cost:
Direct materials	$60	Factory overheads	$60,000
Direct labor	$100	Administrative cost	$80,000
Variable factory overheads	$40	Selling and distribution cost	$50,000
Variable administrative overhead	$20
Variable selling and distribution	$15

Required: Income statement under variable costing

[Answer: Net income = $60,000]

SOLUTION:

Income Statement under Variable Costing

For 1,000 units

Particulars				Amount $
Sales revenue		[1,000 @ $500]		500,000
		(A)		500,000
Variable cost:
	Direct materials	[1,000 @ $60]		60,000
	Direct labour	[1,000 @ $100]		100,000
	Variable manufacturing cost	[1,000 @ $40]		40,000
		Cost of Production [$200,000 ÷ 1,000 units = $200]		200,000
Add:	Beginning inventory	[Units @ $200]		Nil
Less:	Ending inventory	[Units @ $200]		Nil
		COGS (B)		200,000
		Gross Contribution (A – B)		300,000
Less:	Variable administrative cost	[1,000 @ $20]		(20,000)
Less:	Variable selling and distribution cost	[1,000 @ $2]		(30,000)
		Net Contribution		250,000
Less:	Fixed manufacturing cost		60,000
	Fixed administrative cost		80,000
	Fixed selling and distribution cost		50,000	190,000
Net Income				60,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

Following are data pertaining to month of December of operation for BR Textile Company related to school dress textile:

Units sold 5,000 miters

Selling price per unit $200

Units produced 6,000 miters

Fixed manufacturing cost $100,000

Other information:

Variable cost:	Administrative expenses:	Selling and distribution expenses:
Direct materials $40	Fixed $50,000	Fixed $30,000
Direct labor $30	Variable $100,000	Variable (per unit) $10
Factory overheads $20

Required: Income statement under variable costing

[Answer: Net income = $220,000]

SOLUTION:

Given and working note:

Sold unit	=	Opening stock + Production – Closing stock
5,000	=	Nil + 6,000 – Closing stock
Closing stock	=	1,000

Income Statement under Variable Costing

For 6,000 units

Particulars				Amount $
Sales revenue		[5,000 @ $200]		10,00,000
		(A)		10,00,000
Variable cost:
	Direct materials	[6,000 @ $40]		240,000
	Direct labour	[6,000 @ $30]		180,000
	Variable manufacturing cost	[6,000 @ $20]		120,000
		Cost of Production @ $90]		540,000
Add:	Opening stock	[0 @ $90]		Nil
Less:	Closing stock	[1,000 @ $90]		(90,000)
		COGS (B)		450,000
		Gross Contribution (A – B)		550,000
Less:	Variable administrative cost			(100,000)
Less:	Variable selling and distribution cost	[5,000 @ $10]		(50,000)
		Net Contribution		400,000
Less:	Fixed manufacturing cost		100,000
	Fixed administrative cost		50,000
	Fixed selling and distribution cost		30,000	(180,000)
Net Income				$220,000

Reconciliation of Difference in Net Cost

If there is no difference in the size of opening stock and closing stock, in such a condition net income of absorption costing and variance costing is same.

The difference between opening stock, closing stock and fixed manufacturing overhead are the main cause of difference in net income.

These differences can be solved by reconciliation.

Where:

Difference in stock units	= Difference in income ÷ Fixed cost per unit
According to variable costing, Opening stock in units	= Closing stock in units − Difference in stock units
According to absorption costing, Opening stock in units	= Closing stock in units + Difference in stock units

According to variable costing, Closing stock– Opening stock	= Difference
According to absorption costing, Opening stock – Closing stock	= Difference

Reconciliation Statement

Particulars	Amount
Net income as per variable costing	xxxx
Add: Closing stock (units @ FCPU)	xxxx
Less: Opening stock (units @ FCPU)	(xxx)
Net income as per absorption costing	xxxx

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	xxxx
Add: Opening stock (units @ FCPU)	xxxx
Less: Closing stock (units @ FCPU)	(xxx)
Net income as per variable costing	xxxx

Reconciliation Statement

Particulars	Year 1	Year 2
Net income as per variable costing	xxxx	xxxx
Net income as per absorption costing	xxxx	xxxx
Different in income	xxxx	xxxx
Opening stock in units	xxxx	xxxx
Closing stock in units	xxxx	xxxx
Different stock in units (A)	xxxx	xxxx
Fixed cost per unit (B)	x	x
Different in income (A x B)	xxxx	xxxx

Keep in Mind (KIM)

FMC = fixed manufacturing cost per unit
FCPU = fixed cost per unit	= Fixed manufacturing cost ÷ Normal output
SFOR = standard fixed overhead rate

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

The extracted data are taken from EP Manufacturing Company:

Net profit as per variable costing	$450,000	Fixed cost	$300,000
Opening stock	10,000 units	Normal output	40,000 units
Closing stock	7,000 units

Required: Net profit as per absorption costing

[Answer: $427,500]

SOLUTION:

Fixed cost per unit (FCPU)

= Fixed manufacturing cost ÷ Normal output

= $300,000 ÷ 40,000 units

= $7.50

Reconciliation Statement

Particulars	Amount
Net income as per variable cost	450,000
Add: Closing stock (7,000 units @ $7.50)	52,500
Less: Opening stock (10,000 units @ $7.50)	(75,000)
Net income as per Absorption Cost	427,500

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

An absorption costing statement showed a less profit (loss) $8,000 than variable costing with the closing stock was 2,000 units in first year. An excess profit of $16,000 with 4,000 closing stock units in second year. Fixed cost per unit $8 and variable cost per unit $12 were used for two years.

Required: Reconciliation statement for net profit under variable costing system

[Answer: $45,000; ($90,000)]

SOLUTION

Given and working note:

Difference in profit	=	Difference in stock x FCPU
–8,000	=	Difference in stock x $8
Difference in stock	=	–1,000

Closing stock

Closing stock – Opening stock	=	Difference
Closing stock – 5,000	=	– 1,000
Closing stock	=	3,000 units

Closing stock of first becomes opening stock of second year

Reconciliation Statement

Particulars				Year 2020	Year 2021
Net profit as per absorption costing				(8,000)	16,000
Add: Opening stock	3,000	2,000	@ $8	24,000	16,000
Less: Closing stock	2,000	4,000	@ $8	(16,000)	(32,000)
Net profit as per variable costing				45,000	(90,000)

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2E

While converting the variable income statement of last two years 2020 and 2021:

(a) The income statement reported loss of $16,000 in 2020 with the opening stock of 5,000 units

(b) Profit of $8,000 with the closing stock of 4,000 units in 2021.

Required: (1) Opening stock in units for 2020; (2) Net profit (loss) of absorption costing by reconciliation statement;

(3) Closing stock in units for 2021

[Answer: (1) Opening stock = 3,000 units;

(2) Year 2020 loss = ($32,000); year 2021 profit = $16,000;

(3) Closing stock in 2021 = 3,000 units]

SOLUTION

Given and working note:

Difference in profit	=	Difference in stock x FCPU
–16,000	=	Difference in stock x $8
Difference in stock	=	–2,000

Closing stock

Closing stock – Opening stock	=	Difference
Closing stock – 5,000	=	– 2,000
Closing stock	=	3,000 units

Reconciliation Statement

Particulars				Year 2020	Year 2021
Net profit as per absorption costing				(16,000)	8,000
Add: Opening stock	3,000	4,000	@ $8	24,000	32,000
Less: Closing stock	5,000	3,000	@ $8	(40,000)	(24,000)
Net profit as per variable costing				(32,000)	16,000

Keep in Mind (KIM)

More or higher profit means net profit

Less or lesser profit means net loss

Use always fixed cost per unit (never use variable cost per unit)

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Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2060 Modified

The income statement of XYZ Company based on Absorption costing is given below:

Particulars			Amount	Amount
Sales revenue		@ $40 each		400,000
Less:	Manufacturing cost
	Direct material	@ $5 each	45,000
	Direct labour	@ $10 each	90,000
	Fixed manufacturing	@ $10 each	90,000
			2,25,000
Add:	Opening stock	2,000 units @ $25 each	50,000
			2,75,000
Less:	Closing stock	1000 units @ $25 each	25,000	(2,50,000)
		Gross profit before adjustment		1,50,000
Less:	Under absorption of fixed manufacturing cost			10,000
	Gross profit after adjustment			1,40,000
Less:	Non-manufacturing cost:
	Fixed cost		60,000
	Variable cost @ $4		40,000	1,00,000
Net Income				40,000

Required: (1) Income statement by using variable costing; (2) Reconciliation of difference in profit

[Answers: (1) $50,000; (2) $10,000] *FMC in V.C = 100,000]

SOLUTION

Given and working note:

Sold units = Opening stock + Production – Closing stock

10,000 = 2,000 + 9,000 – 1,000

In the question, there is under absorption manufacturing cost $10,000

Fixed production cost $10,000 units @ $10 per unit.

So, total fxed production cost = $10,000 + $90,000 = $100,000

Income Statement under Variable Costing

For 9,000 units

Particulars				Amount
Sales revenue		(10,000 units @ $40)		4,00,000
		(A)		4,00,000
Variable cost:
	Direct materials	(9,000 units @ $5)		45,000
	Direct labour	(9,000 units @ $10)		90,000
	Variable manufacturing cost			Nil
		Cost of production ($1,35,000 ÷ 9,000 units = $15)		1,35,000
Add:	Beginning inventory	(2,000 @ $15)		30,000
Less:	Ending inventory	(1,000 @ $15)		(15,000)
		COGS (B)		1,50,000
		Gross contribution (A – B)		2,50,000
Less:	Variable administrative cost			–
Less:	Variable non-manufacturing	(10,000 units @ $4)		40,000
		Net contribution		2,10,000
Less:	Fixed production cost	[$90,000 A.C + $10,000 under]	1,00,000
	Fixed non-manufacturing cost		60,000	(1,60,000)
Net Income				$50,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2061/S Modified

The absorption Costing income Statement of AL Manufacturing Company has been provided as:

Production 22,000 units

Sales unit 25,000 units

Particulars			Amount
Sales revenue		@ $20 (A)	500,000
Less:	Cost of goods sold:
	Variable manufacturing cost	@ $10	220,000
	Fixed manufacturing overhead cost	@ $4	88,000
		Total cost of products @ $14	308,000
Add:	Value of beginning inventory	5000 units @ $14	70,000
Less:	Value of ending inventory	2000 units @ $14	(28,000)
		Total cost of goods sold (B)	350,000
		Gross margin before adjustment (A – B)	150,000
Add:	Manufacturing overhead over absorbed		8,000
		Gross margin after adjustment	158,000
Less:	Variable S&D cost @ $3	75,000
	Fixed S&D cost	50,000	(125,000)
Net income before tax			33,000

Required: (1) Income statement under variable costing; (2) Reconciliation statement

[Answers: (1) $45,000; (2) = $33,000;

*FMC in V.C (88,000 – 8,000) = $80,000]

SOLUTION

Sold units = Opening stock + Production – Closing stock

25,000 = 5,000 + 22,000 – 2,000

Fixed cost per unit = $4* given

Income Statement under Variable Costing

For 22,000 units

Particulars				Amount
Sales revenue		(25,000 @ $20		5,00,000
		(A)		5,00,000
Variable cost:
	Direct materials
	Direct labour
	Variable manufacturing cost	(22,000 @ $10)		2,20,000
		Cost of production ($2,20,000 ÷ 22,000 units = $10)		2,20,000
Add:	Beginning inventory	(5,000 @ $10)		50,000
Less:	Ending inventory	(2,000 @ $10)		(20,000)
		COGS (B)		2,50,000
		Gross contribution (A – B)		2,50,000
Less:	Variable administrative cost			–
Less:	Variable S&D cost	(25,000 @ $3)		75,000
		Net contribution		1,75,000
Less:	Fixed production cost	($88,000 – $8,000)	80,000
	Fixed administrative cost		Nil
	Fixed S&D cost		50,000	(130,000)
Net Income				$45,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2063 Modified

A mill has provided the cost for the annual normal capacity output of 50,000 kg.

Direct material cost per kg	$10
Direct labour cost per kg	$8
Manufacturing overhead per kg	$10 (50% fixed)
Selling and distribution overhead per kg	$4 (25% variable)
The selling price per kg	$35
The annual fixed administrative expenses incurred	$100,000
The mill sold 50,000 kg in the last year.
The store ledger recorded 10,000 kg of beginning inventory and 15,000 kg of ending inventory in the period.

Required: Income statement based on variable costing

[Answer: $50,000]

SOLUTION

Given and working note:

Sold unit	=	Opening stock + Production – Closing stock
50,000	=	10,000 + Production – 15,000
Production	=	55,000 units

Income Statement under Variable Costing

For 55,000 units

Particulars				Amount
Sales revenue		(50,000 units @ $35)		17,50,000
		(A)		17,50,000
Variable cost:
	Direct materials	(55,000 @ $10)		5,50,000
	Direct labour	(55,000 @ $8)		4,40,000
	Variable manufacturing cost	(55,000 @ $10@50%)		2,75,000
		Cost of production ($12,65,000 ÷ 55,000 units = $23)		12,65,000
Add:	Beginning inventory	(10,000 @ $23)		2,30,000
Less:	Ending inventory	(15,000 @ $23)		(3,45,000)
		COGS (B)		11,50,000
		Gross contribution (A – B)		6,00,000
Less:	Variable administrative cost	(50,000 @ $4@25%)		(50,000)
Less:	Variable S&D cost			Nil
		Net contribution		5,50,000
Less:	Fixed production cost	(50,000@ $10@50%)	2,50,000
	Fixed administrative cost	(given)	1,00,000
	Fixed S&D cost	(50,000 @ $4@75%)	1,50,000	(5,00,000)
Net income				$50,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2066 Modified

A Manufacturing Company has reported its income statement under absorption costing technique as under:

Particulars		Amount	Amount
Sales revenue	(10,000 units x $45)		450,000
Less: Cost of goods sold:
Beginning inventory	(2,000 x $27)	54,000
Variable manufacturing cost	(9,000 x $23)	207,000
Fixed manufacturing cost	(9,000 x $4)	36,000
Ending inventory	(1,000 x $27)	(27,000)	(270,000)
Gross margin before adjustment			180,000
Less: Fixed manufacturing cost under absorbed			(4,000)
Less: Variable administrative cost			(50,000)
Net income			126,000

Required: (a) Income statement under variable costing; (b) Reconciliation statement

[Answer: $130,000]

SOLUTION

Income Statement under Variable Costing

For 9,000 units

Particulars				Amount
Sales revenue		[10,000 units @ $45]		450,000
		(A)		450,000
Variable cost:
	Direct materials	[9,000 units @ $0]		Nil
	Direct labour	[9,000 units @ $0]		Nil
	Variable manufacturing cost	[9,000 units @ $23]		207,000
		Cost of production ($207,000 ÷ 9,000 = $23)		207,000
Add:	Beginning inventory	[2,000 units @ $23]		46,000
Less:	Ending inventory	[1,000 units @ $23]		(23,000)
		COGS (B)		230,000
		Gross contribution (A – B)		220,000
Less:	Variable administrative			(50,000)
	Variable S&D			Nil
		Net contribution		170,000
Less:	Fixed manufacturing cost	[$36,000 A.C. + $4,000 under absorbed]	40,000
	Fixed administrative cost		Nil
	Fixed S&D cost		Nil	(40,000)
Net income				$130,000

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	126,000
Add: Opening stock (2,000 units @ $4*)	8,000
Less: Closing stock (1,000 units @ $4*)	(4,000)
Net income as per variable costing	$130,000

#####

Problems and Answers of Variable Costing

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

Following are data pertaining to month of December of operation for ABC Textile related to school dress:

Opening stock 2,000 units	Administrative expenses:
Units produced 6,000 units	Fixed $250,000
Normal output 5,000 units	Variable $250,000
Units sold 7,000 units	Selling and distribution expenses:
Selling price per unit $300	Variable (per unit) $20
Fixed manufacturing cost $200,000	Fixed (per unit) $15
Variable cost:
Direct materials $50
Direct labor $40
Factory overheads $30

Required: (a) Income statement under variable costing; (b) Reconciliation statement

[Answer: (1) Net income = $315,000; (2) $275,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

AK Manufacturing Company has reported its income statement under absorption costing technique as under:

Particulars			Amount	Amount
Sales revenue		(10,000 units x $45)		450,000
Less:	Cost of goods sold:
	Beginning inventory	(2,000 x $27)	54,000
	Variable cost	(9,000 x $23)	207,000
	Fixed manufacturing cost	(9,000 x $4)	36,000
	Ending inventory	(1,000 x $27)	(27,000)	(270,000)
	Gross margin before adjustment			180,000
Less:	Fixed manufacturing cost under absorbed			(4,000)
	Gross margin after adjustment			176,000
Less:	Other variable cost			(50,000)
Net income before tax				$126,000

Required: Income statement under variable costing technique

[Answer: Net income under variable costing = $130,000;

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

Following details are given to you:

Normal capacity 200,000 units per year

Standard variable manufacturing expenses $20 per unit

Fixed manufacturing overhead $300,000 per year

Variable selling expenses $2 per unit

Fixed selling expenses $100,000

Unit sale price $25

The operating results for the year ending December of the last year were as follows

Sales 150,000 units

Production 180,000 units

Required: (a) variable costing income statement; (b) Reconciled profit under absorption costing

[Answers: Income under VC = $50,000, under AC = $95,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

XYZ Manufacturing Company with normal capacity of 50,000 units supplied you with the following particular:

Production	55,000 units
Sales	60,000 units
Closing stock	5,000 units
Unit variable manufacturing cost	$6
Unit fixed manufacturing overhead	$3
Unit variable selling and administrative cost	$2
Fixed selling and administrative cost	$90,000
Unit selling price	$15

Required: (1) Variable costing income statement; (2) Reconciled profit under absorption costing

[Answers: (1) $180,000; (2) $165,000]

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Absorption Costing | Product Cost | Period Cost | Problems and Solutions

Manju@2050 — Sat, 05 Feb 2022 01:50:10 +0000

Absorption Costing | External Costing | Traditional Costing

Absorption costing is a traditional costing system.

It is also called full absorption, conventional costing or traditional costing and external costing.

It includes variable cost and fixed cost manufacturing.

Absorption costing includes direct materials, direct labour, variable manufacturing cost and fixed manufacturing cost in product cost.

It includes administrative cost, selling and distribution cost in period cost.

But it does not include fixed manufacturing cost in period cost.

The main object of the business company is to earn more and more profit.

Success or failure of the company is depended on profit.

The income statement measures profit or loss of the company.

There are two types of methods to find out profit and loss from income statement.

Absorption costing and variable costing are two methods to prepare income statement.

Absorption costing is suitable for internal as well as external users but variable costing is suitable for internal users with management decision.

Definition of absorption costing

According to ICMA London, “The practice of charging all costs, both variable cost and fixed cost to operation, process or products is called absorption costing.”

Direct materials, direct labour, variable manufacturing cost and fixed manufacturing cost = Production units x Cost per unit

Period cost under absorption costing = Administrative cost + Selling and distribution cost

Total variable, selling and distribution cost = Sales units x Cost per unit

Advantages of Absorption Costing

The main advantages of absorption costing are following:

It has been accepted by FASB, ASC, ASB, taxation department etc for external reporting purpose and inventory valuation.

It makes clear distinguish between manufacturing and non-manufacturing cost.

It provides clear information about efficient or inefficient utilization of capacity by over or under absorption of manufacturing cost.

Under this, work in progress is valued at work cost and finished goods are valued at total cost.

It is useful for price fixation.

It helps to calculate gross profit and net profit separately in income statement.

It helps to management to allocation production and non-production cost etc.

Limitation or Disadvantage of Absorption Costing

The main limitations of absorption costing are following:

It is not suitable for internal purpose viz it is not suitable for managerial decision making.

In absorption costing, fixed manufacturing cost is added with manufacturing cost or product cost.

It is not proper accounting transaction.

It is not helpful to prepare flexible budget; because it does not separate fixed cost and variable cost.

Fixed cost increases value of inventory.

It is not good because fixed cost should not be included in inventory.

Income Statement under Absorption Costing

For ….. units

Particulars			Amount
Sales Revenue (sales units @ $)			xxxx
(A)			xxxx
Manufacturing cost:
	Direct materials (production units @ $)
	Direct labour (production units @ $)
	Variable production overhead (production units @ $)
	Fixed production cost (production units @ $*)
	Total manufacturing cost or Cost of production		xxxx
Add:	Beginning inventory (opening stock @ $)		xxxx
Less:	Ending inventory (closing stock @ $)		(xxx)
	COGS before adjustment		xxxx
Add:	Under absorption manufacturing cost (compare with actual)		xxxx
Less:	Over absorption manufacturing cost (compare with actual)		(xxx)
	COGS after adjustment (B)		xxxx
	Gross profit (A–B)		xxxx
Less:	Variable administrative cost (production units x $)	xxxx
	Variable S&D cost (sales units x $)	xxxx
Less:	Fixed administrative cost (production units x $)	xxxx
	Fixed S & D cost (sales units x $)	xxxx	xxxx
Net Income			xxxx

Fixed cost per unit (FCPU*) = Fixed manufacturing cost ÷ Normal output

Either over absorption^# or under absorption

Keep in Mind (KIM)

FASB = Financial Accounting Standard Board, USA

ASC = Accounting Standard Committee, UK

ASB = Accounting Standard Board, India

The value of inventory is always over valued in absorption costing

The value of inventory is always undervalued in variable costing.

If actual output units are more than normal outputs units, there will be over absorption of fixed manufacturing overhead

If actual output units are less than normal outputs, there will be under absorption of fixed manufacturing overhead

If actual output units are equal to normal output, neither under absorption nor over absorption.

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Product Cost

All the expenses related to manufacturing or production is called product cost.

It is also known inventorial cost.

It is used for valuation of inventory.

Product cost is related to direct material, direct labour, consumable supplies and manufacturing overhead.

Product cost can be recorded as an inventory asset if the product has not yet been sold.

Examples of products costs are:

Direct material

Direct labour

Direct or chargeable expenses

Factory overhead

Product costing under variable costing	Product costing under absorption costing
Direct materials	Direct materials
Direct labour	Direct labour
Variable manufacturing costs	Variable manufacturing costs
Fixed manufacturing costs	Nil

Keep in Mind (KIM)

Product cost appears in the financial statements.

Since it includes the manufacturing overhead that is required by both GAAP and IFRS.

Period Cost

A period cost is also called period expenses.

All the expenses related to administrative, selling and distribution are called period cost.

These costs may be variable or fixed.

Period cost is charged to expense always.

It is not capitalized expenses.

It is not included within the cost of goods sold on the income statement.

But it is included within the administrative and selling expenses.

These costs are NOT part of production or manufacturing or cost of goods sold on income statement.

Generally, period costs are recorded on income statement NOT on balance sheet.

Examples of period costs

General and administrative expenses

Executive and administrative salaries and benefits

Office rent

Depreciation on office equipment

Amortization of intangible assets

Interest expense

Selling expenses

Advertising expenses

Travel and entertainment expenses

Commissions to sales person

Depreciation on warehouse and delivery van etc

Items that are NOT period costs

Direct materials

Direct labour

Direct expenses

Prepaid expenses like insurance and rent

Capitalized expenses (purchase and installation of fixed asset)

Period costing under variable costing	Period costing under absorption costing
Nil	Fixed manufacturing costs
Administrative cost	Administrative cost
Selling and distribution cost	Selling and distribution costs

Differences between Product Cost and Period Cost

Bases	Product cost	Period cost
Meaning	Product cost is related to manifesting of a product.	Period cost is related to administrative and selling expenses.
Recording	It is recorded on GOGS section of income statement and ending inventories on the balance sheet.	It is recorded on the income statement on administrative and selling and distribution section.
Example	Direct labour, direct materials and manufacturing expenses.	Administrative and selling and distribution expenses.

Keep in Mind (KIM)

These are not period cost:
Costs included in prepaid expenses, such as prepaid rent
Costs included in inventory, such as direct labor, direct materials, and manufacturing overhead
Costs included in fixed assets, such as purchased assets and capitalized interest

Under absorption costing	Under variable costing
Product costs:	Product costs:
Direct materials	Direct materials
Direct labour	Direct labour
Variable manufacturing costs	Variable manufacturing costs
Fixed manufacturing costs	Nil

Period cost:	Period cost:
Nil	Fixed manufacturing costs
Administrative costs	Administrative costs
Selling and distribution costs	Selling and distribution costs

Treatment of Opening and Closing Stock

In manufacturing company, all manufactured goods may not be sold out during one accounting period.

In such a condition, closing stock remains for current accounting period.

This closing stock becomes opening stock for next accounting period.

Sold units = Opening stock + Production – Closing stock

There are three conditions for opening stock and closing stock

If sales equal to production, there is neither opening stock nor closing stock.

If sales less than production, there must be closing stock.

If sales more than production, there must be opening stock.

Opening stock, Production, Sales and Closing stock

Here,

Opening stock 4,000 units

Production 60,000 unit

Example: 1A

Opening stock 4,000 units

Production 6,000 units

Sales 10,000 units

Explanation:

Here,

Opening stock + production = Sales

So, there is NOT any closing stock

Sold units	=	Opening stock + Production – Closing stock
10,000	=	4,000 + 6,000 – Closing stock
Closing stock	=	10,000 – 10,000
	=	Nil

Example: 1B

Opening stock 3,000 units

Production 6,000 units

Sales 10,000 units

Here,

Sold units	=	Opening stock + Production – Closing stock
10,000	=	3,000 + 6,000 – Closing stock
10,000	=	9,000 – Closing stock
– Closing stock	=	9,000 – 10,000
Closing stock	=	1,000 units

Example: 1C

Production 6,000 units

Sales 6,000 units

Explanation:

Here, sales = production, so neither opening stock nor closing stock.

Example: 1D

Production 6,000 units

Sales 7,000 units

Closing stock 3,000 units

Here,

Sold units	=	Opening stock + Production – Closing stock
7,000	=	Opening stock + 6,000 – 3,000
7,000	=	Opening stock + 3,000
7,000 – 3,000	=	Opening stock
Opening stock	=	4,000 units

Conditions	Reason	Result
Sales = Production	No change in inventory	Opening stock = closing stock
Sales > Production	Decrease in inventory	Opening stock > closing stock
Sales < Production	Increase in inventory	Opening stock < closing stock

Over or Under Absorption of Manufacturing Cost

While preparing absorption costing income statement, there may be over or under fixed manufacturing cost.

For adjustment of under or over, following points should be kept in mind:

Over absorption of fixed manufacturing overhead

If actual output units are more than normal outputs units, there will be over absorption of fixed manufacturing overhead.

It is also known favorable capacity variances.

It can be either deducted from cost of goods sold or added to the gross margin.

Over absorption

= (Production units – Normal output) x SFOR

= Fixed production cost in AC – Fixed production cost in VC

Where:

FCPU (SFOR) = Fixed manufacturing cost ÷ Normal output

AC = absorption costing

VC = variable costing

FCPU = fixed cost per unit

SFOR = standard fixed overhead rate

Under absorption of fixed manufacturing overhead

If actual output units are less than normal outputs, there will be under absorption of fixed manufacturing overhead.

It can be either added from cost of goods sold or deducted to the gross margin.

Under absorption

= (Normal output – Production units) x FCPU

= Fixed production cost in VC – Fixed production cost in AC

= Old FMC – New FMC

Where:

FCPU (SFOR) = Fixed manufacturing cost ÷ Normal output

Keep in Mind (KIM)

There are three types of questions:

Question in question

Question in variable costing

Question in absorption costing

When absorption costing income statement is prepared:

Add: Under absorption [compare with variable costing or question]

Less: Over absorption [compare with variable costing or question]

When variable costing income statement is prepared:

Under absorption manufacturing cost is added to fixed manufacturing cost

Over absorption manufacturing cost is deducted from fixed manufacturing cost

Most of the Tribhuvan University questions are given in different ways:

Add: Over absorption [compare with variable costing or question]

Less: Under absorption [compare with variable costing or question]

Be careful while solving Tribhuvan University questions

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1A

Following are data pertaining to month of December of operation for BR Textile Company related to school dress textile:

Units sold 5,000 miters	Administrative expenses:
Normal output 5,550 miters	Fixed $50,000
Selling price per unit $200	Variable $100,000
Units produced 6,000 miters
Fixed manufacturing cost $100,000
	Selling and distribution expenses:
Variable cost:	Fixed $30,000
Direct materials $40	Variable (per unit) $10
Direct labor $30
Factory overheads $20

Required: Income statement under absorption costing

Answer: Net income = $238,000]

SOLUTION

Given and working note:

Sold units	= Opening stock + Production – Closing stock
5,000	= Nil + 6,000 – Closing stock
Closing stock	= 1,000

Fixed cost per unit (FCPU)

= Fixed manufacturing cost ÷ Normal output

= $100,000 ÷ 5,550 units

= $18

Income Statement under Absorption Costing

For 6,000 miters

Particulars		Amount
Sales revenue [5,000 @ $200]		10,00,000
(A)		10,00,000
Variable cost:
Direct materials [6,000 @ $40]		240,000
Direct labour [6,000 @ $30]		180,000
Variable manufacturing cost [6,000 @ $20]		120,000
Fixed manufacturing cost [6,000 @ $18]		108,000
Cost of Production @ $108]		648,000
Add: Beginning inventory (0 @ $108)		Nil
Less: Ending inventory (1,000 @ $108)		(108,000)
COGS before adjustment		540,000
Add: Under absorption		Nil
Less: Over absorption [$108,000 – $100,000]		(8,000)
COGS after adjustment (B)		532,000
Gross profit (A–B)		468000
Less: Variable administrative cost	100,000
Variable S & D cost [5,000 x $10]	50,000
Less: Fixed administrative cost	50,000
Fixed selling and distribution cost	+ 30,000	(230,000)
Net Income		238,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1B

Prime Plastic Industries manufactures plastic goods. Following transaction is related to small size item on 31^st December:

Production	50,000 units	Fixed cost:
Sales	40,000 units	Manufacturing cost	$200,000
Closing stock	15,000 units	Office expenses	$50,000
Normal capacity	40,000 units	Selling and distribution expenses	$1.50 per unit
Selling price per unit	$20

Variable cost per unit:
Raw materials	$5
Direct labour	$3
Variable manufacturing cost	$2
Variable administrative cost	$1
Variable selling and distribution	$0.50

Required: Income statement under absorption costing

[Answer: $70,000]

SOLUTION:

Given and working note:

Sold units	= Opening stock + Production – Closing stock
40,000	= Opening stock + 50,000 – 15,000
Opening stock	= 5,000

Fixed cost per unit (FCPU)

= Fixed manufacturing cost ÷ Normal output

= $200,000 ÷ 40,000 units

= $5

Income Statement under Absorption Costing

For 50,000 units

Particulars		Amount
Sales revenue [40,000 @ $20]		800,000
(A)		800,000
Variable cost:
Direct materials [50,000 @ $5]		250,000
Direct labour [50,000 @ $3]		150,000
Variable manufacturing cost [50,000 @ $2]		100,000
Fixed manufacturing cost [50,000 @ $5]		250,000
Cost of Production @ $15]		750,000
Add: Opening stock (5,000 @ $15)		75,000
Less: Closing stock (15,000 @ $15)		(225,000)
COGS before adjustment		600,000
Add: Under absorption		–
Less: Over absorption [$250,000 – $200,000]		(50,000)

Gross profit after adjustment (B)		550,000
Gross profit (A–B)		250,000
Less: Variable administrative cost [50,000 x $1]	50,000
Variable S&D cost [40,000 x $0.5]	20,000
Less: Fixed office cost	50,000
Fixed S&D cost [40,000 x $1.5]	60,000	(180,000)
Net Income		70,000

Reconciliation of Difference in Net Cost

If there is no difference in the size of opening stock and closing stock, in such a condition net income of absorption costing and variance costing is same.

The difference between opening stock, closing stock and fixed manufacturing overhead are the main cause of difference in net income.

These differences can be solved by reconciliation.

Where:

Difference in stock units	= Difference in income ÷ Fixed cost per unit
According to variable costing, Opening stock in units	= Closing stock in units − Difference in stock units
According to absorption costing, Opening stock in units	= Closing stock in units + Difference in stock units

According to variable costing, Closing stock– Opening stock	= Difference
According to absorption costing, Opening stock – Closing stock	= Difference

Reconciliation Statement

Particulars	Amount
Net income as per variable costing	xxxx
Add: Closing stock (units @ FCPU)	xxxx
Less: Opening stock (units @ FCPU)	(xxx)
Net income as per absorption costing	xxxx

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	xxxx
Add: Opening stock (units @ FCPU)	xxxx
Less: Closing stock (units @ FCPU)	(xxx)
Net income as per variable costing	xxxx

Reconciliation Statement

Particulars	Year 1	Year 2
Net income as per variable costing	xxxx	xxxx
Net income as per absorption costing	xxxx	xxxx
Different in income	xxxx	xxxx
Opening stock in units	xxxx	xxxx
Closing stock in units	xxxx	xxxx
Different stock in units (A)	xxxx	xxxx
Fixed cost per unit (B)	x	x
Different in income (A x B)	xxxx	xxxx

Keep in Mind (KIM)

FMC = fixed manufacturing cost per unit
FCPU = fixed cost per unit	= Fixed manufacturing cost ÷ Normal output
SFOR = standard fixed overhead rate

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1C

The extracted data are taken from EP Manufacturing Company:

Net profit as per absorption costing	$450,000	Fixed cost	$300,000
Opening stock	10,000 units	Normal output	40,000 units
Closing stock	7,000 units

Required: Net profit as per variable costing

[Answer: $472,500]

SOLUTION:

Fixed cost per unit (FCPU)

= Fixed manufacturing cost ÷ Normal output

= $300,000 ÷ 40,000 units

= $7.50

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	450,000
Add: Opening stock (10,000 units @ $7.50)	75,000
Less: Closing stock (7,000 units @ $7.50)	(52,500)
Net income as per variable costing	$472,500

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Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2060/S Modified

The income statement of a company under variable costing technique is given below:

Particulars	Amount	Amount
Sales revenue @ $20 each		360,000
Less: Variable cost of production @ $12 per unit	252,000
Add: Opening stock	12,000
Less: Closing stock	(48,000)	216,000
Contribution margin		144,000
Less: Non variable or constant cost:
Fixed factory overhead	50,000
Fixed selling & administrative expenses	10,000	(60,000)
Net income		84,000

Consider normal capacity 20,000 units

Required: (1) Income statement for external reporting; (2) Reconciliation statement showing reasons for difference in profit

[Answer: (1) $91,500; (2) $84,000; * Over absorption = $2,500]

SOLUTION:

Given and working note:

Sold units	= Opening Stock + Production – Closing Stock
18,000	= 1,000 + Production – 4,000
Production	= 21,000

Fixed cost per unit (FCPU)

= Fixed manufacturing overhead ÷ Normal output

= $50,000 ÷ 20,000 units

= $2.50

Income Statement under Absorption Costing

For 21,000 units

Particulars		Amount
Sales revenue (18,000 units @ 20)		3,60,000
(A)		3,60,000
Manufacturing cost:
Direct materials		NIL
Direct labour		NIL
Variable production overhead (21,000 units @ $12)		2,52,000
Fixed production cost (21,000 units @ $2.50)		52,500
Cost of production @ $14.5)		3,04,500
Add: Beginning inventory (1,000 units @ $14.5)		14,500
Less: Ending inventory (4,000 units @ $14.5)		(58,000)
COGS before adjustment		2,61,000
Add: Under absorption		Nil
Less: Over absorption ($52,500 in A.C. – $50,000 in V.C.)		(2,500)
COGS before adjustment		258,500
Gross profit (A − B)		1,01,500
Less: Variable administrative cost	Nil
Variable S&D	Nil
Less: Fixed administrative cost	Nil
Fixed S&D cost	10,000	(10,000)
Net Income		$91,500

Reconciliation Statement

Particulars	Amount
Net Income as per absorption costing	91,500
Add: Opening stock (units @ FCPU) 1,000 units x $2.50	2,500
Less: Closing stock (units @ FCPU) 4,000 units x $2.50	(10,000)
Net profit as per variable costing	$84,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2061 Modified

Following information were supplied by AH Manufacturing Concern for the year ended December 31:

Normal production capacity 25,000 units	Non-production fixed expenses $6,250
Variable production cost per unit $7	Variable administrative and selling expenses $0.25 per unit sold
Fixed production cost $62,500	Closing stock 2,500 units
Actual production and sales 21,000 units	Unit selling price $16

Required: (1) Income statement necessary for external reporting; (2) Reconcile profit under variable costing

[Answers: (1) $115,000; (2) $115,000]

* Under absorption = $10,000]

SOLUTION:

Given and working note:

Sold units	= Opening stock + Production – Closing stock
21,000	= Opening stock + 21,000 – 2,500
Opening stock	= 2,500 units

Fixed cost per unit (FCPU)

= Manufacturing Overhead ÷ Normal Output

= $50,000 ÷ 20,000 units

= $2.50

Income Statement under Absorption Costing

For 21,000 units

Particulars		Amount
Sales revenue (21,000 units @ 16)		3,36,000
(A)		3,36,000
Manufacturing cost:
Direct materials		Nil
Direct labour		Nil
Variable production overhead (21,000 units @ $7)		1,47,000
Fixed production cost (21,000 units @ $2.50)		52,500
Cost of production @ $9.5)		1,99,500
Add: Beginning inventory (2,500 units @ $9.5)		23,750
Less: Ending inventory (2,500 units @ $9.5)		(23,750)
COGS before adjustment		1,99,500
Add: Under absorption ($62,500 – $52,500)		10,000
Less: Over absorption		Nil
COGS after adjustment (B)		209,500
Gross profit (A − B)		1,26,500
Less: Variable administrative cost	NIL
Variable S & D cost (21,000 units @ $0.25)	5,250
Less: Fixed administrative cost	6,250
Fixed S & D cost	NIL	(11,500)
Net Income		$1,15,000

Reconciliation Statement

Particulars	Amount
Net Income as per Absorption Cost	1,15,000
Add: Opening stock (units @ FCPU) 2,500 units x $2.50	6,250
Less: Closing stock (units @ FCPU) 2,500 units x $2.50	(6,250)
Net profit as per variable cost	$1,15,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2062 Modified

The data relating to income statement of a company have been provided below:

Normal capacity volume	25,000 units	Fixed manufacturing cost	$100,000
Actual production volume	28,000 units	Variable selling and distribution cost	$2 per unit
Sales unit	30,000 units	Fixed selling and distribution cost	$50,000
Ending inventory	3,000 units	Selling price per unit	$30
Variable manufacturing cost per unit	$20

Required: (1) Income statement under absorption costing; (2) Reconciled profit under variable costing

[Answers: (1) $82,000 and (2) $90,000]

*Over absorption = $12,000]

SOLUTION

Given and working note:

Sold units	= Beginning inventory + Production – Ending inventory
30,000	= Beginning inventory + 28,000 – 3,000
Beginning inventory	= 5,000 units

Fixed cost per unit (FCPU)

= Manufacturing Overhead ÷ Normal Output

= $100,000 ÷ 25,000 units

= $4

Income Statement under Absorption Costing

For 28,000 units

Particulars		Amount
Sales revenue (30,000 units @ 30)		9,00,000
(A)		9,00,000
Manufacturing cost:
Direct materials		Nil
Direct labour		Nil
Variable production overhead (28,000 units @ $20)		5,60,000
Fixed production cost (28,000 units @ $4)		1,12,000
Cost of production @ $24)		6,72,000
Add: Beginning inventory (5,000 units @ $24)		1,20,000
Less: Ending inventory (3,000 units @ $24)		(72,000)
COGS before adjustment		7,20,000
Add: Under absorption		Nil
Less: Over absorption (New $112,000 – Old $100,000)		(12,000)
COGS after adjustment (B)		7,08,000
Gross profit (A − B)		1,92,000
Less: Variable administrative cost	NIL
Variable S & D cost (30,000 units @ $2)	60,000
Less: Fixed administrative cost	Nil
Fixed S & D cost	50,000	(1,10,000)
Net Income		$82,000

Reconciliation Statement

Particulars	Amount
Net Income as per absorption cost	82,000
Add: Opening stock (units @ FCPU) 5,000 units x $4	20,000
Less: Closing stock (units @ FCPU) 3,000 units x $4	(12,000)
Net profit as per variable cost	$90,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2064 Modified

ABC Manufacturing has following extracted data:

The estimated annual fixed costs for the capacity output of 20,000 units are as follows:

Factory overhead	$100,000	The estimated variable cost per unit:
Office overheads	$50,000	Material cost	$5
Selling and distribution overheads	$75,000	Labour	$3
		Factory overheads	$2
		Selling & distribution overheads	$2

The selling price per unit is fixed $25. The factory has beginning inventory 5,000 units and finalized the production schedule for 25,000 units with a sales forecast 28,000 units.

Required: Budgeted absorption costing income statement.

[Answer: Net income = $124,000; * Over absorption = $25,000]

SOLUTION:

Given and working note:

Sold units	= Opening stock + Production – Closing stock
28,000	= 5,000 + 25,000 – Closing stock
Closing stock	= 2,000 units

Fixed cost per unit (FCPU)

= $100,000 ÷ 20,000 units

= $5

Income Statement under Absorption Costing

For 25,000 units

Particulars		Amount
Sales revenue (28,000 units @ $25)		7,00,000
(A)		7,00,000
Manufacturing cost:
Direct materials (25,000 units@ $5)		1,25,000
Direct labour (25,000 units@ $3)		75,000
Variable production overhead (25,000 units @ $2)		50,000
Fixed production cost (25,000 units @ $5)		1,25,000
Cost of production (Rs 3,75,000 ÷ 25,000 units = $15)		3,75,000
Add: Opening stock (5,000 units @ $15)		75,000
Less: Closing stock (2,000 units @ $15)		(30,000)
COGS before adjustment		4,20,000
Add: Under absorption		Nil
Less: Over absorption ($125,000 new – $100,000 old)		(25,000)
COGS after adjustment (B)		395,000
Gross profit (A − B)		3,05,000
Less: Variable administrative	50,000
Variable S & D cost (28,000 units @ $2)	56,000
Less: Fixed administrative cost	Nil
Fixed S & D cost	75,000	(181,000)
Net Income		$1,24,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2065 Modified

AM Manufactures Company produces a single product. The normal level of operation is 40,000 units. Data for the last financial year were as follows:

Production units	30,000	Variable cost per unit:
Sales units	35,000	Direct materials	$5
Closing stock	Nil	Direct labour	$4
Fixed manufacturing overhead	$200,000	Other direct expenses (manufacturing)	$2
Fixed selling overhead	$105,000	Selling overhead	4% of selling price
Selling price per unit	$25

Required: Income statement under absorption costing

[Answer: $125,000] * Under absorption = $50,000]

SOLUTION:

Given and working note:

Sold units	= Opening stock + Production – Closing stock
35,000	= Opening stock + 30,000 – Nil
Opening stock	= 5,000 units

Fixed cost per unit (FCPU)

= $200,000 ÷ 40,000 units

= $5

Income Statement under Absorption Costing

For 30,000 units

Particulars		Amount
Sales revenue (35,000 units @ $25)		875,000
(A)		875,000
Manufacturing cost:
Direct materials (30,000 units@ $5)		150,000
Direct labour (30,000 units@ $4)		120,000
Variable production overhead (30,000 units @ $2)		60,000
Fixed production cost (30,000 units @ $5)		150,000
Cost of production @ $16)		480,000
Add: Opening stock (5,000 units @ $16)		80,000
Less: Closing stock (0 units @ $16)		Nil
COGS before adjustment		560,000
Add: Under absorption ($200,000 old – $150,000 new)		50,000
Less: Over absorption		Nil
COGS after adjustment (B)		610,000
Gross profit (A − B)		265,000
Less: Variable administrative	Nil
Variable S & D cost (sales @ 4%)	35,000
Less: Fixed administrative cost	Nil
Fixed S & D cost	105,000	(140,000)
Net Income		$125,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2067 Modified

The manufacturing overhead of ML Industries for last year was $200,000. The fixed administrative overhead was $150,000 and fixed selling and distribution overhead was $75,000. The variable costs per unit of the industries are as follows:

Material cost	$8	Variable manufacturing overhead	$7
Direct wages	$6	Variable selling and distribution overhead	$4

The normal capacity output was 40,000 units.

The industries realized 44,000 units of output during the period and it has 5,000 units of beginning finished goods in that period.

The industries sold 45,000 units during the period at $36 per unit.

Required: (1) Income statement based on absorption costing; (2) Reconciliation statement

[Answer: Net profit: Absorption = $65,000; Variable = $70,000]

SOLUTION

Given and working note:

Sold units	= Beginning inventory + Production – Ending inventory
45,000	= 5,000 + 44,000 – Ending inventory
Ending inventory	= 4,000 units

Fixed cost per unit (FCPU)

= Manufacturing Overhead ÷ Normal Output

= $200,000 ÷ 40,000 units

= $4

Income Statement under Absorption Costing

For 44,000 units

Particulars		Amount
Sales revenue [45,000 @ $36]		16,20,000
(A)		16,20,000
Manufacturing cost:		.
Direct materials [44,000 @ $8]		352,000
Direct labour [44,000 @ $6]		264,000
Variable manufacturing cost [44,000 @ $7]		308,000
Fixed manufacturing cost [44,000 @ $5]		220,000
Cost of production @ $26]		11,44,000
Add: Beginning inventory [5,000 @ $26)		130,000
Less: Ending inventory [4,000 @ $26)		(104,000)
COGS before adjustment		11,70,000
Add: Under absorption		Nil
Less: Over absorption [$220,000 new – $200,000 old]		20,000
COGS after adjustment (B)		11,50,000
Gross profit (A–B)		470,000
Less: Variable administrative cost	Nil
Variable S&D cost [45,000 x $4]	180,000
Less: Fixed administrative cost	150,000
Fixed S&D cost	75,000	(405,000)
Net Income		$65,000

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	65,000
Add: Opening stock (Units x FCPU viz 5,000 @ $5)	25,000
Less: Closing stock (Units x FCPU viz 4,000 @ $5)	(20,000)
Net income as per variable costing	$70,000

#####

Problems and Answers of Absorption Costing

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1A

The cost abstract of EP Manufacturing Company was as follows:

Particulars	Units cost	The operations of the year ended December were:
Direct materials	$12	Opening stock	10,000 units
Direct labour	$3	Production	90,000 units
Variable manufacturing cost	$2	Sales	80,000 units
Variable selling & distribution expenses	$1	Sales price per unit	$30

Budgeted normal output was 100,000 units with $200,000 fixed manufacturing cost. The fixed selling and distribution expenses were $50,000

Required: (1) Income statement under absorption costing; (2) Reconciled profit under variable costing

[Answer: Net profit: A.C = $730,000; V.C = $710,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1B

The summarized data of a manufacturing concern for a capacity output of 50,000 units for a year is reported as:

Items	Units Cost	Items	Cost
Direct materials	$14	Fixed manufacturing overhead	$75,000 annual
Direct labour	$6	Fixed selling expenses	$50,000 annual
Variable manufacturing overhead	$4	Production	45,000 units
Variable selling expenses	$2	Sales	40,000 units
Sales price per unit	$30

Required: (1) Absorption costing income statement; (2) Reconciled profit under variable costing

[Answers: (1) Net income = $42,500; (2) $35,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1C

ABC Manufacturing Company with normal capacity of 20,000 units furnished you the following information:

Beginning inventory units	3,000	Standard variable cost	$6.50
Units produced during the year	18,000	Fixed factory overhead at normal capacity	$50,000
Units sold during the year	20,000	Fixed selling and distribution cost	$5,000
		Unit selling price	$12

Required: (1) Income statement under absorption costing; (2) Reconciled profit under variable costing

[Answers: (1) $50,000; (2) $55,000] *Under absorption = $5,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 1D

Following are the references data of month June of operation for XYZ Company:

Opening stock	15,000 units	Variable cost:
Units produced	45,000 units	Direct materials per unit	$4
Units sold	50,000 units	Direct labour per unit	$2
Normal output	50,000 units	Factory overheads per unit	$1
Selling price per unit	$20	Administrative	$50,000
Fixed manufacturing cost	$150,000	Selling and distribution per unit	$1
		Fixed cost:
		Manufacturing	$150,000
		Administrative	$40,000
		Selling and distribution	$30,000

Required: (1) Income statement under absorption costing; (2) Reconciliation statement

[Answer: (1) Net income = $315,000; (2) $330,000]

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