Instructions

1. Prepare income statements for each year using variable costing
2. Prepare income statements for each year using absorption costing.
3. Reconcile the difference each year in net income under the two costing approches
4. ....Comment on the effects of production and sales on net income under the two costing approaches

Solution

(b)

(c)     

The variable costing and the absorption costing net income can be reconciled as follows:

⁽¹⁾In 2016, with absorption costing $2,450,000 {$2,800,000 X 3,500 units sold / 4,000 units produced} of the fixed manufacturing overhead is expensed as part of cost of goods sold, and $350,000 {$2,800,000 X 500 units in inventory / 4,000 units produced} is included in the ending inventory.

⁽²⁾In 2017, with absorption costing $3,150,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2017 of $2,800,000 plus $350,000 of fixed manufacturing overhead from 2016 that was included in the beginning inventory for 2017.

(d)     

Income parallels sales under variable costing as seen in the increase in net income in 2017 when 500 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2016 when production exceeded sales by 500 tons.