Chapter 5

Harvey Company produces a single product with the following information available
Number of units produced annually 25,000
Variable cost per unit:
Direct materials, direct labor and variable mfg. overhead $10
Selling and administrative expenses $3

Fixed costs per year:

Manufacturing overhead $150,000
Selling and administrative expenses $100,000

Let’s assume the following additional information for Harvey Company. 20,000 units were sold during
the year at a price of $30 each. There were no units in beginning inventory. Now, let’s compute net
operating income using both absorption and variable costing.

Solution:
Production = 25,000 units; Sales = 20,000 units; Selling price = $30

Costs:
• Variable manufacturing = $10/unit; Variable S&A = $3/unit
• Fixed manufacturing OH = $150,000
• Fixed S&A = $100,000

Fixed OH per unit = 150,000 ÷ 25,000 = $6

Absorption cost = 10 + 6 = $16

Variable Costing:

Particulars Calculation Amount

Sales 20,000 units × $30 $600,000
Less: Variable Expenses
Variable COGS 20,000 units × $10 (200,000)
Variable S&A 20,000 units × $3 (60,000)
Contribution Margin $340,000
Less: Fixed Expenses
Fixed Manufacturing OH (150,000)
Fixed S&A (100,000)
Net Operating Income $90,000

Absorption Costing

Particulars Calculation Amount

Sales 20,000 units × $30 $600,000
Less: Cost of Goods Sold 20,000 units × $16 (320,000)
Gross Margin $280,000
Less: Selling & Admin Expenses
Variable S&A 20,000 units × $3 (60,000)
Fixed S&A (100,000)
Net Operating Income $120,000

Reconciliation: 120,000 − 90,000 = 30,000

2. ABC Company produced different types of consumer goods. They sold goods at a price of Tk. 15. Monthly
production is 6,000 units and at this level the variable manufacturing cost is Tk. 5 per unit and fixed factory
overhead is Tk. 18,000 per month.
Gross margin statement for the first three month of the year, using absorption costing show:
Particulars April May June
(A) Sales 50,000 40,000 1,00,000
Opening finished goods 0 16,000 40,000
Cost of goods manufactured 48,000 48,000 48,000
Cost of goods available for sale 48,000 64,000 88,000
Less: Closing finished goods 16,000 40,000 24,000
(B) Cost of goods sold 32,000 24,000 64,000
Gross margin (A – B) 18,000 16,000 34,000

Required:
i. Prepare gross margin statement for each month, using direct costing method.
ii. A reconciliation statement of difference in gross margin for each month.

Given,
Selling price = Tk. 15 per unit, Production = 6,000 units, Variable cost = Tk. 5 per unit
Fixed Factory overhead cost = (18,000/6000) = Tk. 3 per unit.
Absorption Cost: $5 + 3 =$ Tk. 8 per unit.

Units sold each month (COGS ÷ Tk. 8 per unit):

April: 32,000 ÷ 8 = 4,000 units; May: 24,000 ÷ 8 = 3,000 units; June: 64,000 ÷ 8 = 8,000 units

Part (i): Gross Margin Statement – Direct (Variable) Costing

Particulars April May June

(A) Sales 50,000 40,000 1,00,000
Opening finished goods 0 (16,000/8)*5 (40,000/8)*5
Cost of goods manufactured (48,000/8)*5 (48,000/8)*5 (48,000/8)*5
Cost of goods available for sale (48,000/8)*5 (64,000/8)*5 (88,000/8)*5
Less: Closing finished goods (16,000/8)*5 (40,000/8)*5 (24,000/8)*5
(B) Cost of goods sold (32,000/8)*5 (24,000/8)*5 (64,000/8)*5
Gross margin (A – B) 30,000 25,000 60,000
Less: Fixed Factory Overhead 18,000 18,000 18,000
Gross Margin (Direct Costing) 12,000 7,000 42,000

Part (ii): Reconciliation Statement

Month Absorption Profit (Table) Direct Profit Difference

April 18,000 12,000 6,000
May 16,000 7,000 9,000
June 34,000 42,000 (8,000)
Problem 5: Manufacturing company has the following data for 1990 and 1991:
Basic production data at standard cost:

Direct materials 1.30

Direct labor 1.50
Variable overhead 0.20
Fixed overhead (Tk. 1,50,000 ÷ 1,50,000 unit of normal volume) 1.00
Total standard factory cost 4.00
Selling price per unit 5.00
Other expenses:
Fixed selling and administration 65,000
Sales commission 4% of sales value

Output and sales in unit: 1990 1991

Beginning inventory 0 30,000
Production 1,70,000 1,40,000
Sales 1,40,000 1,60,000
Ending inventory 30,000 10,000
Required:

i. Prepare an income statement for each of two years 1990 and 1991 under variable costing and
absorption costing system.
ii. A reconciliation of the differences in net income reported under the two systems.

Cost per unit

Direct material = 1.30, Direct labor = 1.50 and Variable OH = 0.20
∴ Variable cost = 1.3+1.5+0.2= 3
Fixed OH = 1
∴ Absorption cost = 3+1 = 4
 Particulars 1990 1991
(A) Sales 7,00,000 (1,40,000×5) 8,00,000 (1,60,000×5)
Opening inventory 0 (30,000 × 3) = 90,000
Cost of goods (1,70,000 × 3) = 5,10,000 (1,40,000 × 3) = 4,20,000
manufactured
Cost of goods available 5,10,000 (90,000 + 4,20,000) = 5,10,000
Less: Closing inventory (30,000 × 3) = (90,000) (10,000 × 3) = (30,000)
(B) Variable COGS (5,10,000 − 90,000) = 4,20,000 (5,10,000 − 30,000) = 4,80,000
Less: Commission (7,00,000 × 4%) = (28,000) (8,00,000 × 4%) = (32,000)
Contribution (A − B) (7,00,000 − 4,20,000 − 28,000) = (8,00,000 − 4,80,000 − 32,000) =
2,52,000 2,88,000
Less: Fixed Factory OH (1,50,000) (1,50,000)
Less: Fixed S&A (65,000) (65,000)
Net Income (Direct) (2,52,000 − 1,50,000 − 65,000) = (2,88,000 − 1,50,000 − 65,000) =
37,000 73,000

Particulars 1990 1991

(A) Sales 7,00,000 (1,40,000×5) 8,00,000 (1,60,000×5)
Opening inventory 0 (30,000 × 4) = 1,20,000
Cost of goods (1,70,000 × 4) = 6,80,000 (1,40,000 × 4) = 5,60,000
manufactured
Cost of goods available 6,80,000 (1,20,000 + 5,60,000) = 6,80,000
Less: Closing inventory (30,000 × 4) = (1,20,000) (10,000 × 4) = (40,000)
(B) COGS (6,80,000 − 1,20,000) = 5,60,000 (6,80,000 − 40,000) = 6,40,000
Gross Profit (A − B) (7,00,000 − 5,60,000) = 1,40,000 (8,00,000 − 6,40,000) = 1,60,000
Less: Commission (7,00,000 × 4%) = (28,000) (8,00,000 × 4%) = (32,000)
Less: Fixed S&A (65,000) (65,000)
Net Income (Absorption) (1,40,000 − 28,000 − 65,000) = (1,60,000 − 32,000 − 65,000) =
47,000 63,000

Reconciliation of Net Income

Particulars 1990 1991

Net Income (Absorption Costing) 47,000 63,000
Net Income (Variable Costing) 37,000 73,000
Difference to explain 10,000 (10,000)
Problem 6:
Ahmed Ltd. Uses absorption costing system. The president has recently heard about variable costing. However,
he supplies you the following data:
Normal Capacity 1,000 units
Beginning inventory 200 units
Production 900 units

Sales 1,000 units @ Tk. 10.00 per unit

Materials costs Tk. 2.00 per unit
Labour Tk. 2.00 per unit
Variable overhead Tk. 1.00 per unit
Fixed manufacturing expenses Tk. 2,700
Fixed selling expenses Tk. 1,300
Unfavorable variable cost variance from standard Tk. 200

Required:
Prepare Income statement under: (i) Absorption costing method; (ii) Variable costing method.

Solution
Closing = (200 + 900 − 1,000) = 100 units
Selling price = 10, Sales = 1,000 units → (1,000 × 10) = Tk. 10,000

Variable cost per unit: 2 (Materials costs) + 2 (Labor) + 1 (Variable OH) = Tk. 5 per unit
Fixed OH per unit (absorption): 2,700 ÷ 1,000 = 2.7

Absorption cost per unit = 5 + 2.7 = 7.7

Particulars Amount (Tk.)

(A) Sales 10,000
Opening inventory (200 × 5) = 1,000
Cost of goods manufactured (900 × 5) = 4,500
Cost of goods available (1,000 + 4,500) = 5,500
Less: Closing inventory (100 × 5) = (500)
(B) Variable COGS (5,500 − 500) = 5,000
Add: Unfavorable variance +200
Less: Variable cost of sales (5,200)
Contribution (A − B) (10,000 − 5,200) = 4,800
Less: Fixed manufacturing OH (2,700)
Less: Fixed selling expense (1,300)
Net Income (Variable) 800

Particulars Amount (Tk.)

(A) Sales 10,000
Opening inventory (200 × 7.7) = 1,540
Cost of goods manufactured (900 × 7.7) = 6,930
Cost of goods available (1,540 + 6,930) = 8,470
Less: Closing inventory (100 × 7.7) = (770)
(B) COGS (8,470 − 770) = 7,700
Add: Unfavorable variance +200
Adjusted COGS 7,900
Gross Profit (A − B) (10,000 − 7,900) = 2,100
Less: Fixed selling expense (1,300)
Net Income (Absorption) 800