Absorption and Variable Costing Income Statements for Two Months and Analysis During the first month of operations ended July 31, Head Gear Inc. manufactured 28,500 hats, of which 27,100 were sold. Operating data for the month are summarized as follows: Sales $178,860 Manufacturing costs: Direct materials $108,300 Direct labor 28,500 Variable manufacturing cost 14,250 Fixed manufacturing cost 11,400 162,450 Selling and administrative expenses Variable $8,130 Fixed 5,930 14,060 During August, Head Gear Inc. manufactured 25,700 hats and sold 27,100 hats. Operating data for August are summarized as follows: Sales $178,860 Manufacturing costs: Direct materials $97,660 Direct labor 25,700 Variable manufacturing cost 12,850 Fixed manufacturing cost 11,400 147,610 Selling and administrative expenses: Variable $8,130 Fixed 5,930 14,060 Required: la. Prepare income statement for July using the absorption costing concept. Head Gear Inc. Absorption Costing Income Statement For the Month Ended July 31 Line Item Description Amount Amount V Sales 178,860 Cost of goods sold: $ Cost of goods manufactured 162,450 Inventory, July 31 - V 7,980MING CARAR IA SEA IAMI 154,470 $ V Gross profit 24,390 Selling and administrative expenses V 14,060 $ V Operating income 10,330 Feedback Check My Work 1a. Sales - (cost of goods manufactured - ending inventory*) = Gross profit; gross profit - selling and administrative expenses = operating ncome (Manufactured Units - Sold units) x (total manufacturing costs/manufactured units) 1b. Prepare income statement for August using the absorption costing concept. Head Gear Inc. Absorption Costing Income Statement For the Month Ended August 31 Line Item Description Amount Amount $ V Sales V 178,860 Cost of goods sold: $ X Inventory, August 1 V 8,386 Cost of goods manufactured 147,610 Total cost of goods sold Gross profit Selling and administrative expenses 14,060 Operating income Feedback Check My Work10. Sales - (cost of goods manufactured - ending inventory") = Gross profit; gross profit - selling and administrative expenses = operating income *(Manufactured Units - Sold units) x (total manufacturing costs/manufactured units) 2a. Prepare income statement for July using the variable costing concept. Head Gear Inc. Variable Costing Income Statement For the Month Ended July 31 Line Item Description Amount Amount $ Sales" 178,860 Variable cost of goods sold: Variable cost of goods manufactured Inventory, July 31 V - Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses V Contribution margin Fixed costs: Fixed manufacturing costs V Fixed selling and administrative expenses V Total fixed costs Operating income = Feedback Check My Work Partially correct 2b. Prepare income statement for August using the variable costing concept. Head Gear Inc. Variable Costing Income Statement For the Month Ended August 31 Line Item Description Amount Amount Sales V178,860 Variable cost of goods sold: Inventory, August 1" V $ Variable cost of goods manufactured V - Total variable cost of goods sold - V Manufacturing margin V Variable selling and administrative expenses V $ Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses V - Total fixed costs Operating income V 11 1 Feedback Check My Work Partially correct 3a. For July, operating income reported under variable _ v costing is less than absorption _ v costing due to part o fixed _ v manufacturing costs that are expensed, 3b. When large changes in inventory levels occur from one period to the next, it is possible for management to misinterpret suc increases (or decreases) in operating income as due to changes in: a. costs. b. prices. c. sales volume. d. "sales volume", "prices" and "costs" are correct. e. None of these choices is correct. The correct answer is: 4. Based on your answers to (1) and (2), did Head Gear Inc. operate more profitably in July or in August? Explain. Head Gear Inc. was equally profitable in July and in August - v under the variable costing concept. The difference inL LIKE July 31 ending inventory_ v . Feedback Check My Work 3a. Review the effects on operating income when the number of units manufactured differs from the number of units sold and how managers should analyze these s 3b. Remember that under absorption costing, both variable and fixed selling and administrative costs are combined and then subtracted from gross profit to obtain operating income. 4. Consider what causing the difference in operating income reported under the two methods. There is a need for management to exercise care in interpreting operating income reported under absorption costing when large changes in inventory levels occur. Feedback Check My Work Partially correct