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Mastery Problem: Variable Costing for Management Analysis

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Absorption vs. Variable

Operating income is one of the most important items reported by a company. Depending on the decision-making needs of management, operating income can be determined using absorption costing or variable costing.

Select whether the following characteristics are most often associated with absorption costing or variable costing.

Required under generally accepted accounting principles (GAAP)	Absorption CostingVariable CostingAbsorption Costing
Often used for internal use in decision making	Absorption CostingVariable CostingVariable Costing
Cost of goods manufactured includes only variable manufacturing costs	Absorption CostingVariable CostingVariable Costing
Used in reports prepared for external users	Absorption CostingVariable CostingAbsorption Costing
Fixed factory overhead costs are not part of cost of goods manufactured	Absorption CostingVariable CostingVariable Costing
Both fixed and variable factory costs are included in cost of goods sold and inventory	Absorption CostingVariable CostingAbsorption Costing

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Review the differences between absorption and variable costing, and how each type of costing is used in the organization and for management processes.

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Absorption Statement

Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goods sold.

Saxon, Inc. Absorption Costing Income Statement For the Year Ended December 31
Sales		$1,280,000
Cost of goods sold:
Cost of goods manufactured	$800,000
Ending inventory	(160,000)
Total cost of goods sold		(640,000)
Gross profit		$640,000
Selling and administrative expenses		(305,000)
Operating income		$335,000

Variable Statement

Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statement includes a computation of manufacturing margin.

Saxon, Inc. Variable Costing Income Statement For the Year Ended December 31
Sales		$1,280,000
Variable cost of goods sold:
Variable cost of goods manufactured	$560,000
Ending inventory	(112,000)
Total variable cost of goods sold		(448,000)
Manufacturing margin		$832,000
Variable selling and administrative expenses		(240,000)
Contribution margin		$592,000
Fixed costs:
Fixed manufacturing costs	$240,000
Fixed selling and administrative expenses	65,000
Total fixed costs		(305,000)
Operating income		$287,000

Method Comparison

Review the income statements on the Absorption Statement and Variable Statement, then complete the following table. The companys sales price per unit is $80, and the number of units in ending inventory is 4,000. There was no beginning inventory.

Item	Amount
Number of units sold	fill in the blank 5dd7d5faff8bfa8_1
Variable sales and administrative cost per unit	$fill in the blank 5dd7d5faff8bfa8_2
Number of units manufactured	fill in the blank 5dd7d5faff8bfa8_3
Variable cost of goods manufactured per unit	$fill in the blank 5dd7d5faff8bfa8_4
Fixed manufacturing cost per unit	$fill in the blank 5dd7d5faff8bfa8_5

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Review the definitions of the items in the table, and think backwards from one of the income statements to get the desired values.

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Manufacturing Decisions

Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing operating income, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.

All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.

The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement and the Variable Statement, he notices that the operating income is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the companys capacity for manufacturing, in the coming year. He reasons that this will boost operating income and satisfy the companys owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow. If the answer is zero, enter "0".

1. Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.

Operating Income
Original Production Level-Absorption	Original Production Level-Variable	Additional 10,000 Units-Absorption	Additional 10,000 Units-Variable
$fill in the blank 27abf5033051fa5_1	$fill in the blank 27abf5033051fa5_2	$fill in the blank 27abf5033051fa5_3	$fill in the blank 27abf5033051fa5_4

2. What is the change in operating income from producing 10,000 additional units under absorption costing?

$fill in the blank 27abf5033051fa5_5

3. What is the change in operating income from producing 10,000 additional units under variable costing?

$fill in the blank 27abf5033051fa5_6

I need a help on Operating Income #1 ,2, 3