Variable and Absorption Costing

The following data were adapted from a recent income statement of Ansara Company for the year ended December $31$:

$($in millions$)$

Sales $$27,960$

Cost of goods sold $$(23,770)$

Selling, administrative, and other expenses $(2,520)$

Total expenses $$(26,290)$

Operating income $$1,670$

Assume that $$6,090$ million of cost of goods sold and $$1,380$ million of selling, administrative, and other expenses were fixed costs. Inventories at the beginning and end of the year were as follows:

Beginning inventory $$3,320$

Ending inventory $$3,880$

Also, assume that $30\%$ of the beginning and ending inventories were fixed costs.

Question Content Area

a$.$ Prepare an income statement according to the variable costing concept for Ansara Company. Round numbers to nearest million.

Ansara Company

Variable Costing Income Statement $($assumed$)$

For the Year Ended December $31$

Sales

$Sales

$27,960$

Variable cost of goods sold:

Beginning inventory $fill in the blank b$2$d$5$eb$06$bfbef$95\_3$

$2,324$

Variable cost of goods manufactured

Variable cost of goods manufactured

Ending inventory

Ending inventory

$2,716$

Total variable cost of goods sold

Total variable cost of goods sold

Manufacturing margin

$Manufacturing margin

Variable selling and administrative expenses

Variable selling and administrative expenses

$1,140$

Contribution margin

$Contribution margin

Fixed costs:

Fixed manufacturing costs

$Fixed manufacturing costs

$6,090$

Fixed selling and administrative expenses

Fixed selling and administrative expenses

$1,380$

Total fixed costs

Total fixed costs

$7,470$

Operating income

$Operating income

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Sales $-$ variable cost of goods sold $=$ Manufacturing margin; Variable cost of goods sold $=($beginning inventory of $70\%$ x $$3,320$ million$)+$ variable cost of goods manufactured$*-($ending inventory of $70\%$ x $$3,880$ million$)$; Manufacturing margin $-$ variable selling and administrative expenses$**=$ Contribution margin; Contribution margin $-($fixed manufacturing costs $+$ fixed selling, administrative and other expenses$)=$ income from operations

$*$Variable cost of goods manufactured $=$ cost of goods sold $+$ ending inventory $-$ beginning inventory $-$ fixed manufacturing costs

$**$Variable selling and administrative expenses $=$ selling and administrative expenses $-$ fixed selling, administrative and other expenses

Question Content Area

b$.$ Explain the difference between the amount of operating income reported under the absorption costing and variable costing concepts.

The income from operations under the variable costing concept

will not

be the same as the income from operations under the absorption costing concept when the inventories either increase or decrease during the year. In this case, Ansara$$s inventory

increased

$,$ meaning it sold

less

than it produced. As a result, the income from operations under the variable costing concept will be

less

than the income from operations under the absorption costing concept. The reason is because the variable costing concept

does

deduct the fixed costs in the period that they are incurred, regardless of changes in inventory balances.

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Absorption costing will match costs with sales by allocating the fixed costs to the beginning and ending inventories. Therefore, when inventories decrease, fixed costs from the beginning inventory are deducted in determining cost of goods sold under absorption costing.