Questions

➢ Explain the absorption costing method.

➢ Explain the variable costing method.

➢ Discuss the differences between variable and absorption costing.

➢ When is it appropriate to use variable or absorption costing in financial reporting?

➢ Under what specific circumstances would you expect net income to be larger under variable costing than under absorption costing? What is the reason for this difference?

Exercise I The following data relate to Socks Company for the year ended 2013 December 31:

Cost of production:

Direct materials (variable) $360,000

Direct labor (variable) 504,000

Manufacturing overhead:

Variable 180,000

Fixed 360,000

Sales commissions (variable) 108,000

Sales salaries (fixed) 72,000

Administrative expenses (fixed) 144,000

Units produced 150,000

Units sold (at $18 each) 120,000

Beginning inventory, 2013 January 1 -0­

There were no beginning inventories. Assume direct materials and direct labor are variable costs. Prepare two income statements—a variable costing income statement and an absorption costing income statement.

Problem G Costner Company uses an absorption costing system in accounting for the single product it manufactures. The following selected data are for the year

The company produced 12,000 units and sold 10,000 units. Direct materials and direct labor are variable costs. One unit of direct material goes into each unit of finished goods. Overhead rates are based on a volume of 12,000 units and are $1.08 and $1.44 per unit for variable and fixed overhead, respectively. The ending inventory is the 2,000 units of finished goods on hand at the end of 2013. There was no inventory at the beginning of 2013.

1. Calculate production cost per unit under variable and absorption costing.
2. Prepare an income statement for 2013 under variable costing.
3. Prepare an income statement for 2013 under absorption costing.
4. Explain the reason for the difference in net income between b and c.