Exercise ( Variable and Absorption Costing )

Super Bicycle produces an inexpensive yet rugged bicycle for P5,000. Selected data for the
company’s operations last year follow :
Un its in beginning inventory none
Units produced 10,000
Units sold 8,000
Units in ending inventory 2,000
Variable cost per unit :
Direct materials 1,200
Direct labor 1,400
Variable manufacturing overhead 500
Variable selling and administrative 200
Fixed costs :
Fixed manufacturing overhead 6,000,000
Fixed selling and administrative 4,000,000
Required :
1. Assume that the company uses absorption costing, Compute the unit product cost for one
bicycle.
Answer :
Direct materials 1,200
Direct labor 1,400
Variable manufacturing overhead 500
Fixed overhead (6,000,000/10,000) 600
Unit cost, absorption 3,700

2. Assume that the company uses variable costing.Compute the unit product cost for one
bicycle.
Answer:
Direct materials 1,200
Direct labor 1,400
Variable manufacturing overhead 500
Unit cost, variable 3,100

II. Max Company manufactures and sells a single product. The following costs were incurred
during the company’s first year of operations:
Variable cost per unit :
Production
Direct materials 18
` Direct labor 7
Variable overhead 2
Variable operating 5
Fixed costs per year
Fixed manufacturing overhead 160,000
 Fixed operating 110,000
During the year, the company produced 20,000 units and sold 16,000 units. Unit selling price
is P50 per unit.
Required :
Prepare income statements under absorption and variable costing. Reconcile the difference in
net income.

a. The unit product cost under absorption costing would be:

Direct materials P18
Direct labor 7
Variable manufacturing overhead     2
Total variable manufacturing costs 27
Fixed manufacturing overhead (P160,000 ÷ 20,000 units)     8
Unit product cost P35

b. The absorption costing income statement:

P800,00
Sales (16,000 units × P50 per unit) 0
Less cost of goods sold:
Beginning inventory P         0
Add cost of goods manufactured  700,00
(20,000 units × P35 per unit) 0
Goods available for sale 700,000
Less ending inventory  140,00
(4,000 units × P35 per unit) 0  560,000
Gross margin 240,000
Less selling and administrative expenses  190,000 *
Net operating income P 50,000
*(16,000 units × P5 per unit) + P110,000 = P190,000.

Requirement 2
a. The unit product cost under variable costing would be:
Direct materials P18
Direct labor 7
Variable manufacturing overhead     2
Unit product cost P27

b. The variable costing income statement:

P800,00
Sales (16,000 units × P50 per unit) 0
Less variable expenses:
Variable cost of goods sold:
Beginning inventory P         0
Add variable manufacturing costs
(20,000 units × P27 per unit)  540,000
Goods available for sale 540,000
 Less ending inventory
(4,000 units × P27 per unit)  108,000
Variable cost of goods sold 432,000
Variable selling expense  512,00
(16,000 units × P5 per unit)    80,000 0
Contribution margin 288,000
Less fixed expenses:
Fixed manufacturing overhead 160,000
 270,00
Fixed selling and administrative  110,000 0
P 18,00
Net operating income 0
* The variable cost of goods sold could be computed more simply as: 16,000 units × P27 per unit
= P432,000.

III.C. Romero has gone over the financial statements for Romero Parts Inc. The income
statement has been prepared on an absorption costing basis and Romero would like to have
the statement revised on a variable costing basis.
The company has a normal production capacity of 1,200,000 units per year. Only one line of
product is manufactured and the inventory is accounted for on a FIFO basis. In 20x3, the fixed
factory overhead was P6,000,000. During the year, Romero Parts Inc. manufactured 1,100,000
units of product.
Romero Parts
Income Statement – Manufacturing
For the year ended December 31, 20x3
Sales 20,700,000
Less : Cost of goods sold
Inventory, first year 1,980,000
Current production 13,200,000
Available for sale 15,180,000
Less : Inventory , end 1,380,000 13,800,000
Gross margin 6,900,000
Factory overhead capacity variance ` 500,000
Income from manufacturing 6,400,000
For the current year, 20x4, plans have been made to manufacture 1,400,000 units of product and to sell
1,450,000 units. The unit variable cost and the selling price are expected to be the same as they were
last year. The normal capacity will remain unchanged but fixed factory overhead can be reduced to
5,400,000 for the year.
Required :
1. recast the income statement for 20x3 to place it on a variable costing basis. Show beginning
inventory at variable cost.
2. Prepare an estimated income statement for 20x4 on an absorption costing basis.
3. Prepare another income statement for 20x4 on variable costing basis.
 Requirement 1: Variable Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing

For the Year Ended December 31, 20X3

Sales P20,700,000

Less: Variable Cost of Sales

Inventory, Jan. 1 (165,000 x P7) P1,155,000

Current Production (1,100,000 x 7) 7,700,000

Total Available for Sale P8,855,000

Inventory, Dec. 31 (115,000 x 7) 805,000 8,050,000

Contribution Margin P12,650,000

Less Fixed Costs and Expenses 6,000,000

Net Income P 6,650,000

Beginning 165,000 units + 1,100,000- 115,000 = 1,150,000 units sold

USP = 20,700,000/1, 150,000 = P18

Requirement 2: Absorption Costing Method

Romero Parts, Inc.

Income Statement – Manufacturing

For the Year Ending December 31, 20X4

Sales ( 1,450,000 x 18) P26,100,000

Less Cost of goods sold:

 Inventory, Jan. 1(115,000 x12) P 1,380,000

Current Production ( 1,400,000 x 11.50) 16,100,000

Total Available for Sale P17,480,000

Inventory, Dec. 31 ( 65,000 x 11.5) 747,500

Cost of Sales - Standard P16,732,500

Favorable Capacity Variance 900,000 15,832,500

Income from Manufacturing P10,267,500

( 1,400,000 -1,200,000 ) x 4.50 = 900,000 F

Requirement 3: Variable Costing Method

Romero Parts, Inc.

Income Statement - Manufacturing

For the Year Ending December 31, 20X4

Sales ( 1,450,000 x18) P26,100,000

Less Variable Cost of Sales:

Inventory, Jan. 1 ( 11 5,000 x 7) P 805,000

Production( 1,400,000 x 7) 9,800,000

Total Available for Sale P10,605,000

Inventory, Dec. 31 (65,000 x 7) 455,000 10,150,000

Contribution Margin - Manufacturing P15,950,000

Less Fixed Cost 5,400,000

Income from Manufacturing P10,550,000

 Reconciliation

Net Income, absorption costing P10,267,500

Add Fixed Factory Overhead Inventory, 1/1(115,000 x 5) 575,000

Total P10,842,500

Less Fixed Factory Overhead Inventory, 12/31 (65,000 x 4.5) 292,500

Net Income, direct costing P10,550,000

Current production cost ( absorption ) 13,200,000/1,100,000 20x3 = P12

Less : FFOH portion (6,000,000/1,200,000) 5
Variable unit cost 7