Costing question problem

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hersimrenjeet singh (Querist)
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08 December 2014 Dear all I need help in solving one question.Kimi Co. makes and sells high tech googles, Operating results for the first three years of operations for this company (using absorption costing) were as follows:

2012 2013 2014
Sales 700,000 717,500 717,500
Cost of goods sold 492,727 539,136 525,500
Gross margin 207,273 178,364 192,000
Selling & administrative 110,000 111,750 111,750
Operating income $97,273 $66,614 $80,250

Sales and production in each year is shown below:

2012 2013 2014
Production 2200 1950 2050
(production and actual units)
Sales unites 2000 2050 2050

The company’s manufacturing facilities are highly automated. Fixed manufacturing overhead costs are applied to units of product on the basis of each year’s production, thus, a new fixed overhead rate is computed each year. The company uses a last-in, first-out (LIFO) inventory flow assumption.

Variable manufacturing costs
(direct materials, direct labor, variable manufacturing overhead) $110.00 per unit
Fixed manufacturing overhead costs $300,000 per year
Variable selling and admin. expenses $35.00 per unit sold
Fixed selling and admin. expenses $40,000 per year

Required:
1. Prepare a variable costing (contribution format) income statement for each year.
2. a. Compute the fixed overhead rate per unit produced for each year under absorption
costing.
b. Compute the total product (inventroiable) cost per unit for each year under absorption costing.
3. Reconcile the difference in operating income between absorption and variable costing, in each year, using the following formula: FMOH in ending inventory – FMOH in beginning inventory = difference in income. Note that a little rounding error (should be less than $1) is ok.
4. Refer to the absorption costing income statements given above. Thoroughly explain (in words, not numbers) why net operating income was lower in 2013 than it was in 2012 under absorption costing, even though more units were sold in 2013 than in 2012.
5. Refer again to the absorption costing income statements above. Thoroughly explain (in words, not numbers) why profits increased in 2014 when the sales volume stayed the same as in 2013.
6. Absorption costing is required by generally accepted accounting principles for external reporting; however, many companies use variable costing for internal reporting and analysis purposes. Identify and thoroughly discuss two advantages and two disadvantages of using variable costing for internal purposes.

Please solve the question and write solution

hersimrenjeet singh

hersimrenjeet singh (Querist)
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08 December 2014 or mail me at jeet.hersimren12@gmail.com

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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20 July 2024 To tackle the problem effectively, let's go step by step through each requirement:

### 1. Variable Costing (Contribution Format) Income Statement

**Year 2012:**

```
Sales $700k
Variable costs:
Variable COGS $220k (2000 units * $110 per unit)
Variable S&A $ 70k (2000 units * $35 per unit)
Total Variable Costs $290k

Contribution Margin $410k

Fixed costs:
Fixed Manufacturing $300k (applied based on production)
Fixed S&A $ 40k
Total Fixed Costs $340k

Operating Income $ 70k
```

**Year 2013 and 2014:** The calculations follow the same format using the respective production and sales numbers for each year.

### 2. Absorption Costing Calculations

a. **Fixed Overhead Rate per Unit Produced:**

```
Year 2012: $300k / 2200 units = $136.36 per unit
Year 2013: $300k / 1950 units = $153.85 per unit
Year 2014: $300k / 2050 units = $146.34 per unit
```

b. **Total Product (Inventoriable) Cost per Unit:**

```
Variable costs per unit: $110.00
Fixed overhead per unit (as calculated above):
Year 2012: $136.36
Year 2013: $153.85
Year 2014: $146.34
Total product cost per unit = Variable cost per unit + Fixed overhead per unit
```

### 3. Reconciling Operating Income Difference

To reconcile the difference in operating income between absorption and variable costing, you need to calculate the change in Fixed Manufacturing Overhead (FMOH) in ending inventory compared to beginning inventory for each year.

### 4. Explanation for Lower Operating Income in 2013 under Absorption Costing

In 2013, despite selling more units than in 2012, the operating income under absorption costing was lower. This is because absorption costing allocates fixed manufacturing overhead costs based on production levels, not actual sales. If production exceeds sales (as seen in 2012), more fixed costs are absorbed into inventory, resulting in higher reported income. Conversely, if production is less than sales (as in 2013), more fixed costs remain in expense, reducing reported income.

### 5. Explanation for Increased Profits in 2014 under Absorption Costing

In 2014, profits increased despite the same sales volume as in 2013 because the production volume matched sales volume more closely, leading to a more efficient absorption of fixed manufacturing overhead costs. This efficient absorption results in lower expenses under absorption costing, thereby increasing reported profits.

### 6. Advantages and Disadvantages of Variable Costing for Internal Purposes

**Advantages:**
- **Better Decision Making:** Variable costing provides clearer insights into the contribution margin and the impact of changes in production and sales volumes on profitability.
- **Performance Evaluation:** It aligns costs more closely with revenues, making it easier to evaluate the profitability of different products, divisions, or segments.

**Disadvantages:**
- **Not GAAP Compliant:** Variable costing is not compliant with Generally Accepted Accounting Principles (GAAP), which require absorption costing for external financial reporting.
- **Fixed Costs Management:** It may overlook the importance of fixed costs in the long-term profitability and sustainability of the business.

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These steps should help you work through the problem systematically. Ensure to perform the actual numerical calculations for each year based on the given data to derive accurate results.

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