Last year, Harris Company manufactured 17,000 units and sold 13,000 units. Production costs for the year were as follows:
$\begin{array} { | l | r | }
\hline \text { Direct materials } & \$ 153,000 \
\hline \text { Direct labour } & 110,500 \
\hline \text { Variable manufacturing overhead } & 204,000 \
\hline \text { Fixed manufacturing overhead } & 255,000 \
\hline
\end{array}$Sales were $780,000 for the year, variable selling and administrative expenses were $88,400, and fixed selling and administrative expenses were $170,000. There was no beginning inventory. Assume that direct labour is a variable cost.

-Under variable costing,what was the company's operating income for the year,as compared with under absorption costing?
A) $60,000 higher than under absorption costing.
B) $108,000 higher than under absorption costing.
C) $108,000 lower than under absorption costing.
D) $60,000 lower than under absorption costing.

Question

Last year, Harris Company manufactured 17,000 units and sold 13,000 units. Production costs for the year were as follows:
$\begin{array} { | l | r | } 
\hline \text { Direct materials } & \$ 153,000 \
\hline \text { Direct labour } & 110,500 \
\hline \text { Variable manufacturing overhead } & 204,000 \
\hline \text { Fixed manufacturing overhead } & 255,000 \
\hline
\end{array}$Sales were $780,000 for the year, variable selling and administrative expenses were $88,400, and fixed selling and administrative expenses were $170,000. There was no beginning inventory. Assume that direct labour is a variable cost.

-Under variable costing,what was the company's operating income for the year,as compared with under absorption costing?
A) $60,000 higher than under absorption costing.
B) $108,000 higher than under absorption costing.
C) $108,000 lower than under absorption costing.
D) $60,000 lower than under absorption costing.

Quizplus · Accepted Answer

Under variable costing, only variable production costs are included in product costs. Fixed manufacturing overhead is treated as a period cost and expensed in the period incurred. Under absorption costing, both variable and fixed manufacturing overheads are included in product costs.Variable Costing Calculation:- Variable Costs (Direct materials + Direct labor + Variable manufacturing overhead) = $153,000 + $110,500 + $204,000 = $467,500- Variable Selling and Administrative Expenses = $88,400- Total Variable Costs = $467,500 (Production) + $88,400 (Selling and Administrative) = $555,900- Contribution Margin = Sales - Total Variable Costs = $780,000 - $555,900 = $224,100- Fixed Costs (Manufacturing and Selling & Administrative) = $255,000 + $170,000 = $425,000- Operating Income under Variable Costing = Contribution Margin - Fixed Costs = $224,100 - $425,000 = -$200,900Absorption Costing Calculation:- Total Production Costs = Direct materials + Direct labor + Variable manufacturing overhead + Fixed manufacturing overhead = $153,000 + $110,500 + $204,000 + $255,000 = $722,500- Cost per Unit = Total Production Costs / Units Produced = $722,500 / 17,000 = $42.5 per unit- Cost of Goods Sold (COGS) = Cost per Unit * Units Sold = $42.5 * 13,000 = $552,500- Gross Margin = Sales - COGS = $780,000 - $552,500 = $227,500- Total Fixed Selling and Administrative Expenses = $170,000- Operating Income under Absorption Costing = Gross Margin - Fixed Selling and Administrative Expenses = $227,500 - $170,000 = $57,500Difference in Operating Income:- Operating Income under Variable Costing = -$200,900- Operating Income under Absorption Costing = $57,500- Difference = Operating Income under Variable Costing - Operating Income under Absorption Costing = -$200,900 - $57,500 = -$258,400The calculation error in determining the operating income under both costing methods led to an incorrect conclusion. The correct approach to find the difference in operating income between variable and absorption costing involves understanding how fixed manufacturing overhead is treated under each method and calculating the effect of the difference in inventory levels on operating income.Under variable costing, fixed manufacturing overhead is expensed in the period incurred. Under absorption costing, it is allocated to the units produced and only expensed as those units are sold. The difference in operating income is due to the fixed manufacturing overhead costs deferred in inventory under absorption costing but expensed under variable costing.Given the information, the correct calculation involves determining the fixed manufacturing overhead per unit, multiplying it by the difference in units produced and sold to find the deferred amount under absorption costing, and then comparing the operating incomes.Fixed manufacturing overhead per unit = Total fixed manufacturing overhead / Units produced = $255,000 / 17,000 units = $15 per unit.Units produced but not sold = 17,000 units - 13,000 units = 4,000 units.Deferred fixed manufacturing overhead under absorption costing = Fixed manufacturing overhead per unit * (Units produced - Units sold) = $15 * 4,000 units = $60,000.Therefore, the operating income under absorption costing would be $60,000 higher than under variable costing because this amount of fixed manufacturing overhead is deferred in inventory rather than expensed in the period incurred. This correction aligns with the understanding that absorption costing results in higher income when inventory levels increase, as it defers some costs that variable costing would expense immediately.

Last Year, Harris Company Manufactured 17,000 Units and Sold 13,000