Quiz 18: Kinkead Equipment

Business

Explanation: In the month of august, the factory at G Inc. was not busy as compared to the normal month of July because the production level was down as compared to production levels in July. This is despite the fact that sales were reported higher in the month of August.

Income Statements using absorption costing and direct costing for normal month and the month of august: Absorption Costing: Under absorption costing, costs are classified as per their function played in the organization like manufacturing, selling and administration. In this system, material, labor and manufacturing overhead are charged to inventory for units produced. These costs forms the part of cost of goods sold for units sold to consumers. Direct Costing: Under direct costing, costs are classified as per their behavior like fixed cost and variable cost. It include as product costs only those costs that varies with the level of production. Manufacturing overheads that does not vary with production levels are included with period costs like selling and administrative costs. The month of July is considered normal for analyzing variance because of the following reasons: • The production level was normal in the month of July. • The inventory levels at the beginning of the month July is not known although it is known that whatever was produced in the month of July was not all sold. Income Statement of G Inc. for the normal month using absorption costing and direct costing: img Income Statement of G Inc. for the month of August using absorption costing and direct costing: img • Sales were high in the months of august when compared to July. • Production levels were lower in in the months of august when compared to July Analysis of difference in earnings: (a) Absorption costing: Earnings in the month of July are higher than the month of august due to the following reasons: 1. Due to presence of high overhead in terms of volume earnings are less in the month of august. This was because sales in the month of august are derived from the inventory level lying at the beginning of July. 2. Higher production overheads due to excess supply in the month of august also resulted in reduced earnings. (b) Direct costing: Since all products in the month of July are not sold therefore as per the principle of direct costing almost all type of costs are marginally high in the month of august and sales are also significantly higher than in the month of August. Therefore, in the month of August there is high profit.

(a) Absorption Costing: Under absorption costing, costs are classified as per their function played in the organization like manufacturing, selling, and administration. In this system, material, labor and manufacturing overhead are charged to inventory for units produced. These costs forms the part of cost of goods sold for units sold to consumers. Direct Costing: Under direct costing, costs are classified as per their behavior like fixed cost and variable cost. It include as product costs only those costs that varies with the level of production. Manufacturing overheads that does not vary with production levels are included with period costs like selling and administrative costs. Difference in the profits figure reported for the month of August, 1993 using absorption costing and direct costing: img Due to the following reasons profit figures are different using two different costing systems: 1. August sales include inventory balance at the beginning derived from the production in July. As per absorption costing, inventory at the beginning includes fixed as well as variable component whereas under direct costing beginning inventory includes only variable part. 2. Difference in cost of goods sold had a significant impact on the contribution or gross margin. 3. The different treatment of fixed factory overhead under two systems also caused reporting of two different profit figures. Under Direct costing, fixed factory overhead is charged as a normal period cost whereas in absorption costing it is charged to cost of goods sold. 4. Fixed factory overhead includes the remains from the current period only under direct costing whereas it also includes remains from the activity in the previous month under absorption costing. (b) img Due to the following reasons profit figures are different using two different costing systems: 1. The different treatment of fixed factory overhead under two systems caused reporting of two different profit figures. Under direct costing, fixed factory overhead is charged as a normal period cost whereas in absorption costing it is charged to cost of goods sold. 2. Though there is not a significant difference in overhead variances under two systems, but due to higher charge of fixed factory overhead in direct costing the amount of profits declined significantly.

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