The following data are available for Brennan Soft Toys Company for the year ended September 30, 2015

Sales: 24,000 units at $50 each
Expected and actual production: 30,000 units
Manufacturing costs incurred:
Variable: $525,000
Fixed: $372,000
Nonmanufacturing costs incurred:
Variable: $144,800
Fixed: $77,400
Beginning inventories: none

Required:
a. Determine operating income using the variable-costing approach.
b. Determine operating income using the absorption-costing approach.
c. Explain why operating income is not the same under the two approaches.

Answer:
a. Sales = 24,000 × $50 = $1,200,000
Variable manufacturing cost = ($525,000/30,000) × 24,000 = $420,000
Contribution margin = $1,200,000 - $420,000 - $144,800 = $635,200
Operating income = $635,200 - $372,000 - $77,400 = $185,800

b. Manufacturing fixed cost = ($372,000/30,000) × 24,000 = $297,600
Gross margin = $1,200,000 - $420,000 - $297,600 = $482,400
Operating income = $482,400 - $144,800 - $77,400 = $260,200

c. Absorption-costing considers fixed manufacturing cost as product cost, whereas variable-costing approach treats fixed manufacturing costs as period costs. In case of Brennan, production is 30,000 units, whereas sales is only 24,000 and hence 6,000 units are likely to remain as ending inventory. These 6,000 units will have fixed manufacturing cost of $12.40 per unit ($372,000/30,000). The total fixed manufacturing cost in ending inventory under absorption-costing approach is $74,400 ($12.40 × 6,000 units). Since this cost is inventoried, and not expensed, under absorption-costing approach, the profit is higher by $74,400 ($260,200 − $185,800) compared to profits under variable-costing approach.