Variable and absorption costing, explaining operating-income differences

Crystal Clear Corporation manufactures and sells 50-inch television sets and uses standard costing. Actual data relating to January, February, and March 2014 are as follows:

The selling price per unit is $3,500. The budgeted level of production used to calculate the budgeted fixed manufacturing cost per unit is 1,400 units. There are no price, efficiency, or spending variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs.

1. Prepare income statements for Crystal Clear in January, February, and March 2014 under (a) variable costing and (b) absorption costing.
2. Explain the difference in operating income for January, February, and March under variable costing and absorption costing.

1. Key inputs for income statement computations are:

January February March
Beginning inventory
Production
Goods available for sale
Units sold
Ending inventory 0
1,400
1,400
1,300
100 100
1,375
1,475
1,375
100 100
1,430
1,530
1,455
75

The budgeted fixed manufacturing cost per unit and budgeted total manufacturing cost per unit under absorption costing are:

January February March
(a) Budgeted fixed manufacturing costs
(b) Budgeted production
(c) = (a) ÷ (b) Budgeted fixed manufacturing cost per unit
(d) Budgeted variable manufacturing cost per unit
(e) = (c) + (d) Budgeted total manufacturing cost per unit $490,000
1,400
$350
$950
$1,300 $490,000
1,400
$350
$950
$1,300 $490,000
1,400
$350
$950
$1,300

(a) Variable Costing
January 2014 February 2014 March 2014
Revenuesa $4,550,000 $4,812,500 $5,092,500
Variable costs
Beginning inventoryb
$ 0 $ 95,000
$ 95,000
Variable manufacturing costsc 1,330,000 1,306,250 1,358,500
Cost of goods available for sale
Deduct ending inventoryd 1,330,000
(95,000) 1,401,250
(95,000) 1,453,500
(71,250)
Variable cost of goods sold
Variable operating costse
Total variable costs 1,235,000
942,500

2,177,500 1,306,250
996,875

2,303,125 1,382,250
1,054,875

2,437,125
Contribution margin
Fixed costs
Fixed manufacturing costs
Fixed operating costs
Total fixed costs
Operating income

490,000
120,000

2,372,500

610,000
$1,762,500

490,000
120,000

2,509,375

610,000
$1,899,375

490,000
120,000

2,655,375

610,000
$2,045,375

a $3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b $? × 0; $950 × 100; $950 × 100
c $950 × 1,400; $950 × 1,375; $950 × 1,430
d $950 × 100; $950 × 100; $950 × 75
e $725 × 1,300; $725 × 1,375; $725 × 1,455

(b) Absorption Costing

January 2014 February 2014 March 2014
Revenuesa
Cost of goods sold
Beginning inventoryb

$ 0 $4,550,000

$ 130,000 $4,812,500

$ 130,000 $5,092,500

Variable manufacturing costsc 1,330,000 1,306,250 1,358,500
Allocated fixed manufacturing costsd 490,000 481,250 500,500
Cost of goods available for sale 1,820,000 1,917,500 1,989,000
Deduct ending inventorye (130,000) (130,000) (97,500)
Adjustment for prod. vol. var.f 0 8,750 U (10,500) F
Cost of goods sold 1,690,000 1,796,250 1,881,000
Gross margin 2,860,000 3,016,250 3,211,500
Operating costs
Variable operating costsg 942,500 996,875 1,054,875
Fixed operating costs 120,000 120,000 120,000
Total operating costs 1,062,500 1,116,875 1,174,875
Operating income $1,797,500 $1,899,375 $2,036,625

a $3,500 × 1,300; $3,500 × 1,375; $3,500 × 1,455
b $?× 0; $1,300 × 100; $1,300 × 100
c $950 × 1,400; $950 × 1,375; $950 × 1,430
d $350 × 1,400; $350 × 1,375; $350 × 1,430
e $1,300 × 100; $1,300 × 100; $1,300 × 75
f $490,000 – $490,000; $490,000 – $481,250; $490,000 – $500,500
g $725 × 1,300; $725 × 1,375; $725 × 1,455

2. Absorption-costingoperating income – Variable costingoperating income = Fixed manufacturingcosts inending inventory – Fixed manufacturingcosts inbeginning inventory

January: $1,797,500 – $1,762,500 = ($350 × 100) – $0
$35,000 = $35,000

February: $1,899,375 – $1,899,375 = ($350 × 100) – ($350 × 100)
$0 = $0

March: $2,036,625 – $2,045,375 = ($350 × 75) – ($350 × 100)
– $8,750 = – $8,750

The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in January) and out of inventories as they decrease (as in March).