# Jorgansen Light manufactures heavy-duty street lighting systems for municipalities. The company...

## Question:

Jorgansen Light manufactures heavy-duty street lighting systems for municipalities. The company uses variable costing for Internal management reports and absorption costing for external reports to shareholders, creditors, and the government. The company has provided the following data:

 Year 1 Year 2 Year 3 Inventories: Beginning (units) 214 153 186 Ending (units) 153 186 227 Variable costing net operating income $298,500$271,900 $257,400 The company's fixed manufacturing overhead per unit was constant at$565 for all three years.

Required:

1. Determine each year's absorption costing net operating income.

2. In Year 4, the company's variable costing net operating income was $252,100 and its absorption costing net operating income was$270,100.

a. Did inventories increase or decrease during Year 4?

b. How much fixed manufacturing overhead cost was deferred in or released from inventory during Year 4?

## Variable Costing And Absorption Costing

Variable costing is primarily used for management reporting purposes while absorption costing is used for external reporting purposes. The difference between the two is the treatment of fixed manufacturing overhead. Under variable costing, fixed manufacturing overhead is recognized outright in the income statement while under absorption costing, portion of fixed overhead will be deferred since absorption costing recognizes fixed overhead as part of product cost.

Question 1

At year 1, since beginning inventory is greater than ending inventory, we are sure that the number of units sold is greater than the number of units produced. If number of units sold is greater then we can assume that the fixed overhead recognized in the income statement is greater under the absorption costing method than the variable costing method. Thus net income in absorption costing is lower than net income in variable costing method. To compute:

• Absorption costing net operating income (year 1) = variable costing operating income + ((ending inventory - beginning inventory) x fixed overhead cost per unit))
• Absorption costing net operating income (year 1) = $298,500 + ((153- 214) x$565))
• Absorption costing net operating income (year 1) = $298,500 + (-61 x$565))
• Absorption costing net operating income (year 1) = $298,500 - 34,465 • Absorption costing net operating income (year 1) =$264,035

At year 2, the opposite will happen since the beginning inventory is lesser than the ending inventory.

• Absorption costing net operating income (year 2) = variable costing operating income + ((ending inventory - beginning inventory) x fixed overhead cost per unit))
• Absorption costing net operating income (year 2) = $271,900 + ((186- 153) x$565))
• Absorption costing net operating income (year 2) = $271,900 + (33 x$565))
• Absorption costing net operating income (year 2) = $271,900 + 18,645 • Absorption costing net operating income (year 2) =$290,545

At year 3, the same scenario will happen as year 2:

• Absorption costing net operating income (year 3) = variable costing operating income + ((ending inventory - beginning inventory) x fixed overhead cost per unit))
• Absorption costing net operating income (year 3) = $257,400 + ((227- 186) x$565))
• Absorption costing net operating income (year 3) = $257,400 + (41 x$565))
• Absorption costing net operating income (year 3) = $257,400 + 23,165 • Absorption costing net operating income (year 3) =$280,565

Question 2

a. Since absorption costing income is greater than variable costing income, we can conclude that the inventory increased during year 4. Why is this so? Note that the difference between the two is due to the fixed overhead cost. Fixed overhead cost is constant in variable costing while fixed overhead cost in absorption costing will vary depending on the number of units sold. Therefore if the absorption costing income is higher, the number of units sold is lesser than the number of units sold resulting to an increase in inventory at year-end.

b. The amount of fixed manufacturing overhead deferred in the inventory amounted to \$18,000. 