Jorgansen Lightning, Inc. manufactures heavy duty street lightning systems for municipalities....

Question:

Jorgansen Lightning, Inc. manufactures heavy-duty street lightning 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) 200 160 190
Ending (units) 160 190 240
Variable costing net operating income $290,000 269,000 $250,000

The company's fixed manufacturing overhead per unit was constant at $550 for all three years.

Required: 1. Calculate each year's absorption costing net operating income. Enter any losses or deductions as a negative value.

Reconciliation of Variable costing and Absorption Costing Net Operating incomes
Year 1 Year 2 Year 3
Variable costing net operating income
Add (deduct) fixed manufacturing overhead deferred in released from inventory under absorption costing
Absorption costing net operating income

Variable 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, the fixed manufacturing overhead is recognized outright in the income statement while under the absorption costing, portion of the fixed overhead will be deferred since absorption costing recognizes fixed overhead as part of product cost.

Answer and Explanation:

Year 1 Year 2 Year 3
Variable Costing and Costing Net Operating Incomes. $290,000 $269,000 $250,000
Add (deduct) fixed manufacturing overhead deferred in (released from) inventory under absorption costing. ($22,000) 16,500 27,500
Absorption costing net operating income. $268,000 $285,500 $277,500

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) = $290,000 + ((160- 200) x $550))
  • Absorption costing net operating income (year 1) = $290,000 + (-40 x $550))
  • Absorption costing net operating income (year 1) = $290,000 - 22,000
  • Absorption costing net operating income (year 1) = $268,000

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) = $269,000 + ((190- 160) x $550))
  • Absorption costing net operating income (year 2) = $269,000 + (30 x $550))
  • Absorption costing net operating income (year 2) = $269,000+ 16,500
  • Absorption costing net operating income (year 2) = $285,500

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) = $250,000 + ((240- 190) x $550))
  • Absorption costing net operating income (year 3) = $250,000 + (50 x $550))
  • Absorption costing net operating income (year 3) = $250,000 + 27,500
  • Absorption costing net operating income (year 3) = $277,500

Learn more about this topic:

Loading...
Variable Costing: Method, Formula & Advantages

from Financial Accounting: Help and Review

Chapter 13 / Lesson 5
2.7K

Related to this Question

Explore our homework questions and answers library