The following data were adapted from a recent income statement of Procter & Gamble Company:
|Cost of products sold||$ 42,428|
|Marketing, administrative, and other expenses||30,337|
|Total operating costs||$ 72,765|
|Income from operations||$11,402|
Assume that the variable amount of each category of operating costs is as follows:
|Cost of products sold||$ 23,760|
|Marketing, administrative, and other expense||12,135|
a. Based on the data given, prepare a variable costing income statement for Procter & Gamble Company, assuming that the company maintained constant inventory levels during the period. b. If Procter & Gamble reduced its inventories during the period, what impact would that have on the income from operations determined under absorption costing?
Variable Costing And Absorption Costing:
Variable costing is used only for internal reporting purposes, while absorption costing is mainly used for external reporting purposes. The difference between the two is the way fixed manufacturing overhead is recognized. Under variable costing, fixed manufacturing overhead is treated as a period cost while under absorption costing, it is treated as a product cost.
Answer and Explanation:
Since the inventory level is maintained, we can ascertain that the number of units sold and produced are also equal therefore variable costing and absorption costing will yield the same income as long as there are no changes in the fixed overhead per unit. Now let us present the variable costing income statement:
|Cost of products sold||23,760|
|Marketing, administrative and other expenses||12,135||35,895|
|Cost of products sold||18,668|
|Marketing, administrative and other expenses||18,202||36,870|
Under the variable costing income statement, we are segregating the fixed cost and variable cost portion of each type of expense provided.
If inventory is reduced, it means that the number of products sold is greater than the number of units produced. Under absorption costing, fixed manufacturing overhead being recognized in the income statement will be greater than fixed manufacturing overhead under variable costing. Therefore, operating income under absorption costing will be lesser than operating income under variable costing.
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from Financial Accounting: Help and ReviewChapter 13 / Lesson 5