SOLUTION: 8-42

ABSORPTION-COSTING OPERATING INCOME STATEMENTS:

Year 1 Year 2
Sales revenue ............................................................................... $62,500a $62,500d
Less: Cost of goods sold:
Beginning finished-goods inventory .............................. $ 0 $ 5,250e
Cost of goods manufactured .......................................... 31,500b 28,000f
Cost of goods available for sale ..................................... $31,500 $33,250
Ending finished-goods inventory ................................... 5,250c 0
Cost of goods sold .......................................................... $26,250 $33,250
Gross margin ............................................................................... $36,250 $29,250
Selling and administrative expenses ......................................... 22,500 22,500
Operating income ........................................................................ $13,750 $ 6,750

a2,500 units  $25 per unit

b$10,500 + $21,000 (i.e., both variable and fixed costs)
c500 units  ($31,500/3,000 units)
d2,500 units  $25 per unit
eSame as year 1 ending inventory
f$7,000 + $21,000 (i.e., both variable and fixed costs)
1. Variable-costing operating income statements:
Year 1 Year 2
Sales revenue ............................................................................... $62,500a $62,500d
Less: Cost of goods sold:
Beginning finished-goods inventory .............................. $ 0 $ 1,750e
Cost of goods manufactured .......................................... 10,500b 7,000f
Cost of goods available for sale ..................................... $10,500 $ 8,750
Ending finished-goods inventory ................................... 1,750c 0
Cost of goods sold .......................................................... $ 8,750 $ 8,750
Variable selling and administrative costs ...................... $12,500 $12,500
Total variable costs: .................................................................... $21,250 $21,250
Contribution margin .................................................................... $41,250 $41,250
Less: Fixed costs:
Manufacturing .................................................................. $21,000 $21,000
Selling and administrative .............................................. 10,000 10,000
Total fixed costs .............................................................. $31,000 $31,000
Operating income ........................................................................ $10,250 $10,250

a2,500 units  $25 per unit

bThe variable manufacturing cost only, $10,500
c500 units  ($10,500/3,000 units)
d2,500 units  $25 per unit
eSame as year 1 ending inventory
fThe variable manufacturing cost only, $7,000
2. Reconciliation of reported operating income under absorption and variable costing:
Actual Difference in Absorption-
Change in Fixed- Fixed Minus Variable-
Inventory Overhead Overhead Costing
Year (in units) Rate Expensed Op’g Income
1 500 increase  $7 $ 3,500 $3,500
2 500 decrease  $7* $(3,500) (3,500)

*The 500 units which were sold in year 2, but which were manufactured in year 1,
include an absorption-costing product cost of $7 per unit for fixed overhead. Since
these 500 units were manufactured in year 1, it is the year 1 fixed-overhead rate that is
relevant to this calculation, not the year 2 rate.

Explanation: At the end of year 1, under absorption costing, $3,500 of fixed overhead
remained stored in finished-goods inventory as a product cost (year 1 fixed-overhead rate of
$7 per unit  500 units = $3,500). However, in year 1, under variable costing, that fixed
overhead was expensed as a period cost.

In year 2, under absorption costing, that same $3,500 of fixed overhead was expensed when
the units were sold. However, under variable costing, that $3,500 of fixed overhead cost had
already been expensed in year 1 as a period cost.