Absorption and Variable Costing (Accounting) - Please Help

Hi,

I have been going over this problem for hours and would greatly appreciate any help.

Here is the data:

| March 2012 | April 2012 |

Beginning Inventory | Nil | 150 Units |

Production | 500 Units | 400 Units |

Sales | 350 Units | 520 Units |

Variable Cost Data: | | |

Manufacturing cost per unit produced | $100 | $100 |

Operating Cost (Non-manufacturing Costs) per unit sold | $30 | $30 |

| | |

Fixed Cost Data: | | |

Manufacturing Costs | $20 000 | |

Operating Costs (Non-manufacturing Costs) | $6 000 | |

Selling Price per unit | $240 | |

Stocks are valued on First In First Out (FIFO) basis. | | |

I need to calculate the net profit using both absorption and variable costing methods.

This is my working:

Absorption costing

| April 2012 |

Sales (520 x $240) | $124,800 |

Less: Cost of Goods Sold | |

Variable manufacturing costs ($100 x 520) | 52,000 |

Fixed manufacturing costs ($20,000/500 x 150)+($20,000/400 x 370) | 24,500 |

Cost of Goods Sold | 76,500 |

Gross Profit | 48,300 |

Less: Operating costs | |

Variable operating costs ($30 x 520) | 15,600 |

Fixed operating costs | 6,000 |

Total operating costs | 21,600 |

__Net Profit__ | __$26,700**__ |

**Variable costing**

| April 2012 |

Sales (520 x $240) | $124,800 |

Less: Variable costs | |

Variable manufacturing costs ($100 x 520) | 52,000 |

Variable operating costs ($30 x 520) | 15,600 |

Total variable costs | 67,600 |

Contribution margin | 57,200 |

Less: Fixed costs | |

Fixed manufacturing cost | 20,000 |

Fixed operating costs | 6,000 |

Total fixed costs | 26,000 |

__Net Profit__ | __$31,200**__ |

The profit difference between these 2 methods is $4,500 ($31,200 - $26,700).

However when I try and reconcile income using the formula (Difference in income = Change in inventory units x Fixed overhead rate per unit)

ie. (120 units x $40($20,000/500)) I get an answer of $4,800, which is $300 greater than the profit difference calculated above.

Can someone please explain to me why this is the case and what I am doing wrong?

Thankyou.

Re: Absorption and Variable Costing (Accounting) - Please Help

Hi Oscar,

First, you need to find the Unit Product Cost (UPC) for both Absorption Costing (AC) and Variable Costing (VC).

UPC for AC

= Variable Manufactured cost + (Fixed Manufactured cost / Production)

= $100 + ($20 000 / 400 units)

= $100 + $50

= $150

UPC for VC

= Variable Manufactured cost

= $100

Second, you forgot to put Beginning Inventory (BI) for both AC and VC.

BI for AC

= 150 units x UPC for AC

= 150 units x $150

= $22 500

BI for VC

= 150 units x UPC for VC

= 150 units x $100

= $15 000

Third, you put the wrong value of reconcile income.

(Difference in income = Change in inventory units x Fixed overhead rate per unit)

Fixed overhead rate per unit should be $20,000/400

Here's the summary.

Absorption costing; Net Profit = $25 200

Variable costing; Net Profit = $31 200

Profit difference = $6 000

Reconcile the difference in income for AC and VC

= Change in inventory units x Fixed overhead rate per unit

= 120 x (20000/400)

= 120 x 50

= $6 000

Cheers...