Assignment 5 During The First Year Of Operations Greenwood V
Assignment 5during The First Year Of Operations Greenwood Village Fr
Assignment 5 during the first year of operations, Greenwood Village Fridge Company manufactured 40,000 mini refrigerators, of which 36,000 were sold. Operating data for the year are summarized as follows: sales totaling $6,480,000; manufacturing costs including direct materials ($3,200,000), direct labor ($1,120,000), variable manufacturing overhead ($880,000), and fixed manufacturing overhead ($560,000); variable selling and administrative expenses of $648,000; and fixed selling and administrative expenses of $288,000.
Required: Prepare the company's income statement under absorption costing and variable costing. Explain any differences between the company's income under these costing methods.
Paper For Above instruction
Introduction
The analysis of financial statements through different costing methods provides crucial insights into a company's operational efficiency and profitability. In this paper, we will analyze Greenwood Village Fridge Company's financial performance during its first year of operation by preparing income statements using both absorption costing and variable costing. Furthermore, we will explain the differences observed between these two methods in terms of reported income, considering the inherent accounting principles and their influence on financial analysis.
Absorption Costing Income Statement
Absorption costing, also known as full costing, allocates all manufacturing costs—direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead—to the cost of goods sold (COGS). This method complies with generally accepted accounting principles (GAAP) and is typically used for external financial reporting.
Calculation of Cost of Goods Sold (COGS):
Total manufacturing costs (including fixed manufacturing overhead) need to be assigned to the units sold.
Total units manufactured = 40,000 units
Units sold = 36,000 units
The total manufacturing cost incurred is:
- Direct materials: $3,200,000
- Direct labor: $1,120,000
- Variable manufacturing overhead: $880,000
- Fixed manufacturing overhead: $560,000
Total manufacturing costs = $3,200,000 + $1,120,000 + $880,000 + $560,000 = $5,760,000
Cost per unit:
- Total manufacturing costs per unit = $5,760,000 / 40,000 units = $144 per unit
Cost of goods sold:
- COGS = 36,000 units × $144 = $5,184,000
Gross profit:
- Sales = $6,480,000
- COGS = $5,184,000
- Gross profit = $1,296,000
Operating expenses:
- Variable selling and administrative expenses = $648,000
- Fixed selling and administrative expenses = $288,000
- Total operating expenses = $648,000 + $288,000 = $936,000
Net income under absorption costing:
- Net income = Gross profit – Operating expenses = $1,296,000 – $936,000 = $360,000
Absorption Costing Income Statement:
- Sales: $6,480,000
- Cost of Goods Sold: $5,184,000
- Gross Profit: $1,296,000
- Operating Expenses: $936,000
- Net Income: $360,000
Variable Costing Income Statement
Variable costing considers only variable manufacturing costs (direct materials, direct labor, and variable manufacturing overhead) for product costs, while fixed manufacturing overhead is treated as a period expense.
Calculation of variable manufacturing costs per unit:
- Direct materials: $3,200,000 / 40,000 = $80 per unit
- Direct labor: $1,120,000 / 40,000 = $28 per unit
- Variable manufacturing overhead: $880,000 / 40,000 = $22 per unit
- Total variable manufacturing cost per unit = $80 + $28 + $22 = $130
Total variable manufacturing costs for units sold:
- 36,000 units × $130 = $4,680,000
Contribution margin:
- Sales: $6,480,000
- Variable COGS: $4,680,000
- Contribution margin = $1,800,000
Variable selling and administrative expenses:
- $648,000
Fixed manufacturing overhead:
- Treated as a period expense, not allocated to inventory
- Fixed manufacturing overhead expense = $560,000
Fixed selling and administrative expenses:
- $288,000
Net income under variable costing:
- Net income = Contribution margin – Fixed manufacturing overhead – Fixed S&A expenses
- Net income = $1,800,000 – $560,000 – $288,000 = $952,000
Variable Costing Income Statement:
- Sales: $6,480,000
- Variable COGS: $4,680,000
- Contribution Margin: $1,800,000
- Fixed Manufacturing Overhead: $560,000
- Fixed Selling & Administrative Expenses: $288,000
- Net Income: $952,000
Comparison and Explanation of Differences
The net income figures under absorption and variable costing differ significantly, with $360,000 reported under absorption costing and $952,000 under variable costing. This difference arises primarily because of the treatment of fixed manufacturing overhead.
Under absorption costing, fixed manufacturing overhead is allocated to the cost of each unit produced and is included in inventory valuation. When inventory levels change, some fixed manufacturing overhead costs are deferred in inventory or released from inventory to the cost of goods sold, affecting net income. Specifically, since the company produced more units than it sold, part of the fixed manufacturing overhead costs are deferred in inventory, resulting in a higher net income under absorption costing.
Conversely, variable costing charges all fixed manufacturing overhead costs directly to the income statement in the period incurred. This method provides a clearer view of the contribution margin attributable solely to variable costs and is useful for internal decision-making.
The variance in net income illustrates how inventory fluctuations impact income statements prepared under these different accounting approaches. When inventory increases, absorption costing reports higher net income because some fixed manufacturing costs are deferred; when inventory decreases, it reports lower net income because previously deferred costs are released.
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