Calculate The Ending Inventory Using Absorption And Variable

Calculate the ending inventory using absorption and variable costing for Biff Enterprises and prepare an absorption costing income statement for Gigantic Company

1biff Enterprises Inc reports data for three years, including units sold, units produced, fixed and variable production costs, and selling prices. The task involves calculating the ending inventory value using both absorption costing and variable costing approaches.

2) Gigantic Company provides information on production, sales, costs, and pricing for 2011, with the goal of preparing an income statement using absorption costing methodology. This requires understanding the principles of absorption costing, including the treatment of fixed manufacturing overhead costs, and accurately allocating costs to inventory and cost of goods sold.

Paper For Above instruction

Accounting for inventory valuation and cost allocation plays a vital role in financial reporting and managerial decision-making. Two primary methods—absorption costing and variable costing—serve different purposes and have important implications for how inventory and income are reported. This paper discusses the methods by which Biff Enterprises can calculate its ending inventory under both approaches and provides a comprehensive preparation of a financial statement for Gigantic Company using absorption costing.

Part 1: Calculating Ending Inventory for Biff Enterprises

Biff Enterprises reports three years of operational data, with consistent sales volume but varying production levels. The focus is on computing ending inventory values at year-end using two different costing methods. Absorption costing includes all manufacturing costs—both fixed and variable—in inventory valuation, while variable costing considers only variable manufacturing costs, treating fixed manufacturing overhead as a period expense.

Absorption Costing Calculation

To calculate ending inventory using absorption costing, the unit cost includes both variable manufacturing costs and allocated fixed manufacturing overhead per unit allocated based on units produced. The formula for unit cost under absorption costing is:

Unit Cost = Variable manufacturing costs per unit + Fixed manufacturing costs allocated per unit

Fixed manufacturing costs allocated per unit = Total fixed manufacturing overhead / Units produced

For example, in 2010, units produced are 24,000, with fixed costs of $1,200,000, hence:

Fixed overhead per unit = $1,200,000 / 24,000 = $50

The variable cost per unit is $200, so total unit cost under absorption costing is:

Unit Cost = $200 + $50 = $250

Since in 2010, units sold are 20,000, and units produced are 24,000, ending inventory units are:

Ending inventory units = Units produced - Units sold = 24,000 - 20,000 = 4,000

Thus, ending inventory value is:

Ending inventory = 4,000 units × $250 = $1,000,000

Repeating similar calculations for other years provides the comprehensive ending inventory valuation under absorption costing, considering adjustments based on production and sales levels. The key insight is that the fixed manufacturing overhead per unit varies inverse to units produced, influencing inventory valuation and net income depending on the production volume.

Variable Costing Calculation

Under variable costing, only variable manufacturing costs are included in inventory. Fixed manufacturing overhead is treated as a period expense and is reflected in the income statement in full in the period incurred.

The variable cost per unit is $200, as given. The ending inventory consists of units not sold, which in 2010 are 4,000 units, valued at simply:

Ending inventory = 4,000 units × $200 = $800,000

This approach highlights the impact of fixed manufacturing overhead on net income, as it is expensed immediately, unlike in absorption costing where it is allocated to inventory.

Part 2: Preparing the Absorption Costing Income Statement for Gigantic Company

Gigantic Company’s data for 2011 includes production of 40,000 units, sales of 38,000 units, and inventory of 2,000 units at year-end. With direct costs and fixed costs outlined, the goal is to prepare an income statement based on absorption costing principles.

Calculation of Cost of Goods Sold (COGS)

The total manufacturing cost per unit in absorption costing includes variable costs and fixed manufacturing overhead:

Variable manufacturing cost per unit = $100 (materials) + $160 (labor) + $40 (overhead) = $300

Fixed manufacturing overhead allocated per unit = Total fixed manufacturing overhead / Units produced = $700,000 / 40,000 = $17.50

Hence, total manufacturing cost per unit = $300 + $17.50 = $317.50

COGS for 38,000 units sold = 38,000 units × $317.50 = $12,065,000

Inventory Valuation at Year-End

Ending inventory units = 2,000

Ending inventory value = 2,000 units × $317.50 = $635,000

Calculating Gross Profit and Net Income

Sales revenue = 38,000 units × $820 = $31,160,000

Cost of goods sold = $12,065,000 as calculated above

Gross profit = Sales revenue - COGS = $31,160,000 - $12,065,000 = $19,095,000

Adding other expenses: Selling and administrative expenses are $200,000, assuming they are period costs expensed in the period. Total expenses = $200,000

Net income = Gross profit - Expenses = $19,095,000 - $200,000 = $18,895,000

Conclusion

Understanding the differences between absorption and variable costing is critical for accurate financial analysis. Absorption costing allocates a proportionate share of fixed manufacturing overhead to inventory, affecting gross profit and net income depending on production levels. Variable costing, by expense recognition of fixed overhead immediately, provides valuable insights into contribution margin and operational efficiency. For companies like Biff Enterprises, adjusting inventory valuation techniques directly impacts reported profitability, while for firms like Gigantic Company, adopting absorption costing aligns with external financial reporting standards and provides a comprehensive view of product costs and profitability.

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