Heather Inc has the following information for its first year of operations:   Units produced 1,800Units sold 1,800Unit sales price$130.00Direct material per unit$25.00Direct labor per unit$10.00Variable manufacturing overhead per unit$20.00Fixed manufacturing overhead$57,600Variable selling expenses$10.00Fixed selling and administrative expenses$33,000 a. Prepare Heather's full absorption costing income statement.b. Prepare Heather's variable costing income statement.

What will be an ideal response?


a.

Sales (1,800 × $130)$234,000
Less: Cost of Goods Sold (1,800 × $87)156,600
Gross Margin ($234,000 - $156,600)$77,400
Less: Nonmanufacturing Expenses [($10 × 1,800) + $33,000]51,000
Profit ($77,400 - $51,000)$26,400

(Cost of goods sold per unit = $25 + $10 + $20 + ($57,600/1,800) = $87)
 
b.
  
Sales (1,800 × $130)$234,000
Less: Variable Costs (1,800 × $65)117,000
Contribution Margin ($234,000 - $117,000)$117,000
Less: Fixed Costs ($57,600 + $33,000)90,600
Profit ($117,000 - $90,600)$26,400

(variable cost per unit = $25 + $10 + $20 + $10 = $65)
 
Full absorption costing uses the income statement format Sales - Cost of goods sold = Gross margin - Nonmanufacturing expenses = Profit. Variable costing uses the format Sales - Variable costs = Contribution margin - Fixed costs = Profit. Note that the net incomes are equal under both methods. This only happens when the units sold equals the number of units manufactured.

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