Denham Company began operations in January 2009. Standard costs were established

Question

Denham Company began operations in January 2009. Standard costs were established at that time. . During 2009, Denham produced only 140,000 units of output and sold 100,000 units at a selling price of $180 per unit. Variable costs total $7,000,000, of which 60% are manufacturing. Fixed costs total $11,200,000, of which 50% are manufacturing. Denham has no materials or work-in-process inventories at December 31, 2009. Actual input prices per unit of output and actual input quantities per unit of output are equal to the standard amounts.

a. Compute the cost of finished goods inventory at December 31, 2009, under variable costing.

b. Compute the cost of finished goods inventory at December 31, 2009, under absorption costing.

c. Compute operating income for 2009 under variable costing.(Prepare income statement Hint)

d. Compute operating income for 2009 under absorption costing. (Prepare Income Statement Hint)

e. Reconcile by formula the difference between operating income for 2009 under variable costing and absorption costing (that is, the difference between the answers for parts (c) and (d) above).

Explanation / Answer

Finished Goods Inventory = Production - Sales = 140000-100000 = 40000 Units

A) Variable Cost per unit of Production = $7000000 / 140000 units = $50 per unit

Hence cost of Finished Goods inventory under variable costing = 40000 units * $50 = $20,00,000

B) Fixed Cost = $1,12,00,000

Fixed Manufacturing Cost = $ 1,12,00,000 * 50% = $56,00,000

Fixed Manufacturing Cost per unit = $56,00,000 / 140000 units = $40 per unit

Cost of Finished Goods Inventory under absorption costing = (Variable cost per unit + Fixed Manufacturing cost per unit) * Finished Goods Inventory = ($50 + $40) * 40000 units = $36,00,000

C) Operating Income under Variable costing as under

Sales = No.of Units sold * Sale price per unit = 100000 units * $180 = $1,80,00,000

Variable cost = No.of Units sold * Variable cost per unit = 100000 units * $50 = $50,00,000

Hence Operating income = Sales - Variable Cost = $1,80,00,000 - $50,00,000 = $1,30,00,000

D) Operating income under absorption costing as under,

Fixed Manufacturing cost of unit sold = Fixed Manufacturing cost per unit * No.of Units sold = $40 * 100000 units = $40,00,000

Operating Income = Sales - Variable Cost - Fixed Manufacturing Cost = $1,80,00,000 - $50,00,000 - $40,00,000 = $90,00,000

E) Under variable costing ,fixed cost are treated as period cost and are not considered while calculating product cost and operating income inder Variable costing method.This is the main reason behind difference in operating income under both method.

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