Manta Ray Company manufactures diving masks with a variable cost of $20. The mas

Question

Manta Ray Company manufactures diving masks with a variable cost of $20. The masks sell for $29. Budgeted fixed manufacturing overhead for the most recent year was $791,700. Actual production was equal to planned production Required: State whether operating income is higher under variable or absorption costing and the amount of the difference in reported operating income under the two methods. Treat each condition as an independent case. (Do not round intermediate calculations.) 1. Production 2. Production 3. Production Sales Sales Sales 101,500 units 99,400 units 91,000 units 96,100 units 79,000 units 79, 000 units 16,380 costing 2. Variable costing 3. under both

Explanation / Answer

1) Fixed manufacturing cost per unit = Fixed Manufacturing Overhead/Units produced

= $791,700/101,500 units = $7.80 per unit

Under Absorption costing, fixed manufacturing overhead is considered as a product costs and included in the cost of inventory whereas under variable costing, fixed manufacturing overhead is considered as period costs and not included in the cost of inventory.

Ending Inventory = Units produced - Units sold

= 101,500 units - 99,400 units = 2,100 units

Fixed Manufacturing Overhead included in Ending Inventory under Absorption costing = 2,100 units*$7.80 per unit

= $16,380

Therefore $16,380 of fixed manufacturing cost will be deferred to next year under absorption costing, hence the income under absorption costing will be higher by $16,380.

2) Fixed manufacturing cost per unit = Fixed Manufacturing Overhead/Units produced

= $791,700/91,000 units = $8.70 per unit

In this case, units sold are more than units produced it means that there is no ending inventory but there is an beginning inventory of 5,100 units (96,100 units - 91,000 units). In this case the income under variable costing will be higher because the fixed manufacturing overhead included in the beginning inventory is released under absorption costing and decrease the income under absorption costing.

Fixed Manufacturing Overhead included in Beg. Inventory = 5,100 units*$8.70 per unit

= $44,370

Therefore the amount of difference is $44,370.

3) In this case units produced and units sold are same it means that there is no ending inventory and no beginning inventory, therefore there will be no release of fixed overhead and no deferrement of fixed overhead. Hence the income under both methods (absorption and variable) will be same and the amount of difference will be 0 (Zero).

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