PROBLEMS-SETB riable and Absorption Costing Frances Manufacturing makes a produc
ID: 2541325 • Letter: P
Question
PROBLEMS-SETB riable and Absorption Costing Frances Manufacturing makes a product turing cost of $64, of which $36 is variable. No units were on hand at the beginning of 2015. During 2015 and 2016, the only product manufactured was sold for $96 per unit, and the cost structure did not change. Frances uses the first-in, first-out inventory method and has the following production and sales for 2015 and 2016: P7-1 B. Va with total unit manufac- Lo2, Units Manufactured 100,000 100,000 Units Sold 70,000 120,000 Required a. Prepare gross profit computations for 2015 and 2016 using absorption costing. b. Prepare gross profit computations for 2015 and 2016 using variable costing. c. Explain how your answers illustrate the impact of differences between production and sales vol- umes on the gross profits reported each year under absorption and variable costing.Explanation / Answer
a) Absorption costing
Year 2015
Sales = Units sold*Selling price per unit = 70,000 units*$96 per unit = $6,720,000
Cost of goods sold = 70,000 units*$64 per unit = $4,480,000
(Absorption costing considered fixed cost as product cost)
Gross Profit = Sales - cost of goods sold
= $6,720,000 - $4,480,000 = $2,240,000
Year 2016
Sales = Units sold*Selling price per unit = 120,000 units*$96 per unit = $11,520,000
Cost of goods sold = 120,000 units*$64 per unit = $7,680,000
Gross Profit = Sales - cost of goods sold
= $11,520,000 - $7,680,000 = $3,840,000
b) Variable Costing
Year 2015
Sales = 70,000 units*$96 per unit = $6,720,000
Variable cost = 70,000 units*$36 per unit = $2,520,000
(Variable costing considered fixed cost as period cost)
Contribution Margin = Sales - Variable costs
= $6,720,000 - $2,520,000 = $4,200,000
Fixed Manufacturing cost = 100,000 units*($64 - $36) = $2,800,000
Gross Profit = Contribution Margin - Fixed costs
= $4,200,000 - $2,800,000 = $1,400,000
Year 2016
Sales = 120,000 units*$96 per unit = $11,520,000
Variable cost = 120,000 units*$36 per unit = $4,320,000
Contribution Margin = Sales - Variable costs
= $11,520,000 - $4,320,000 = $7,200,000
Fixed Manufacturing cost = $2,800,000
Gross Profit = Contribution Margin - Fixed costs
= $7,200,000 - $2,800,000 = $4,400,000
c) The difference in gross profits under absorbtion costing and variable costing each year is due to fixed manufacturing cost of $28 per unit ($64-$36) is included in inventory under absorption costing.
2015 gross profit under absorption costing = $2,240,000
Fixed Manufacturing cost included in closing Inventory = 30,000 units*$28 per unit = $840,000
2015 gross profit under Variable costing = $2,240,000 - $840,000 = $1,400,000
2016 gross profit under absorption costing = $3,840,000
Fixed Manufacturing cost included in closing Inventory = 10,000 units*$28 per unit = $280,000
2016 gross profit under Variable costing = Gross profit Absorption costing-Closing Inventory Fixed cost+Opening Inventory Fixed cost
= $3,840,000 - $280,000 + $840,000 = $4,400,000
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