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Income Statements under Absorption Costing and Variable Costing

Fresno Industries Inc. manufactures and sells high-quality camping tents. The company began operations on January 1 and operated at 100% of capacity (77,000 units) during the first month, creating an ending inventory of 7,000 units. During February, the company produced 70,000 units during the month but sold 77,000 units at $90 per unit. The February manufacturing costs and selling and administrative expenses were as follows:

	Number of Units		Unit Cost		Total Cost
Manufacturing costs in February 1 beginning inventory:
Variable	7,000		$36.00		$252,000
Fixed	7,000		14.00		98,000
Total			$50.00		$350,000
Manufacturing costs in February:
Variable	70,000		$36.00		$2,520,000
Fixed	70,000		15.40		1,078,000
Total			$51.40		$3,598,000
Selling and administrative expenses in February:
Variable	77,000		$18.20		$1,401,400
Fixed	77,000		7.00		539,000
Total			$25.20		$1,940,400

a. Prepare an income statement according to the absorption costing concept for the month ending February 28.

Fresno Industries Inc.
Absorption Costing Income Statement
For the Month Ended February 28
		$
Cost of goods sold:
	$
		$
		$

b. Prepare an income statement according to the variable costing concept for the month ending February 28.

Fresno Industries Inc.
Variable Costing Income Statement
For the Month Ended February 28
		$
		$
		$
Fixed costs:
	$
		$

c. What is the reason for the difference in the amount of operating income reported in (a) and (b)?

Under the method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory decreases, the income statement will have a lower operating income.

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