Question

Gallatin County Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1 and operated at 100% of capacity during the first month. The following data summarize the results for July:

Sales (20,000 units) $1,800,000
Production costs (26,000 units):
Direct materials $865,800
Direct labor 416,000
Variable factory overhead 208,000
Fixed factory overhead 137,800 1,627,600
Selling and administrative expenses:
Variable selling and administrative expenses $252,300
Fixed selling and administrative expenses 97,700 350,000

If required, round interim per-unit calculations to the nearest cent.

Question Content Area
a. Prepare an income statement according to the absorption costing concept.

Gallatin County Motors Inc.
Absorption Costing Income Statement
For the Month Ended July 31

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Question Content Area
b. Prepare an income statement according to the variable costing concept.

Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31

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Fixed costs:

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Question Content Area
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 increases, the
income statement will have a higher operating income.

Answer 1

Income statements using absorption and variable costing methods differ due to the treatment of fixed factory overhead costs. Under absorption costing, fixed costs are allocated to the cost of goods sold and under variable costing, they are expensed in the period incurred. This leads to differences in operating income when inventory levels change.

Step-by-step explanation:

To prepare an income statement using the absorption costing method for Gallatin County Motors Inc., we need to account for all production costs associated with the units sold. The costs of goods sold (COGS) would include direct materials, direct labor, variable factory overhead, and a portion of the fixed factory overhead that is allocated to the units sold.

Here is how you calculate COGS and the operating income under absorption costing:

• Total production costs (for 26,000 units) = $865,800 + $416,000 + $208,000 + $137,800 = $1,627,600
• Per unit cost = $1,627,600 / 26,000 units = $62.60 per unit
• COGS (for 20,000 units sold) = 20,000 units * $62.60/unit = $1,252,000
• Gross profit = Sales - COGS = $1,800,000 - $1,252,000 = $548,000
• Total Selling and Administrative Expenses = $350,000
• Operating income = Gross profit - Selling and Administrative Expenses = $548,000 - $350,000 = $198,000

For the variable costing income statement, only the variable costs are included in the COGS. Fixed factory overhead is treated as a period cost and is not allocated to the units.

Here is how you calculate it:

• Variable costs (for 20,000 units) = Direct materials + Direct labor + Variable factory overhead = $865,800 + $416,000 + $208,000 = $1,489,800
• Per unit variable cost = $1,489,800 / 20,000 units = $74.49 per unit
• Variable COGS = 20,000 * $74.49 = $1,489,800
• Gross profit = Sales - Variable COGS = $1,800,000 - $1,489,800 = $310,200
• Total Variable Selling and Administrative Expenses = $252,300
• Total fixed costs = Fixed factory overhead + Fixed Selling and Administrative Expenses = $137,800 + $97,700 = $235,500
• Operating income = Gross profit - Total Variable Selling and Administrative Expenses - Total fixed costs = $310,200 - $252,300 - $235,500 = -$177,600

The difference in operating income under absorption and variable costing is due to the treatment of fixed factory overhead. Under absorption costing, the fixed manufacturing cost included in COGS is matched with the revenues, inflating the operating income when inventory increases. Under variable costing, all fixed manufacturing cost is deducted in the period in which it is incurred, leading to a lower operating income when inventory increases.