Final answer:
Profit statements prepared using absorption costing include both variable and fixed manufacturing costs in product cost, affecting inventory values and COGS. Variable costing, however, only accounts for variable costs in product cost, with fixed overhead being a period expense. The method used influences profit based on inventory levels and production and sales activities.
Step-by-step explanation:
Absorption Costing vs. Variable Costing
To prepare profit statements for Mayana Limited for the months of July and August using absorption costing, we need to account for all manufacturing costs including fixed and variable costs as part of the cost of production. This method allocates a portion of fixed manufacturing overhead to each unit of product, which affects the inventory values and cost of goods sold (COGS). In contrast, variable costing only includes variable manufacturing costs in the product cost, with fixed overhead treated as a period expense.
When reconciling profits between the two costing methods, the main difference will lie in how fixed overhead is treated. Under absorption costing, fixed overhead is included in the cost of inventory and only expensed as part of COGS when the inventory is sold. This means profits can be higher or lower depending on the level of inventory produced and sold within the accounting period. On the other hand, with variable costing, since fixed costs are expensed fully in the period they are incurred, profits are directly influenced by sales activity and not by production levels.
To evaluate and calculate average profit, we must analyze short-run costs in terms of total cost, fixed cost, variable cost, marginal cost, and average cost. Understanding the relationship between production and costs, and recognizing that every factor of production has a corresponding factor price, helps in this analysis. This understanding directly affects the profit reported under each costing method.