Final answer:
To create income statements using absorption and variable costing, include all manufacturing costs in COGS for absorption costing and only variable manufacturing costs for variable costing. The difference in operating income between the two methods is due to the timing of when fixed manufacturing overhead costs are expensed.
Step-by-step explanation:
Absorption Costing vs. Variable Costing
To prepare an income statement based on the absorption costing concept, we include all manufacturing costs in the cost of goods sold (COGS), regardless of whether they are variable or fixed. The income statement will include sales, COGS (including direct materials, direct labor, variable manufacturing costs, and fixed manufacturing costs), gross profit, selling and administrative expenses (variable and fixed), and finally the net operating income.
For variable costing, the income statement will only include variable costs in the cost of goods sold. The fixed manufacturing costs will be treated as a period expense and deducted alongside the selling and administrative expenses. Therefore, the net operating income may differ from that of the absorption costing method.
The difference in income from operations between absorption costing and variable costing arises because, with absorption costing, fixed manufacturing overhead costs are included in inventory costs and are thus expensed as part of COGS only when goods are sold. With variable costing, fixed manufacturing costs are expensed in full in the period they are incurred.