Question

Prior to the first month of operations ending October 31 Marshall Inc. estimated the following operating results:


Sales (20,000 x $71) $1,420,000

Manufacturing costs (20,000 units):
Direct materials 852,000
Direct labor 202,000
Variable factory overhead 94,000
Fixed factory overhead 112,000
Fixed selling and administrative expenses 30,500
Variable selling and administrative expenses 36,800

The company is evaluating a proposal to manufacture 22,400 units instead of 20,000 units, thus creating an Inventory, October 31 of 2,400 units. Manufacturing the additional units will not change sales, unit variable factory overhead costs, total fixed factory overhead cost, or total selling and administrative expenses.

Required:
a. Prepare an estimated income statement, comparing operating results if 20,000 and 22,400 units are manufactured in the absorption costing format.
b. What is the reason for the difference in income from operations reported for the two levels of production by the absorption costing income statement?

Answer 1

Answer:

a.

Estimated income statement, comparing operating results if 20,000 and 22,400 units are manufactured

                                                                             20,000          22,400

Sales (20,000 x $71)                                       $1,420,000      $1,420,000

Less Cost of Goods Sold                               ($1,260,000)   ($1,248,000)

Opening Stock                                                        $ 0                 $0

Add Cost of Goods Manufactured                 $1,260,000      $1,397,760

Less Closing Stock                                                 $0              ($149,760)

Gross Profit                                                        $160,000         $172,000

Less Expenses

Selling and administrative expenses

Fixed                                                                  ($30,500 )       ($30,500 )

Variable                                                              ($36,800)       ($36,800)

Net Income / (Loss)                                             $92,700        $104,700

a. Reasons

Variable Production Costs have increased for the Manufacture of 22,400 units.

Fixed assets have been deferred in Inventory for the Manufacture of 22,400 units.

Explanation:

Cost of Goods Manufactured

Manufacturing costs (20,000 units):

Direct materials                  852,000

Direct labor                         202,000

Variable factory overhead   94,000

Fixed factory overhead       112,000

Total                                 1,260,000

Cost of Goods Manufactured

Manufacturing costs (22,400 units):

Direct materials (852,000  / 20,000 × 22,400)                    =  $954,240

Direct labor (202,000   / 20,000 × 22,400)                          = $226,240

Variable factory overhead (94,000   / 20,000 × 22,400)    =  $105,280

Fixed factory overhead                                                         =   $112,000

Total                                                                                       = $1,397,760

Closing Inventory = $1,397,760 / 22,400 × 2,400

                               = $149,760

Answer 2

The estimated net income in the manufacturing of 22,400 units is more than the income of 20,000 units by applying the method of absorption costing.

What do you mean by Absorption costing?

Absorption costs, sometimes referred to as “total costs,” are a management method of taking into account all the costs associated with producing a particular product.

Direct and indirect costs, such as direct assets, direct employment, rent, and insurance, are calculated using this method.

a) The calculation of the estimated income statement for 22,400 units and 20,000 units is shown in the image below.

b) The reason for the difference in the income from operations for the two production levels is because of the presence of closing inventories, which reduces the cost of goods sold and increases the income from operations.

Working note:

$\rm\,Cost \; of \;Goods \;Manufactured \;=\\Manufacturing \; Costs (20,000 units)= Direct \;Materials \;+ Direct \; Labor + Variable \;factory \;overhead + Fixed \;factory \;overhead\\\\Manufacturing costs (20,000 units)=852,000+202,000+94,000+112,000\\\\Manufacturing costs (20,000 units) = \ 1,260,000$

Cost of manufacturing when 22,400 units are produced:

Manufacturing costs (22,400 units):

$\rm\,Manufacturing \; Costs (22,400 units):\\Direct \; Materials (\dfrac{852,000}{20,000} \times 22,400) = 954,240\\\rm\,Direct \;labor \;\dfrac{202,000}{20,000}\times 22,400 = 226,240\\Variable factory overhead \dfrac{94,000}{20,000 }\times 22,400 = 105,280\\Fixed factory overhead = 112,000$

$\rm\,Cost \; of \;Goods \;Manufactured \;= Manufacturing \; Costs (22,400 units)= Direct \;Materials \;+ Direct \; Labor + Variable \;factory \;overhead + Fixed \;factory \;overhead\\\\\rm\,Cost \; of \;Goods \;Manufactured \; = 954,240+26,240+105,280+ 112,000\\\\\rm\,Cost \; of \;Goods \;Manufactured \; = \ 1,397,760\\\\Closing \,Inventory = \dfrac{\ 1,397,760}{22,400}\times 2,400 \\\\Closing \,Inventory = \ 149,760$

Hence, it can be concluded that the estimated net income in the manufacturing of 22,400 units is more than the income of 20,000 units by applying the method of absorption costing.

Refer to the image to know the calculation of Estimated Net Income.

To learn more about absorption costing, refer to the link:

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