Exercise-2 (Variable costing income statement, reconciliation of net operating income)

Learning objectives:
This exercise illustrates the preparation of variable costing income statement and a schedule to reconcile the net operating income under variable and absorption costing approaches.

The following is the absorption costing income statement of Alpha Manufacturing Company for the year ended December 31, 2016:

Fixed selling and administrative expenses are $600,000. Variable selling and administrative expenses are $6 per unit sold. The unit product cost under absorption costing is computed as follows:

Required:

1. Prepare an income statement of Alpha Manufacturing Company using variable costing system.
2. Reconcile any difference in net operating income figure under variable costing system and under absorption costing system.

Solution

(1). Variable costing income statement:

(2) Reconciliation of net operating income:

The difference in net operating income between absorption and variable costing can be explained by the deferral of fixed manufacturing overhead in inventory that has taken place under the absorption costing system. Under absorption costing, $100,000 of fixed manufacturing overhead has been deferred in inventory to the next period. Thus, net operating income under the absorption costing system is $100,000 higher than it is under variable costing system. We can further look into it by preparing a reconciliation schedule.