Variable & Absorption costing

Income statement
Selling price

300 per unit

Material
Labor

$
$

120 per unit

50 per unit

Variable overhead

30 per unit

Sales
Cost of G

Absorption costing income statements

Year 1
Year 2
$ 9,000,000 $ 10,200,000 $
7,300,000
(8,062,857)

Gross profit

###

Selling expenses
Fixed overhead
Variable selling expenses

$
$

Fixed selling expenses

$
Year 1

Units produced
Units sold

700,000
Year 2

30,000
30,000

Year 3

35,000
34,000

40,000
38,000

Sale
Less, Cost CGS
Fixed Cost
COGM

9,000,000.00

Less. Selling Exp

Selling Fix

30,000 $

20
$

600000
700,000
1300000

(1,300,000.00)

Net Income

Sale
Less, Cost CGS
V/ Selling
COGM
CGS
Less. Selling Exp
Selling Fix

Net Income

(7,300,000)

###

Gross Profit

45,000 Contribution margin

48,000 Fixed overhead
Fixed selling expenses
Net income

###
Variable costing income statements
$
30,000 $
300
30,000 $
200 $
30,000 $
20 $
$
$
$

Less; Ending
COGM
CGS
Less. Selling Exp
Selling Fix

###
1,300,000
700,000
$ 400,000

### $3,055,000

1,300,000
700,000
1,055,000

37,143

63,275

Year 2
Absorption costing income statements
$34,000 $
300
35,000 $
200 $
7,000,000
1,300,000.00
8,300,000.00
1000

9,000,000.00

1,300,000
700,000
2000000

(2,000,000.00)

(6,600,000)
2,400,000.00

###

11,400,000
(7,585,000)
(760,000)

1,300,000
700,000
720,000

237.14

10,200,000.00

(237,142.86)
$

8,062,857

###
2,137,142.86

34,000

20

680000
$

700,000
1380000

Net Income
6,000,000
600,000
6,600,000

(1,460,000)

$1,118,275

Variable costing income statements

$ 9,000,000 $ 10,200,000 $
6,000,000
(6,800,000)
600,000
(680,000)

Sales
Var. cost of goods sold
Year 4 Var. selling expenses

Sale
Less, Cost CGS
Fixed Cost
Good Availble for Sale

(1,380,000)

### $ 757,143

Difference
Year 1
Absorption costing income statements
$
30,000 $
300
30,000 $
200 $ 6,000,000
1,300,000.00
$ 7,300,000

### $2,578,275

1,300,000

Net income

1,300,000
20 per unit

Year 3
11,400,000
(8,821,725)

(1,380,000.00)

757,142.86

Variable costing income statements

Sale
$34,000 $
300
10,200,000.00
Less Cost of Good sale
Opening Inventory
35,000 $
200 $
7,000,000
Cost of Good Available for Sale
$
7,000,000
Less Ending
1000 $
200 $
(200,000) $
(6,800,000)
G Profit
3,400,000.00
V/ Selling
34,000 $
20
$
(680,000)
Less. Selling Exp
Selling Fix

Net Income

$
$

1,300,000
700,000
2000000

(2,000,000.00)

720,000.00

khan Year 03
Sale
Less Cost of Good Sale
Add: Opening Inventory
Less, Cost CGS
Fixed Cost
Good Available for Sale
Less: Ending

Absorption costing income statements

$
38,000 $
300
$

1,000 $
40,000 $

3000 $

11,400,000.00
Sale
Less Cost of Good Sale
238.425 Add; Opening Inventory
Less, Cost CGS
Fixed Cost
Good Available for Sale

237
237000
200 $ 8,000,000
1,300,000.00
9,537,000.00
238
(715,275)

COGM

8,821,725

G Profit

(8,821,725)

###

Less. Selling Exp

Selling Fix

38,000

20 $
$

760,000
700,000
1460000

###

Less Ending Inventory

38,000

300

$
$

1,000
40,000 $

200 $
200 $
$

3,000 $

205

11,400,000.00

200,000
8,000,000
8,200,000
(615,000) $

Gross Profit
V/ Selling
Contribution Margin
Less.Oprranting Exp
Fixed F.O H
Fixed Mis Exp

(7,585,000)

###
$

38,000 $

20

Net Income

$
$

238
200

(760,000)
3,055,000.00

(2,000,000.00)

###

Period 2
V & Absorb Diff
Closing Inventory
Net Income

Variable
Absorb[piton Difference
$
200,000
237,142.86 $ (37,142.86)
720,000.00
757,142.86 $ (37,142.86)

Period 3
V & Absorb Diff
Opening Inventory
Net Income

Variable
Absorb[piton
Difference
$
200,000
237,000.00 $ (37,000.00)
(615,000.00) (715,275.00) $ 100,275.00 $
63,275.00

Period 4
V & Absorb Diff
Opening Inventory
Net Income

Variable
Absorb[piton Difference
$
600,000
714,000.00 $(114,000.00)
1,840,000.00 1,726,000.00 $ 114,000.00

14,400,000.00

714000
9,000,000
1,300,000.00
11,014,000.00

Gross Profit

(11,014,000.00)

Less; Operationg Exp

Misc VARIABLE
Misc Fixed

###
3,386,000.00

$48,000

20
$

960000
700,000
1660000

(1,660,000.00)

Net Income

###
Variable costing income statements
$48,000 $
300

Sale
Less : Cost Of Sale
Opening Inventory
Add COFGM
Cost of Good Available for Sale

$ 3,000
$45,000

$
$

200
200

14,400,000.00
600000
9000000
9600000

(9,600,000.00)

G.Profit
V/ Selling
Contribution Margin
Fixed F.O H
Fixed Mis Exp

1300000
700000

$ 3,000
45,000

(1,460,000.00)

Net Income
Variable costing income statements
Sale
Less Cost of Good Sale
Add Opening Inventory
Less, Cost CGS
Good Available for Sale

Year 04
Absorption costing income statements
$48,000 $
300

Net Income

###
$48,000

20

$
$
$

1,300,000
700,000
2000000

(960,000)
3,840,000.00

(2,000,000.00)

###

Period 4
$ 14,400,000
(11,014,000)

###
(1,660,000)

###

$ 14,400,000
(9,600,000)
(960,000)

###

1,300,000
700,000
1,840,000

###

A decision whether or not to continue an old product line or department, or to start a new one is
an add-or-drop decision. An add-or-drop decision must be based only on relevant information.
Relevant information includes the revenues and costs which are directly related to a product line
department. Examples of relevant information are sales revenue, direct costs, variable overhead
direct fixed overhead. Such decision must not be based on irrelevant information such as allocat
fixed overhead because allocated fixed overhead will not be eliminated if the product line or dep
is dropped.
The following example illustrates an add-or-drop decision:

Sale
Less: V/C
Variable cost

Contribution Margin
Fixed Cost

Product A
$
$

700,000.00

(350,000.00) $

$
$

Total Fixed Cost

(203,636.36)

Total

146,363.64

Ratio :

$
$
$

A
B
D

$
$
$

Variable cost

Contribution Margin

700,000.00

(300,000.00)

(65,454.55)
(109,090.91)

$125,454.55

$
$
$

$
$

(109,090.91)

0.24

0.28
0.24
0.48

$
$
$

250,000.00

600,000.00
(300,000.00)

###

Product D Profit & Loss

$

(200,000.00) $

50,000.00

(72,727.27)
(22,727.27)

1,200,000.00
(400,000.00)

2,750,000.00

(1,250,000.00)

###

(27,272.73) $
(45,454.55) $

(130,909.09)
(218,181.82)

###
$
$

(300,000.00)
(500,000.00)

### $ (800,000.00)
$450,909.09

700,000.00

(218,181.82) Un abvoidable cost of C Dept

$
(45,454.55)
0.48
$
1.00
(12,727.27)
(10,909.09)
(21,818.18)

Product B Product c

(350,000.00) $

350,000.00

### $

(127,272.73) $
(454,545.45)
0.28
$
(45,454.55)
(45,454.55)
(45,454.55)

600,000.00

### $

(76,363.64) $
(127,272.73) $

Product A

Sale
Less: V/C

350,000.00

Avoidable cost
Unavoildable cost

Desription

Product B Product C

tC
is d
ropt
ed

Desription

Product D Profit & LosDeceasing income

$

1,200,000.00

2,500,000.00 due to closind of C Depart

$
$

(400,000.00)

###

(22,727.27)

(1,050,000.00) Note : If we want to

###

closed the Depat C

Fixed Cost

so our income is

Avoidable cost

(76,363.64) $

(65,454.55)

(130,909.09)

(272,727.27) decerasing for $ 1820000

Unavoildable cost

(127,272.73) $

(109,090.91)

(218,181.82)

(454,545.45) -1670000 so , we should

Ratio for Unavidalbe cost of C

(12,727.27) $

(10,909.09)

(21,818.18)

(45,454.55) not closed the depart c

133,636.36

114,545.45

429,090.91

677,272.73

Use the incremental approach to determine if Product C should be dropped.

Solution
By dropping Product C, the company will loose the sale revenue from the product line. The compay
will also obtain gains in the form of avoided costs. But it can avoid only the variable costs and direct fixed costs of product
C and not the allocated fixed costs. Hence:
If Product C is Dropped
Gains:
$ (200,000.00)
Variable Costs Avoided
Direct Fixed Costs Avoid $ (27,272.73)
Toal avoidable cost
$ (227,272.73)
Less: Sales Revenue Los $ 250,000.00
Decrease in Net Income $
22,727.27 $ (272,727.27) $
(22,727.27)

one is
on.
ct line or
rhead and
llocated
or department

epart

###
$

40,000.00

$34,285.71
$

68,571.43

$ 677,272.73

20000

ould

rt c

Desription
Sale

Product A

Product B Product C

467,000.00

314,000.00

598,000.00

(241,000.00)

(169,000.00)

(321,000.00)

Less: V/C
Variable cost

Contribution Mar $
Fixed Cost

226,000.00

### $ 277,000.00

Avoidable cost

(91,000.00)

(86,000.00)

(112,000.00)

Unavoildable cost

(93,000.00)

(62,000.00)

(120,000.00)

Total Fixed Cost

Total

(184,000.00) $(148,000.00) $
42,000.00

(93,000.00)

(213,000.00)

(3,000.00) $

(62,000.00) $

0.44

(27,070.42)

(62,000.00) $

0.56

(34,929.58)

(120,000.00)

Product B Product c

467,000.00

314,000.00

(241,000.00)

(300,000.00)

Less: V/C
Variable cost

Contribution Mar $
Fixed Cost

226,000.00

$ 14,000.00

Avoidable cost

(100,000.00)

(86,000.00)

Unavoildable cost

(93,000.00)

(62,000.00)

Ratio for Unavidalbe co $

(27,070.42)

(34,929.58)

(168,929.58)

5,929.58

0.56

Prod

Product A

uct
C is
drop
ted

(120,000.00)

Sale

45,000.00

Ratio :

Desription

0.44

(232,000.00)

Use the incremental approach to determine if Product C should be dropped.

Solution
By dropping Product C, the company will loose the sale revenue from the product line. The compay
will also obtain gains in the form of avoided costs. But it can avoid only the variable costs and direct fixed c
C and not the allocated fixed costs. Hence:
If Product C is Dropped
Gains:
Variable Costs Avoide $ (169,000.00)
Direct Fixed Co $ (86,000.00)
Toal avoidable c $ (255,000.00)
Less: Sales Rev $ 314,000.00
Decrease in Net $
59,000.00

Product D

Profit & Loss

$
$

1,379,000.00
(731,000.00)

648,000.00

(289,000.00)

(275,000.00)

(564,000.00)
84,000.00

Un abvoidable cost of C Dept

$

C is
drop

ted

(62,000.00)
1.00

Product D
$

Profit & Loss

-

Deceasing income

781,000.00 due to closind of C Depart

$
$

247,000.00

(541,000.00) Note : If we want to

240,000.00

closed the Depat C

so our income is

(186,000.00) decerasing for $ 1820000

(155,000.00) -1670000 so , we should

(62,000.00) not closed the depart c

(163,000.00)

om the product line. The compay

only the variable costs and direct fixed costs of product