ABSORPTION AND VARIABLECOSTING INCOME STATEMENTS
Portland Optics, Inc., specializes in manufacturing lenses for large telescopes and cameras used in space exploration. As the specifications for the lenses are determined by the customer and vary considerably, the company uses a job order costing system. Manufacturing overhead is applied to jobs on the basis of direct labor hours, utilizing the absorption or full costing method. Portland’s predetermined overhead rates for 2006 and 2007 were based on the following estimates:
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|
2006 |
2007 |
|
Direct labor hours |
32,500 |
44,000 |
|
Direct labor cost |
$325,000 |
$462,000 |
|
Fixed manufacturing overhead |
$130,000 |
$176,000 |
|
Variable manufacturing overhead |
$162,500 |
$198,000 |
Jim Bradford, Portland’s controller, would like to use variable (direct) costing for internal reporting purposes as he believes statements prepared using variable costing are more appropriate for making product decisions. In order to explain the benefits of variable costing to the other members of Portland’s management team, Jim plans to convert the company’s income statement from absorption costing to variable costing. He has gathered the following information for this purpose, along with a copy of Portland’s 2006–2007 comparative income statement.
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Portland Optics, Inc. |
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|
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Comparative Income Statement |
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|
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For the Years 2006–2007 |
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|
|
|
2006 |
2007 |
|
Net sales |
$1,140,000 |
$1,520,000 |
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Cost of goods sold: |
|
|
|
Finished goods at January 1 |
$ 16,000 |
$ 25,000 |
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Cost of goods manufactured |
720,000 |
976,000 |
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Total available |
$ 736,000 |
$1,001,000 |
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Less: Finished goods at December 31 Unadjusted cost of goods sold |
25,000 |
14,000 |
|
$ 711,000 |
$ 987,000 |
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|
Overhead adjustment Cost of goods sold |
12,000 |
7,000 |
|
$ 723,000 |
$ 994,000 |
|
|
Gross profit |
$ 417,000 |
$ 526,000 |
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Selling expenses |
(150,000) |
(190,000) |
|
Administrative expenses |
(160,000) |
(187,000) |
|
Operating income |
$ 107,000 |
$ 149,000 |
Portland’s actual manufacturing data for the two years are as follows:
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|
2006 |
2007 |
|
Direct labor hours |
30,000 |
42,000 |
|
Direct labor cost |
$300,000 |
$435,000 |
|
Direct materials used |
$140,000 |
$210,000 |
|
Fixed manufacturing overhead |
$132,000 |
$175,000 |
The company’s actual inventory balances were as follows:
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|
December 31, |
December 31, |
December 31, |
|
|
2005 |
2006 |
2007 |
|
Direct materials |
$32,000 |
$36,000 |
$18,000 |
|
Work in process: |
|
|
|
|
Costs |
$44,000 |
$34,000 |
$60,000 |
|
Direct labor hours |
1,800 |
1,400 |
2,500 |
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Finished goods: |
|
|
|
|
Costs |
$16,000 |
$25,000 |
$14,000 |
|
Direct labor hours |
700 |
1,080 |
550 |
For both years, all administrative expenses were fixed, while a portion of the selling expenses resulting from an 8 percent commission on net sales was variable. Portland reports any over or underapplied overhead as an adjustment to the cost of goods sold.
Required:
1. For the year ended December 31, 2007, prepare the revised income statement for Portland Optics, Inc., utilizing the variable costing method. Be sure to include the contribution margin on the revised income statement.
2. Describe two advantages of using variable costing rather than absorption costing.