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Chapter 8 Class Pop Company Problem

James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida

Chapter 8 | MAAW's Textbook Table of Contents

To demonstrate the difference between absorption costing, direct costing and throughput costing income statements.

The Pop Company produces product Z. The budgeted manufacturing costs for the product are indicated below.

Type of Input Unit Cost
Direct Material $20
Direct Labor 2
Variable Overhead 10
Fixed Overhead ($150,000 รท 10,000) 15

Year 1: Assume that there were no beginning inventories and the actual costs of production are equal to budgeted costs. During the period, Pop Company purchased $200,000 worth of direct materials, incurred selling and administrative costs of $80,000 ($50,000 variable & $30,000 fixed), produced 10,000 units and sold 9,000 units at a price of $100 per unit. Ending inventories of Direct Materials and Work in Process are zero.

Year 2: Again assume that the actual costs of production are equal to budgeted costs. During the period, Pop Company purchased $160,000 worth of direct materials, incurred selling and administrative costs of $80,000 ($50,000 variable & $30,000 fixed), produced 8,000 units and sold 9,000 units at a price of $100 per unit. Ending inventories of Direct Materials and Work in Process are zero.

Required:

1. Develop comparative income statements for absorption costing, direct costing and throughput costing for year 1.

2. Develop comparative income statements for absorption costing, direct costing and throughput costing for year 2.

Solution

Year 1 for Pop Company
Absorption Costing Direct Costing Throughput Costing
Sales   $900,000 Sales   $900,000 Sales   $900,000
COGS:     COGS:     COGS:    
BFG 0   BFG 0   BFG 0  
COGM* 470,000   COGM* 320,000   COGM* 200,000  
Less EFG** 47,000 423,000 Less EFG** 32,000 288,000 Less EFG** 20,000 180,000
Gross Profit   477,000 Manf Margin   612,000 Throughput   720,000
Less S&A   80,000 Less Var S&A   50,000 Less Opt Expense:    
Operating Income   $397,000 Contribution Margin   562,000   Manf*** 270,000+
S&A 80,000
350,000
      Less Fixed Cost   180,000 Operating Income   $370,000
      Operating Income   $382,000      
*150,000 + 32(10,000) 
** 47(1,000)
* 32(10,000)     
** 32(1,000)
*20(10,000)
**20(1,000)
*** 150,000 + 12(10,000)

 

Year 2 for Pop Company
Absorption Costing Direct Costing Throughput Costing
Sales   $900,000 Sales   $900,000 Sales   $900,000
COGS:     COGS:     COGS:    
BFG 47,000   BFG 32,000   BFG 20,000  
COGM* 406,000   COGM* 256,000   COGM* 160,000  
Less EFG 0 453,000 Less EFG 0 288,000 Less EFG 0 180,000
Gross Profit   447,000 Manf Margin   612,000 Throughput   720,000
Less S&A   80,000 Less Var S&A   50,000 Less Opt Expense:    
Operating Income   $367,000 Contribution Margin   562,000   Manf** 246,000+
S&A 80,000
326,000
      Less Fixed Cost   180,000 Operating Income   $394,000
      Operating Income   $382,000      
*150,000 + 32(8,000)
* 32(8,000)     
*20(8,000)
** 150,000 + 12(8,000)

* Note: COGM can be calculated as follows in year 1 for absorption costing:
47(10,000) = 470,000 because the overhead rate is based on 10,000 and production = 10,000.

But this does not work in year 2 because only 8,000 units were produced.
47(8,000) = 376,000. To get to COGM from this number you must add the underapplied fixed overhead
(10,000 - 8,000 units)($15 per unit) = 30,000.

Then 376,000 + 30,000 = 406,000.

Therefore, it is best to use the flexible budget equation to calculate COGM, i.e., in this case Y = 150,000 + (32)(units produced).