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Chapter 8
Class Problem: Pop Company

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 ÷ 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 (9,000)(100)            $900,000
COGS:
BFG                            0
COGM*          470,000
Less EFG**    47,000        423,000

Gross Profit                        477,000
Less S&A                            80,000

Operation Income           $397,000
                                 ======

Sales                                    $900,000
COGS:
BFG                               0
COGM*             320,000
Less EFG**         32,000        288,000

Manufacturing Margin        612,000
Less Variable S&A                 50,000
Contribution margin             562,000
LessFixed 150,000+30,000    180,000
Operating Income                $382,000
                                   =======

Sales                                 $900,000
COGS:
BFG                             0
COGM*            200,000
Less EFG**      20,000     180,000

Throughput                      720,000
Less Operating Exp.
Manf ***    270,000
S&A               80,000         350,000
Operating Income          $370,000
                                ======
*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 (9,000)(100)             $900,000
COGS:
BFG               47,000
COGM*      406,000
Less EFG               0            453,000

Gross Profit                        447,000
Less S&A                             80,000


Operation Income           $367,000
                                 ======

Sales                                    $900 ,000
COGS:
BFG               32,000
COGM*      256,000
Less EFG               0              288,000

Manufacturing Margin       612,000
Less Variable S&A                50,000
Contribution margin            562,000
LessFixed 150,000+30,000   180,000
Operating Income              $382,000
                                 =======

Sales                                 $900,000
COGS:
BFG               20,000
COGM*      160,000
Less EFG               0          180,000

Throughput                      720,000
Less Operating Exp.
    Manf ** 246,000
     S&A        80,000         326,000
Operating Income          $394,000
                              =======
*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).