Problem:
(Comprehensive) Brookfield Fashions produces and sells cotton blouses. The firm uses variable costing for internal management purposes and absorption costing for external purposes. At the end of each year, financial information must be converted from variable costing to absorption costing to satisfy external requirements. At the end of 1999, it was anticipated that sales would rise 20 percent from 1999 levels for 2000. Therefore, production was increased from 20,000 to 24,000 units to meet this expected demand. However, economic conditions kept the sales level at 20,000 for both years. The following data pertain to 1999 and 2000:
|
Selling price per unit
|
1999
|
2000
|
|
Sales (units)
|
$40
|
$40
|
|
Beginning inventory (units)
|
20,000
|
20,000
|
|
Production (units)
|
2,000
|
2,000
|
|
Ending inventory (units)
|
20,000
|
24,000
|
|
Unfavorable labor, material, and variable
|
2,000
|
?
|
|
overhead variances (total)
|
$5,000
|
$4,000
|
Standard variable costs per unit for 1999 and 2000 were
|
Material
|
$ 4.50
|
|
Labor
|
7.50
|
|
Overhead
|
3.00
|
|
Total
|
$15.00
|
Annual fixed costs for 1999 and 2000 (budgeted and actual) were
|
Production
|
$117,000
|
|
Selling and administrative
|
125,000
|
|
Total
|
$242,000
|
The overhead rate under absorption costing is based on practical capacity of 30,000 units per year. All variances and under- or overapplied overhead are taken to Cost of Goods Sold. All taxes are to be ignored.
a. Present the income statement based on variable costing for 2000.
b. Present the income statement based on absorption costing for 2000.
c. Explain the difference, if any, in the income figures. Assuming no Work in Process Inventory, give the entry necessary to adjust the book income amount to the financial statement income amount, if one is necessary.
d. The company finds it worthwhile to develop its internal financial data on a variable costing basis. What advantages and disadvantages are attributed to variable costing for internal purposes?
e. Many accountants believe that variable costing is appropriate for external reporting and many oppose its use for external reporting. What arguments for and against the use of variable costing can you think of in external reporting? (CMA adapted)