Question:
(Absorption vs. variable costing) Tomm's T's is a New York-based company that produces and sells t-shirts. The firm uses variable costing for internal purposes and absorption costing for external purposes. At year-end, financial information must be converted from variable costing to absorption costing to satisfy external requirements.
At the end of 2009, management anticipated that 2010 sales would be 20 percent above 2009 levels. Thus, production for 2010 was increased by 20 percent to meet the expected demand. However, economic conditions in 2010 kept sales at the 2009 unit level of 40,000. The following data pertain to 2009 and 2010:
|
2009
|
2010
|
|
Selling price per unit
|
$22
|
$22
|
|
Sales (units)
|
40,000
|
40,000
|
|
Beginning inventory (units)
|
4,000
|
4,000
|
|
Production (units)
|
40,000
|
48,000
|
|
Ending inventory (units)
|
4,000
|
?
|
Per-unit production costs (budgeted and actual) for 2009 and 2010 were:
|
Material
|
$2.50
|
|
Labor
|
4.00
|
|
Overhead
|
1.75
|
|
Total
|
$8.25
|
Annual fixed costs for 2009 and 2010 (budgeted and actual) were:
|
Production
|
$120,000
|
|
Selling and administrative
|
130,000
|
|
Total
|
$250,000
|
The predetermined OH rate under absorption costing is based on an annual capacity of 60,000 units. Any volume variance is assigned to Cost of Goods Sold. Taxes are to be ignored.
a. Present the income statement based on variable costing for 2010.
b. Present the income statement based on absorption costing for 2010.
c. Explain the difference, if any, in the income figures. Assuming that there is no Work in Process Inventory, provide the entry necessary to adjust the book income amount to the financial statement income amount if an adjustment 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; many others oppose its use for external reporting. List the arguments for and against the use of variable costing in external reporting.