M3A1: Discussion—Absorption versus Variable Costing

Variable and Absorption Costing Sprintin Case Study Sprintin is a company that manufactures sneakers. The company’s data for the previous year is presented below. Sprintin had no beginning inventories in January.

Sale price $156 Fixed manufacturing overhead $7,020,000 Variable manufacturing expense per unit $3,375,000 Fixed operating expense $56 Number of sneakers produced 270,000 Sales commission expense per unit $40 Number of sneakers sold 185,000

Sprintin’s variable costing income statement is as follows: Since fixed manufacturing costs are considered to be a period cost, they are expensed in the period incurred.

Sales (185,000 X 156) $28,860,000 Less variable costs (56 +40 = 96 X185,000) 17,760,000 Contribution margin 11,100,000 Less fixed costs (7,020,000 + 3,375,000) 10,395,000 Operating income $705,000

Sprintin’s absorption costing income statement is as follows: As fixed manufacturing costs are considered to be product costs, they must be allocated between the units sold and units still in inventory. Fixed manufacturing costs = $7,020,000 / 270,000 units produced = $26 per unit.

Sales (185,000 X 156) $28,860,000 Less cost of goods sold: Variable (185,000 X 56) + Fixed (185,000 X 26) Gross profit

15,170,000 13,690,000

Less operating expense: Variable (185,000 X40) + Fixed (3,375,000) Operating income

10,775,000 $2,915,000

Inventory under the two methods would be calculated as follows: Inventory in units (270,000 units produced less 185,000 units sold) = 85,000

Variable costing: Variable manufacturing costs (85,000 X 56) $10,360,000 Absorption costing: Variable manufacturing costs above 10,360,000 Fixed manufacturing costs (85,000 X 26) 2,210,000 Total inventory costs $12,570,000

The difference in variable costing and absorption costing income in our example is equal to the difference in fixed cost included in inventory under the two methods.

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