Overview
This lecture explains how to prepare an absorption costing income statement, highlighting key distinctions from variable costing, focusing on the treatment of fixed manufacturing overhead and its impact on operating income.
Absorption Costing Income Statement Structure
- Absorption costing includes all variable and fixed manufacturing costs in inventory until the goods are sold.
- The income statement format: Revenue – Cost of Goods Sold = Gross Profit; then subtract Operating Expenses to reach Operating Income.
- Unlike variable costing, absorption costing does not show a contribution margin.
Calculating Cost of Goods Sold (COGS)
- COGS calculation: Beginning Inventory + Variable Manufacturing Costs + Allocated Fixed Manufacturing Costs = Cost of Goods Available for Sale.
- Deduct Ending Inventory from Cost of Goods Available for Sale to determine COGS.
- Fixed manufacturing overhead is included in inventory, not expensed immediately.
Gross Margin and Operating Income Calculation
- Gross Margin = Revenue – COGS.
- Operating Costs = Variable Operating Costs (per unit sold) + Fixed Operating Costs.
- Operating Income = Gross Margin – Total Operating Costs.
- Example figures: Revenue $8.4M, COGS $4.9M, Gross Margin $3.5M, Operating Costs $1.65M, Operating Income $1.85M.
Inventory Differences and Production Volume Variance
- Ending Inventory differs under absorption due to inclusion of fixed overhead ($14,000 per unit example).
- Production Volume Variance is an adjustment to COGS when actual production differs from expected and will be relevant in future periods (e.g., $400,000 unfavorable in May).
Key Terms & Definitions
- Absorption Costing — A method including both variable and fixed manufacturing costs in product inventory until sold.
- Variable Costing — Only variable manufacturing costs are inventoried; fixed overhead is expensed immediately.
- Gross Profit (Margin) — Revenue minus COGS.
- Operating Income — Gross Margin minus total operating costs.
- Production Volume Variance — Difference between allocated and actual fixed overhead costs based on production volume.
Action Items / Next Steps
- Complete the absorption costing income statement for May, including a $400,000 unfavorable production volume variance.
- Review the next lesson for comparisons between absorption and variable costing operating incomes.