let's continue working through this problem using absorption costing let's go back to some basics here is absorption costing this is the traditional type of income statement where we subtract cost of goods sold we get gross profit we subtract all of our operating expenses notice we don't have contribution margin under an absorption costing income statement and likewise under a variable costing income statement we do not have gross profit so I did mention that all variable costs and fix manufacturing overhead costs are included in inventory so if there's an increase in inventory that fix manufacturing overhead is treated as inventory it's not expensed in the same period so let's work through a problem and see how that impacts income so we'll continue with this problem we work through a variable costing I'm going to use these numbers we work through a variable costing let me I'm going to copy this the format's going to change so copying it but I'm actually deleting the details just wanted to have a table here perfect so we've got absorption costing of course we start with revenue under both less cost of goods sold and we're going to take a little while to get there we've got beginning inventory we're going to add variable manufacturing costs just like we did here we are also going to add fixed manufacturing costs and it's going to be allocated fixed manufacturing costs highlighting that because I want you to see the difference in how he handles it earlier part of inventory now it's no longer expensed right away this will give me my cost of goods available for sale so notice this number is now incorporating one additional item that's key point here we deduct beginning inventory I'm sorry we deduct ending inventory and I want you to add an extra line here it's an adjustment or production volume variance it won't come up for April but it will come up from a and I'll talk about that when we get to it so here's my cost of goods sold just like we had cost of goods sold up here but again the one thing that's different is what I highlighted in red and also we have this additional item which we'll talk about here's my gross margin so just like I highlighted the basic pieces before revenue less cost of goods sold equals gross margin less operating costs we've got variable operating costs we've got fixed operating costs that will give us operating costs and then finally operating income so let's get started revenue just like earlier that doesn't change 8.4 million dollars it could just copy it beginning inventory that doesn't change it was zero variable manufacturing costs that doesn't change so so far all of this is the same and again I won't copy it again but it was the details were up here allocated fixed manufacturing costs let's jump up four thousand dollars is what is allocated 500 units multiply that out that's your two million dollars correction let's get rid of that two million dollars you could work with the total on top or remind you it was $4,000 times 500 units that we've manufactured but probably better that you just work with a total since it's a fixed cost cost the goods available for sale and the two together seven million dollars so my beginning inventory us my variable manufacturing cost plus my allocated fixed manufacturing costs seven million dollars deduct my ending inventory comes out to be two point 1 million dollars because I have a hundred and fifty units and ending inventory so I I won't remind you 150 units and ending inventory and I'm dealing with total manufacturing cost per unit of fourteen thousand dollars so $14,000 times 150 units so I am subtracting 2 point 1 million dollars I mention that there's no adjustment here but I'll discuss that one when we get to it costs of goods sold 4.9 million dollars so if I take my cost of goods available for sale I subtract my ending inventory cost of goods sold 4.9 million dollars notice my ending inventory in this example is different and my ending inventory in this example and it's all because of how we what we include in inventory it all has to do with that fixed manufacturing costs let's subtract variable costs pretty straightforward actually let's calculate gross margin so if you take your revenue Leste your cost of goods sold gives us gross margin 3.5 million dollars less our variable operating costs 1 million 50,000 that is $3,000 times 350 units $3,000 times 350 units because it's based on unit salt my fixed $600,000 that was given you could see the same thing over here six hundred thousand dollars add the two together that's 1 million six hundred and fifty thousand dollars total operating costs when I subtracted from my gross margin that gives me an operating income of 1 million eight hundred and fifty thousand dollars notice it is different an operating income under variable costing we're going to spend some time talking about that but first I'd like you to work on the numbers from a I will give you one number to include here four hundred thousand dollars to be added and when I walk you through me I will discuss why we have added that four hundred thousand dollars it's an unfavorable production volume variance so work through May and then you can continue on with the next lesson to check your numbers and to have a more detailed conversation about the difference in operating income