Variable Costing and Over/Under Producing
Cathy's Mats Produces and Sells

question 13

Essay

Variable Costing and Over/Under Producing
Cathy's Mats produces and sells artistic placemats for dining room tables. These placemats are manufactured out of recycled plastics. For last year and this year each mat has a variable manufacturing cost of $3, and fixed manufacturing overhead is $150,000 per year (both Last Year and This Year). Cathy's Mats incurs no other costs. The following table summarizes the selling price and the number of mats produced and sold Last Year and This Year: $$\begin{array} { | l | r | r | } \hline & \text { Last Year } & \text { This Year } \\\hline \text { Selling price } & \$ 5.00 & \$ 5.00 \\\hline \text { Variable manufacturing cost } & \$ 3.00 & \$ 3.00 \\\hline \text { Fixed manufacturing cost } & \$ 150,000 & \$ 150,000 \\\hline \text { Units produced } & 150,000 & 50,000 \\\hline \text { Units sold } & 100,000 & 100,000 \\\hline\end{array}$$ Cathy's Mats uses FIFO (First-in First Out) to value its ending inventory. Last Year Cathy's Mats had no beginning inventory.
Required:
a. Prepare income statements for Last Year and This Year using absorption costing.
b. Prepare income statements for Last Year and This Year using variable costing.
c. Write a short memo explaining why the net income amounts for Last Year and This Year are the same or different in parts (a) and (b).
d. Assume all the same facts (and data) as given in the problem, EXCEPT that This Year Cathy's Mats produced 60,000 mats rather than 50,000 mats. Compute net income for Last Year and This Year using (i) absorption costing and (ii) variable costing.
e. Write a short memo explaining why the net income amounts for Last Year and This Year are the same or different in (i) and (ii) of part (d).

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Definitions:

Manufacturing Overhead

All indirect costs related to manufacturing that cannot be directly traced to specific items produced, such as factory rent, utilities, and equipment depreciation.

Variable Costing

An accounting approach that only considers variable costs—costs that change with the level of output—in product costing and decision-making.

Absorption Costing

A financial technique that encompasses all costs associated with manufacturing (including both fixed and variable expenses) in the pricing of a product.

Contribution Format

A layout for income statements where costs are classified as variable or fixed to show the contribution margin and net operating income.