Since opening in 2009,Akron Aviation has built light aircraft

| February 25, 2017

Question
(Absorption costing vs. variable costing) Since opening in 2009,Akron Aviation has built light aircraft engines and has gained a reputation for reliable and quality products. Factory overhead is applied to production using direct labor hours and any underapplied or overapplied overhead is closed at year-end to Cost of Goods Sold. The company’s inventory balances for the past three years and income statements for the past two years follow.

Inventory Balances

12/31/09

12/31/10

12/31/11

Direct Material

$22,000

$30,000

$10,000

Work in Process

Costs

$40,000

$48,000

$64,000

Direct labor hours

1,335

1,600

2,100

Finished Goods

Costs

$25,000

$18,000

$14,000

Direct labor hours

1,450

1,050

820

COMPARATIVE INCOME STATEMENTS

2010

2011

Sales

$840,000

$1,015,000

Cost of goods sold

Finished goods, 1/1

$ 25,000

$ 18,000

Cost of goods manufactured

556,000

673,600

Total available

$581,000

$691,600

Finished goods, 12/31

(18,000)

(14,000)

CGS before overhead adjustment

$563,000

$677,600

Underapplied factory overhead

17,400

19,300

Cost of goods sold

(580,400)

(696,900)

Gross margin

$259,600

$ 318,100

Selling expenses

$ 82,000

$ 95,000

Administrative expenses

70,000

75,000

Total operating expenses

(152,000)

(170,000)

Operating income

$107,600

$ 148,100

The same predetermined OH rate was used to apply overhead to production orders in 2010 and 2011. The rate was based on the following estimates:

Fixed factory overhead

$ 25,000

Variable factory overhead

$155,000

Direct labor cost

$150,000

Direct labor hours

25,000

In 2010 and 2011, actual direct labor hours expended were 20,000 and 23,000, respectively. Raw material costing $292,000 was issued to production in 2010 and $370,000 in 2011. Actual fixed overhead was $37,400 for 2010 and $42,300 for 2011, and the planned direct labor rate per hour was equal to the actual direct labor rate. Actual variable overhead was equal to applied variable overhead.

For both years, all of the reported administrative costs were fixed. The variable portion of the reported selling expenses results from a commission of 5 percent of sales revenue.

a. For the year ending December 31, 2011, prepare a revised income statement using the variable costing method. b. Describe both the advantages and disadvantages of using variable costing.

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