Tip-Top Teak makes storage sheds. Each of their products sells for $1,500. For each shed, the costs of materials total to $200, labor costs are $350, and fixed manufacturing overhead is $500. Tip-top also incurs $65 in variable selling expenses per shed and $100,000 in total fixed selling costs. For the current year, Tip-top made 750 sheds and sold 700 sheds.
Required:
a. Under variable costing, what is the inventoriable cost per unit for each of the 50 sheds put into inventory?
b. Under absorption costing, what is the inventoriable cost per unit for each of the 50 sheds put into inventory?
c. Suppose Tip-top began the year with zero inventories of sheds. What is the difference between the incomes that would be reported under absorption costing and under variable costing?
SOLUTION
a. Under variable costing, inventoriable costs only include variable manufacturing costs. In particular, the value does not contain any allocation for fixed manufacturing overhead. Thus, the inventoriable cost is $200 + $350 = $550 per unit. Notice that selling expenses are not included because they only pertain to units sold.
b. Under absorption costing, inventoriable costs includes variable manufacturing costs PLUS any allocation for fixed manufacturing overhead. Thus, the inventoriable cost is $200 + $350 + $500 = $1,050 per unit.
c. The ending inventory of 50 units contains $25,000 = 50 units * $500 per unit in fixed manufacturing cost. Because Tip-top began with zero inventories, this amount is also the change in the fixed overhead contained in the inventory. Thus, absorption costing income will be higher by $25,000 relative to variable costing income.