Start Me Up, Inc., manufactures a caffeinated energy drink that sells for $4 each. The results for its first year of operations appear in the table below.
Projections
Number of drinks produced 52,000
Number of drinks sold 50,000
Direct materials per drink $0.55
Direct labor per drink $0.25
Variable manufacturing overhead per drink $0.15
Total fixed manufacturing overhead $39,000
Total fixed selling and administrative costs $50,000
1. Compute the income for the first year under absorption costing.
2. Compute the income for the first year under variable costing.
Absorption vs. Variable Costing
Absorption costing reports the full costs of the goods sold while variable costing shows the direct costs related to the production of the units sold. The main difference is the treatment of the fixed manufacturing costs related to the ending inventory, which is excluded in the cost of goods sold in the absorption costing income calculation. On the other hand. the variable costing deducts the entire fixed manufacturing cost whether or not all the produced units are sold during the reporting period. Further, the presentation of the income statement using the absorption costing method is the GAAP format and used in financial statements available to the public. In contrast, the variable costing format is used by the management to analyze break-even point and determine the profitability of the segments, business units, or product lines.