Fields Cutlery, a manufacturer of gourmet knife sets, produced 20,000 sets and sold 23,000 units during the current year. Beginning inventory under absorption costing consisted of 3,000 units valued at $66,000 (Direct materials $12 per unit; Direct labor, $3 per unit; Variable Overhead, $2 per unit, and Fixed overhead, $5 per unit.) All manufacturing costs have remained constant over the 2-year period. At year-end, the company reported the following income statement using absorption costing: Sales (23,000 × $45) $ 1,035,000 Cost of goods sold (23,000 × $22) 506,000 Gross margin $ 529,000 Selling and administrative expenses 115,000 Net income $ 414,000 60% of total selling and administrative expenses are variable. Compute net income under variable costing: Sales (23,000 × $45) $1,035,000
Cost of goods sold (23,000 × $22) 506,000
Gross margin $529,000
Selling and administrative expenses 115,000000
Net income $414,000

60% of total selling and administrative expenses are variable. Compute net income under variable costing.

a. $414,000
b. $399,000
c. $529,000
d. $429,000
e. $644,000

d. $429,000

Explanation:

This can be obtained by preparing an income statement under variable costing. The income statement under variable costing deduct variable costs from the sales revenue to obtain contribution margin firs before deducting fixed costs in order to obtain net income. The income statement under variable costing can therefore be prepared as follows:

                                 Fields Cutlery

                  Income Statement (Variable Costing)

                                For the Year End

Particulars                                                                      $        

Sales (23,000 × $45)                                            1,035,000

Variable cost:

Direct materials ($12 * 23,000)                             (276,000)

Direct labor ($3 * 23,000)                                       (69,000)

Variable Overhead ($2 * 23,000)                           (46,000)

Selling $ admin exp (60% * $115,000)                  (69,000)  

Contribution margin                                                575,000

Fixed cost:

Fixed overhead ($5 * 20,000)                               (100,000)

Selling $ admin exp (40% * $115,000)                   (46,000)  

Net income                                                              429,000

Note:

1. The variable cost is computed using the 23,000 units sold because the variable cost of the opening 3,000 units from the previous year has to be added to the variable cost of the 20,000 units produced this year. This is to obtain the total variable costs for the 23,000 units sold since variable cost varies with units.

2. The Fixed overhead is computed using the 20,000 units produced this year. This is because the total fixed cost does not change as units of production changes. The Fixed overhead of $5 per unit was actually arrived at by dividing $100,000 by 20,000 units. This Fixed overhead was also $100,000 previous year as it remains constant every year.

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