Income statements under absorption costing and variable costing Gallatin County Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1 and operated at 100% of capacity during the first month. The following data summarize the results for July:

Sales (3,500 units) $2,135,000
Production costs (4,000 units):
Direct materials$1,049,200
Direct labor451,200
Variable factory overhead73,600
Fixed factory overhead115,600 1,689,600
Selling and administrative expenses:
Variable selling and administrative expenses$52,400
Fixed selling and administrative expenses22,000 74,400
This information has been collected in the Microsoft Excel Online file. Open the spreadsheet, perform the required analysis, and input your answers in the questions below.

Open spreadsheet

a. Prepare an income statement according to the absorption costing concept.

Gallatin County Motors Inc.
Absorption Costing Income Statement
For the Month Ended July 31
Sales $
Cost of goods sold
Gross profit $
Selling and administrative expenses
Operating income $
b. Prepare an income statement according to the variable costing concept.

Gallatin County Motors Inc.
Variable Costing Income Statement
For the Month Ended July 31
Sales $
Variable cost of goods sold
Manufacturing margin $
Variable selling and administrative expenses
Contribution margin $
Fixed costs:
Fixed factory overhead costs $
Fixed selling and administrative expenses
Total fixed costs
Operating income $
c. What is the reason for the difference in the amount of Operating income reported in (a) and (b)?

Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under variable costing , all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the absorption costing income statement will have a higher Operating income than will the variable costing income statement.