Module 1 Case Absorption vs. Variable Costing Essay

1399 Words Apr 9th, 2014 6 Pages
This case study will look at Jokkmok Industries and one of its managers, Mr. Rosen, who is bucking for a promotion to CEO. His division uses absorption costing and has the ability to produce 50,000 units a quarter with a fixed overhead amount of $600,000. While the sales forecast shows that the company will only sell 25,000 units during each of the next two quarters, Mr. Rosen wants to double his budgeted production for the second quarter from 25,000 to 50,000 units. We will look at Mr. Rosen’s decision and see how it affects his company’s bottom line by putting the figures from last quarter and the next quarter into an absorption income statement and a contribution margin statement. From this we will be able to see the differences in …show more content…
Information for setting up these tables was obtained from the article “Income Comparison of Variable and Absorption Costing” from Accountingexplanation.com.

One can notice right away that there are some major differences between the two income statements especially in the 2nd quarter’s net operating income. Under absorption the net operating income is $650,000 and Mr. Rosen would think that his bottom line is looking better and he could almost see himself in the corner office. But running the numbers using the variable costing method in the contribution income statement, the increase in production shows the same net operating income as the previous quarter which was $350,000. So how can the bottom line look so much better under absorption than contribution? The main reasons have to do with fixed manufacturing overhead and inventories. Fixed manufacturing overhead are things like rent, facilities expenses, salaries, and insurance that do not change over a given period of time. “Since fixed overhead costs do not change substantially, they are easy to predict, and so should rarely vary from the budgeted amount.” (Bragg 2013) This is demonstrated in the cost per unit sold difference between the first and second quarters. First quarter’s was $72 while 2nd was $60. The reason is because fixed manufacturing costs are involved in the

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