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This answer results from calculating cost of goods sold for the operating income statement using the number of units produced instead of the number of units sold. When absorption costing is used (and absorption costing is required for external financial reporting under US GAAP), revenue and cost of goods sold are both based on the number of units sold. When absorption costing is used (and absorption costing is required for external financial reporting under US GAAP), revenue and cost of goods sold are both based on the number of units sold.
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The problem tells us that the volume variance is written off to cost of goods sold in the year incurred. The fixed overhead production-volume variance is budgeted fixed overhead minus the amount of applied fixed overhead. The total budgeted fixed overhead was $15,000 ($20 per unit × 750 units, the denominator level of activity that was used to calculate the per unit amount). The amount of fixed overhead applied to production was $20 per unit × 700 units produced, or $14,000. The amount produced (700 units) was lower than the expected amount of 750 units. Therefore, there is a fixed overhead production-volume variance of $1,000 ($20 × 50 units). Since we are told there were no spending variances, we know that actual fixed overhead was the same as budgeted fixed overhead. Therefore, the production-volume variance and the total fixed overhead variance were the same, and the fixed overhead was underapplied by $1,000. Since this variance is written off to cost of goods sold, $1,000 will be debited to cost of goods sold, increasing the cost of goods sold on the operating income statement. The standard variable manufacturing cost was $90 per unit, and the standard fixed manufacturing cost per unit was $20, so the total standard cost per unit was $110. Since the standard costs for the year previous to the last fiscal year were the same as those for the last fiscal year, we know that the cost of the 100 units in beginning finished goods inventory was also $110 per unit. Since there were no price, efficiency or spending variances, no further adjustments need to be made to cost of goods sold other than the $1,000 for the fixed overhead production volume variance. Therefore, net operating income was: Sales: 750 units at $200/unit $150,000 Cost of Goods Sold: 750 units at $110/unit (82,500) Adjustment: Fixed Overhead Volume Variance (1,000) Gross Profit $ 66,500 Selling and Administrative Expense 45,000 Net Operating Income 21,500
This answer results from two errors: (1) calculating cost of goods sold for the operating income statement using the number of units produced instead of the number of units sold; and (2) omitting the adjustment to cost of goods sold for the variance that is written off to cost of goods sold. When absorption costing is used (and absorption costing is required for external financial reporting under US GAAP), revenue and cost of goods sold are both based on the number of units sold. The amount of fixed overhead applied to production was $20 per unit × 700 units produced, or $14,000. The amount produced (700 units) was 50 units lower than the expected amount of 750 units. Therefore, there is a fixed overhead production-volume variance of $1,000 ($20 × 50 units). Since we are told there were no spending variances, we know that actual fixed overhead was the same as budgeted fixed overhead. Therefore, the production-volume variance and the total fixed overhead variance were the same, and the fixed overhead was underapplied by $1,000. Since this variance is written off to cost of goods sold, $1,000 needs to be debited to cost of goods sold, increasing the cost of goods sold on the operating income statement.