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Year 1 Year 2
Sales revenue ............................................................................... $62,500a $62,500d
Less: Cost of goods sold:
Beginning finished-goods inventory .............................. $ 0 $ 5,250e
Cost of goods manufactured .......................................... 31,500b 28,000f
Cost of goods available for sale ..................................... $31,500 $33,250
Ending finished-goods inventory ................................... 5,250c 0
Cost of goods sold .......................................................... $26,250 $33,250
Gross margin ............................................................................... $36,250 $29,250
Selling and administrative expenses ......................................... 22,500 22,500
Operating income ........................................................................ $13,750 $ 6,750
*The 500 units which were sold in year 2, but which were manufactured in year 1,
include an absorption-costing product cost of $7 per unit for fixed overhead. Since
these 500 units were manufactured in year 1, it is the year 1 fixed-overhead rate that is
relevant to this calculation, not the year 2 rate.
Explanation: At the end of year 1, under absorption costing, $3,500 of fixed overhead
remained stored in finished-goods inventory as a product cost (year 1 fixed-overhead rate of
$7 per unit 500 units = $3,500). However, in year 1, under variable costing, that fixed
overhead was expensed as a period cost.
In year 2, under absorption costing, that same $3,500 of fixed overhead was expensed when
the units were sold. However, under variable costing, that $3,500 of fixed overhead cost had
already been expensed in year 1 as a period cost.