Music World produces student-grade violins for beginning violin students. The company produced 2,100 violins in its first month of operations. At month-end, 550 finished violins remained unsold. There was no inventory in work in process. Violins were sold for $122.50 each. Total costs from the month are as follows:

Direct materials used $87,200
Direct labour 60,000
Variable manufacturing overhead 25,000
Fixed manufacturing overhead 44,100
Variable selling and administrative expense 8,000
Fixed selling and administrative expens 13,900
The company prepares traditional (absorption costing) income statements for its bankers. Hannah would also like to prepare contribution margin income statements for her own management use. Compute the following amounts that would be shown on these income statements:

Requirements

1. Gross profit
2. Contribution margin
3. Total expenses are shown below the gross profit line.
4. Total expenses are shown below the contribution margin line.
5. The dollar value of ending inventory under absorption costing.
6. The dollar value of ending inventory under variable costing.

Which income statement has a higher operating income? By how much? Explain.

Explanation:

1.

Gross profit is Net Sales - Cost of goods sold(COGS). So in order to calculate COGS:

Direct materials used $87,200

Direct labour 60,000

Variable manufacturing overhead 25,000

Fixed manufacturing overhead 44,100

Total cost $216,300

Violins produced 2,100

Cost per violin $103

Sales [(2100-550)*122.50] 189,875

Cost of goods sold [(2100-550)*103] 159,650

Gross profit 30,225

2. Contribution margin = Sales - Variable expenses

So to calculate variable expenses, cost per violins multiplied by violins sold and then variable  selling and administrative expense of 8,000 is added.

Direct materials used $87,200

Direct labour 60,000

Variable manufacturing overhead 25,000

Total cost $172,200

Violins produced 2,100

Cost per violin $82

Variable expenses = (2100-550)*82 +8000 = $135,100

Contribution margin = 189,875 - 135,100 = $54,775

3.

Variable selling and administrative expense 8,000

Fixed selling and administrative expense 13,900

Total expenses shown below the gross profit line 21,900

4.

Fixed manufacturing overhead 44,100

Fixed selling and administrative expense 13,900

Total expenses shown below the contribution margin line 58,000

5. Ending inventory = unsold inventory*Cost per violins = 550*103 = $56,650

6. Ending inventory = unsold inventory*Cost per violins = 550*82 = $45,100

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