Fields cutlery, a manufacturer of gourmet knife sets, produced 20,000 sets and sold 23,000 units during the current year. beginning inventory under absorption costing consisted of 3,000 units valued at $66,000 (direct materials $12 per unit; direct labor, $3 per unit; variable overhead, $2 per unit, and fixed overhead, $5 per unit.) all manufacturing costs have remained constant over the 2-year period. at year-end, the company reported the following income statement using absorption costing: sales (23,000 × $45) $ 1,035,000 cost of goods sold (23,000 × $22) 506,000 gross margin $ 529,000 selling and administrative expenses 115,000 net income $ 414,000 60% of total selling and administrative expenses are variable. compute net income under variable costing.

Net income under variable costing would be $429,000.

Explanation:

Under the variable costing method the most important point to understand here is that fixed cost of the previous period ( 3000 units in this case ) would not be carried over to current period. Which means that the fixed cost and cost of goods sold be less now and the profit will increase.

NET INCOME =

SALES                                   = $ 1035,000  ( 23,000 X 45 )

(-) COST OF GOODS SOLD  = ($ 391,000) ( 23000 X 17 )

 ( We have multiplied 23,000 units by 17 because now those fixed cost of $5 are not carried forward to this period)

GROSS CONTRIBUTION MARGIN  = $1035,000 - $391,000

                                                          = $644,000

(-)VARIABLE SELLING AND ADMINISTRATION EXPENSES = ($69,000)

 ( $115,000 X 60% )

CONTRIBUTION MARGIN = $644,000 - $69,000

                                           = $575,000

(LESS) FIXED COSTS          = ($146,000)   [ $100,000 + $46,000 ]

1) MANUFACTURING COST = 20,000 X $5

                                              = $100,000

2) SELLING AND ADMINISTRATION EXPENSES = $115,000 X 40%

                                                                                = $46,000

INCOME  = $575,000 - $146,000

                = $429,000

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