Sierra Company incurs the following costs to produce and sell its only product.

Sierra Company incurs the following costs to produce and sell its only product.

Variable costs per unit:
Direct materials	$	11
Direct labor	$	7
Variable manufacturing overhead	$	2
Variable selling and administrative expenses	$	5
Fixed costs per year:
Fixed manufacturing overhead	$	121,000
Fixed selling and administrative expenses	$	285,000

During this year, 30,250 units were produced and 24,500 units were sold. The Finished Goods inventory account at the end of this year shows a balance of $115,000 for the 5,750 unsold units.

Required:

1-a. Calculate this year's ending balance in Finished Goods inventory two ways—using variable costing and using absorption costing.

1-b. Does it appear that the company is using variable costing or absorption costing to assign costs to the 5,750 units in its Finished Goods inventory?

 

2. Assume that the company wishes to prepare this year's financial statements for its stockholders.

a. Is Finished Goods inventory of $115,000 the correct amount to include on the balance sheet for external reporting purposes?

b. What balance should be reported in the Finished Goods inventory account for external reporting purposes?

Explanation

1.
The company is using variable costing. The computations are:

	Variable Costing		Absorption Costing
Direct materials	$	11	$	11
Direct labor		7		7
Variable manufacturing overhead		2		2
Fixed manufacturing overhead ($121,000 ÷ 30,250 units)				4
Unit product cost	$	20	$	24
Total cost, 5,750 units	$	115,000	$	138,000

2.

a.

No, $115,000 is not the correct figure to use because variable costing is not generally accepted for external reporting purposes or for tax purposes.

b.

The finished goods inventory account should be stated at $138,000, which represents the absorption cost of the 5,750 unsold units. Thus, the account should be increased by $23,000 for external reporting purposes. This $23,000 consists of the amount of fixed manufacturing overhead cost that is allocated to the 5,750 unsold units under absorption costing (5,750 units × $4 per unit fixed manufacturing overhead cost = $23,000).

Thanks