"A company prepares variable costing income statement for the use of internal management andabsorption costing income statement for the use of external parties like creditors, banks, taxauthorities etc.The company manufactures a product that is sold for $80. The variable and fixed costdata is given below: Direct materials: $30.00Direct labor:$19.00 Factory over head:Variable cost: $6.00Fixed cost ($45,000 / 9000 units): $5.00Marketing, general and administrative:Variable cost (per unit sold): $4.00Fixed cost (per month): $28,000 During the month of June, 9,000 units were produced and 7,500 units were sold. The openinginventory was 2,000 units. Required: (1) Prepare two income statements, one using variable costing method and one using absorptioncosting method.(2) Explain the difference in net operating income (if any) under two approaches Solution:(1)(A) Absorption costing: Units* rate per Amount AmountParticulars unit ($) ($)(a) Sales (7500*$80) 600,000(b) Cost of goods sold:Opening Inventory(2000*$60) 120,000Add : Production cost (9000*$60) 540,000 Less : Closing inventory (**3500*$60) -210,000 Net cost of goods sold 450,000 ( c) Gross Profit (a-b)150,000 (d) Administrative and marketing expenses:Variable cost (7500*$4)30,000Fixed Cost 28,000 total admin and marketing cost58,000 Net Operating Income (c-d) 92,000 (B) Variable costing:(Units*rate per Amount AmountParticulars unit) ($) ($)(a) Sales (7500*$80) 600,000(b) Variable cost:Opening Inventory (2000*$55) 110,000Add : Production cost (9000*$55) 495,000 Less : Closing inventory (**3500*$55) -192,500 Variable net production cost 412,500 Variable marketing and admin. Expenses30,000 total variable cost (b)442,500 (c )Contribution (a-b)157,500(d) Fixed CostManufacturing overhead45,000Marketing and admin. overhead28,000 total fixed cost (d )73,000 Net Operating Income (c-d)84,500 AmountReconciliation: ($)Net operating income as per variable costing84,500Deferred fixed manufacturing overhead cost in inventory (1500*$5) 7,500 Net operating income as per absorption costing 92,000Particulars UnitsOpening inventory2000Produced during the period9000Units sold during the period-7500Closing inventory3500 (2)If we observe the net operating income under absorption costing is $7,500 ($92,000 – $84,500)higher than the net operating income under variable costing. This difference is because of fixedmanufacturing overhead that becomes the part of ending inventory under absorption costingsystem. The ending inventory absorbs a portion of fixed manufacturing overhead and reducesthe burden of the current period. In this way a portion of fixed cost that relates to the currentperiod is transferred to the next period. "