Reconciliation of Net Operating Income

 

The reconciliation of the variable costing and absorption net operating income are shown in the following figure -

 

Particulars

Amount

(TK.)

Amount

(TK.)

Year

2007

2006

Variable costing net operating income

 

Add fixed manufacturing overhead costs deferred in inventory under absorption costing

 

Deduct fixed manufacturing overhead costs released from inventory under absorption costing

 

Absorption costing net operating income note-1

 

1,968,998,200

  

 

31,452,210

  

 

31,413,110

 

 

1,969,037,300

1,627,059,370

  

 

31,413,110

 

 

29,356,500

 

 

1,629,115,980

 

Note-1

Absorption costing income statement show that the Net operating Income of SQUARE PHARMACEUTICALS LTD. for the year 2007 is tk. 1,969,036,800 but in reconciliation it shows that the company’s Net Operating income is 1,969,037,300. This difference is tk. (1,969,037,300 — 1,969,036,800) =500 and in 2006 absorption costing Net Operating Income is tk. 1,629,116,436 but in reconciliation we see that this is tk. 1,629,116,436. Difference is tk. (1,629,116,436—1,629,115,980) = 456. These differences occurred due to the fractions in different figure.

 

Summary Result at a Glance

 

The total result of our calculation for the comparison of net effect on net operating income under both methods Absorption Costing and Variable Costing are shown in the following:

 

Particulars

Year-2007

Year-2006

Costing method

Absorption

Variable

Absorption

Variable

Product cost

1.40

1.23

1.4181865

1.23

Period cost

0.46

0.63

0.4933804

0.6823099

Net operating income

1,969,036,800

1,968,998,200

1,629,116,436

1,627,059,370

Effects

 

 

Inventories

Increased during the year

Increased during the year

 

Net operating income

Absorption costing net operating income > Variable costing net operating income

Absorption costing net operating income > Variable costing net operating income

Net operating income

1,969,036,800>1,968,998,200

1,629,116,436>1,627,059,370

 

 

Overall Comments

 

From the calculations of net operating income of variable costing and absorption costing of Square Pharmaceuticals Limited we see that, in 2006 their net operating income under absorption costing is tk. 1,629,116,436 and under variable costing net operating income is tk. 1,627,059,370. Here a question arise that why this difference is occurred. This difference is occurred due to use of different accounting method. We know that if inventory increase during the year then the net operating income is increased under absorption costing than that of viable costing net operating income statement. Because when inventory increase then fixed manufacturing overhead cost of these ending inventories is deferred to the next period, as a result total cost during the year is decreased. Here fixed manufacturing overhead cost is treated as product cost, but in case of variable costing method fixed manufacturing overhead cost is treated as period cost. So total manufacturing overhead cost is charged in the period regardless their sales volume. As a result net operating income under this method is lower than that of absorption costing method.  In 2006 opening inventory is 173,850,000 units and ending inventory is 184,783,000 units. Here we see that inventories are increased (184,783,000 – 173,850,000) = 10,933,000 units during the year, as a result net operating income is increased under the absorption costing method than the variable costing method.

 

In the same way in 2007 opening inventory is 184,7