Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows:

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,240,000		$	1,860,000
Cost of goods sold (@ $35 per unit)		700,000			1,050,000
Gross margin		540,000			810,000
Selling and administrative expenses*		315,000			345,000
Net operating income	$	\225,000\		$	465,000

* $3 per unit variable; $255,000 fixed each year.

The company’s $35 unit product cost is computed as follows:

Direct materials	$	8
Direct labor		9
Variable manufacturing overhead		3
Fixed manufacturing overhead ($375,000 ÷ 25,000 units)		15
Absorption costing unit product cost	$	35

Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consists of depreciation charges on production equipment and buildings.

Production and cost data for the first two years of operations are:

	Year 1	Year 2
Units produced	25,000	25,000
Units sold	20,000	30,000

Required:

1. Using variable costing, what is the unit product cost for both years? =$20

2. What is the variable costing net operating income in Year 1 and in Year 2?

3. Reconcile the absorption costing and the variable costing net operating income figures for each year.

Answer 1

2.

Heaton Company
Variable costing income statement
	Year 1	Year 2
Sales (@ $62 per unit)	$                       1,240,000	$                       1,860,000
Variable expense
Direct material	20,000*$8 = $160,000	30,000*$8 = $240,000
Direct labour	20,000*$9 = $180,000	30,000*$9 = $270,000
Variable manufacturing overhead	20,000*$3 = $60,000	30,000*$3 = $90,000
Variable selling and administrative overhead	20,000*$3 = $60,000	30,000*$3 = $90,000
total variable cost	$                           460,000	$                           690,000
Contribution margin	$                           780,000	$                       1,170,000
Fixed costs
Manufacturing costs	$                           375,000	$                           375,000
Selling and administrative expenses	$                           255,000	$                           255,000
Total fixed costs	$                           630,000	$                           630,000
Net operating income	$                           150,000	$                           540,000

3.

Reconciliation of Variable costing and Absorption costing net operating income
	Year 1	Year 2
Variable costing net operating income (loss)	$                        150,000	$                            540,000
Add (deduct) fixed manufacturing overhead deferred in (released from) inventory under absorption costing	5,000*$15 = $75,000	-5,000*$15 = -$70,000
Absorption costing net operating income (loss)	$                        225,000	$                            465,000

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