Question

Walsh Company manufactures and sells one product. The following information pertains to each of the company’s first two years of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$	20
Direct labor	$	13
Variable manufacturing overhead	$	4
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	320,000
Fixed selling and administrative expenses	$	70,000

During its first year of operations, Walsh produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $83 per unit.

Required:

1. Assume the company uses variable costing:

a. Compute the unit product cost for Year 1 and Year 2.

b. Prepare an income statement for Year 1 and Year 2.

2. Assume the company uses absorption costing:

a. Compute the unit product cost for Year 1 and Year 2.

b. Prepare an income statement for Year 1 and Year 2.

3. Reconcile the difference between variable costing and absorption costing net operating income in Year 1.

Answer 1

1a.

Direct material	$20
Direct labor	13
Variable manufacturing overhead	4
Unit product cost	$37

1b.

Variable Costing Income Statement
	Year 1	Year 2
Sales	$3,320,000 (40,000*$83)	$4,150,000 (50,000*$83)
Less: Variable costs:
Variable manufacturing overhead	1,480,000 (40,000*$37)	1,850,000 (50,000*$37)
Variable selling and administrative expenses	120,000 (40,000*$3)	150,000 (50,000*$3)
Contribution margin	1,720,000	2,150,000
Less: Fixed costs:
Fixed manufacturing overhead	320,000	320,000
Fixed selling and administrative expenses	70,000	70,000
Net operating income	$1,330,000	$1,760,000

2a.

	Year 1	Year 2
Direct material	$20	$20
Direct labor	13	13
Variable manufacturing overhead	4	4
Fixed manufacturing overhead	6.4 ($320,000/50,000)	8 ($320,000/40,000)
Unit product cost	$43.4	$45

2b.

Absorption Costing Income Statement
	Year 1	Year 2
Sales	$3,320,000	$4,150,000
Less: Cost of goods sold:
Beginning inventory	0	434,000
Add: Cost of goods manufactured	2,170,000 (50,000*$43.4)	1,800,000 (40,000*$45)
Cost of goods available	2,170,000	2,234,000
Less: Ending inventory	434,000 (10,000*$43.4)	0
Cost of goods sold	1,736,000	2,234,000
Gross profit	1,584,000	1,916,000
Less: Selling and administrative expenses
Variable selling and administrative	120,000 (40,000*$3)	150,000 (50,000*$3)
Fixed selling and administrative	70,000	70,000
Net operating income	$1,394,000	$1,696,000

3.

	Year 1	Year 2
Variable costing net operating income	$1,330,000	$1,760,000
Add: Fixed manufacturing overhead deferred in ending inventory	64,000 (10,000*$6.4)
Less: Fixed manufacturing overhead released from ending inventory		64,000
Absorption costing net operating income	$1,394,000	$1,696,000