Question

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

	Year 1			Year 2
Sales (@ $61 per unit)	$	915,000		$	1,525,000
Cost of goods sold (@ $39 per unit)		585,000			975,000
Gross margin		330,000			550,000
Selling and administrative expenses*		298,000			328,000
Net operating income	$	\32,000\		$	222,000

* $3 per unit variable; $253,000 fixed each year.

The company’s $39 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		9
Variable manufacturing overhead		5
Fixed manufacturing overhead ($380,000 ÷ 20,000 units)		19
Absorption costing unit product cost	$	39

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	20,000	20,000
Units sold	15,000	25,000

Required:

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

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

1	The unit product cost for both years - Using variable costing
	Direct materials	$6
	Direct labor	$9
	Variable manufacturing overhead	$5
		$20
2	Calculation of net operating income
		Year -1	Year -2
	Units Sold	15,000	25,000
	Sales	$915,000	$1,525,000
	Less: Variable expenses
	Direct materials	$90,000	$150,000
	Direct labor	$135,000	$225,000
	Variable manufacturing overhead	$75,000	$125,000
	Selling and administrative expenses	$45,000	$75,000
	Contribution margin	$570,000	$950,000
	Less: Fixed Expenses
	Variable manufacturing overhead	$380,000	$380,000
	Selling and administrative expenses	$253,000	$253,000
	Net operating income(loss)	-$63,000	$317,000
3	Reconcile the absorption costing and the variable costing net operating income
	Variable costing net operating income(loss)	-$63,000	$317,000
	Add: Fixed manufacturing overhead deferred	$95,000	$0
	in inventory under absorption costing
	(5,000 x $19)
	Less: Fixed manufacturing overhead released	$0	-$95,000
	from inventory under absorption costing
	(5,000 x $19)
	Absorption costing net operating income	$32,000	$222,000