Question

Diego Company manufactures one product that is sold for $79 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 50,000 units and sold 45,000 units. Variable costs per unit: Manufacturing: Direct materials $ 29 Direct labor $ 16 Variable manufacturing overhead $ 2 Variable selling and administrative $ 4 Fixed costs per year: Fixed manufacturing overhead $ 800,000 Fixed selling and administrative expense $ 516,000 The company sold 35,000 units in the East region and 10,000 units in the West region. It determined that $240,000 of its fixed selling and administrative expense is traceable to the West region, $190,000 is traceable to the East region, and the remaining $86,000 is a common fixed expense. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product.

5. What is the company’s total gross margin under absorption costing?

6. What is the company’s net operating income (loss) under absorption costing?

7. What is the amount of the difference between the variable costing and absorption costing net operating incomes (losses)?

Variable costing net operating income (loss)

   Absorption costing net operating income (loss)

Answer 1

Solution:

First we calculate, unit product cost, under variable costing and absorption costing.

	Variable costing	Absorption costing
Direct materials	$29	$29
Direct labor	$16	$16
Variable manufacturing overhead	$2	$2
Fixed manufacturing overhead ($800,000 / $50,000)	_	$16
Unit product cost	$47	$63

5.) The total gross margin under absorption costing are computed as follows:

Sales ($79 × 45,000 units)	$3,555,000
Cost of goods sold ($63 ×45,000 units)	$2,835,000
Gross margin	$720,000

6.) The company net operating income under absorption costing are computed as follows:

Gross margin	$720,000
Selling and administrative expenses (45000 units ×$4) +$516000	$696,000
Net operating income	$24,000

7.)

First we, calculate, net operating income under variable costing:

Sales		$3,555,000
Variable expenses:
Variable cost of goods sold (45000 units ×$47)	$2,115,000
Variable selling and administrative expenses (45,000 ×$4)	$180,000	$2,295,000
Contribution margin		$1,260,000
Fixed expenses:
Fixed manufacturing overhead	$800,000
Fixed selling and administrative expenses	$516,000	$1,316,000
Net operating loss		$(56,000)

The difference between the absorption costing and variable costing net operating income is explained as follows:

Manufacturing overhead deferred in (released from) inventory = Fixed manufacturing overhead in ending inventory -Fixed manufacturing overhead in beginning inventory = ($16 ×5,000 units)

=$80,000

Variable costing net operating loss	$(56,000)
Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing	$80,000
Net operating income under absorption costing	$24,000