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)	$	1,037,000		$	1,647,000
Cost of goods sold (@ $38 per unit)		646,000			1,026,000
Gross margin		391,000			621,000
Selling and administrative expenses*		300,000			330,000
Net operating income	$	\91,000\		$	291,000

* $3 per unit variable; $249,000 fixed each year.

The company’s $38 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		10
Variable manufacturing overhead		2
Fixed manufacturing overhead ($418,000 ÷ 22,000 units)		19
Absorption costing unit product cost	$	38

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	22,000	22,000
Units sold	17,000	27,000

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

Direct material	7
Direct labour	10
Variable manufacturing overhead	2
Unit product cost	19

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

	Year 1	Year 2
Sales	1037000	1647000
Variable cost of goods sold	17000*19 = 323000	27000*19 = 513000
Manufacturing margin	714000	1134000
Variable selling and administrative expense	17000*3 = 51000	27000*3 = 81000
Contribution margin	663000	1053000
Fixed cost
Fixed manufacturing overhead	418000	418000
Fixed selling and administrative expense	249000	249000
Net operating income	-4000	386000

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

	Year 1	Year 2
Variable costing net operating income	-4000	386000
Add (less) Fixed manufacturing overhead deferred (released) in ending inventory	5000*19 = 95000	-95000
Absorption Costing net operating income	91000	291000