Question

Absorption and Variable Costing with Over- and Underapplied Overhead

Flaherty, Inc., has just completed its first year of operations. The unit costs on a normal costing basis are as follows:

Manufacturing costs (per unit):
Direct materials (3 lbs. @ 1.30)	$3.90
Direct labor (0.4 hr. @ 14.50)	5.80
Variable overhead (0.4 hr. @ 5.00)	2.00
Fixed overhead (0.4 hr. @ 6.00)	2.40
Total	$14.10
Selling and administrative costs:
Variable	$1.90	per unit
Fixed	$218,000

During the year, the company had the following activity:

Units produced	26,500
Units sold	23,850
Unit selling price	$36
Direct labor hours worked	10,600

Actual fixed overhead was $12,600 less than budgeted fixed overhead. Budgeted variable overhead was $5,700 less than the actual variable overhead. The company used an expected actual activity level of 10,600 direct labor hours to compute the predetermined overhead rates. Any overhead variances are closed to Cost of Goods Sold.

Required:

1. Compute the unit cost using (a) absorption costing and (b) variable costing.

	Unit Cost
Absorption costing	$
Variable costing	$

Feedback

The unit cost under absorption costing includes one more cost than under variable costing.

The unit cost under variable costing includes one less cost than under absorption costing.

2. Prepare an absorption-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Absorption-Costing Income Statement
For the First Year of Operations
Sales		$
Cost of goods sold	$
Less:
Overapplied overhead
Gross profit		$
Less: Selling and administrative expenses
Operating income		$

Feedback

Absorption costing assigns all manufacturing costs to each unit produced.

3. Prepare a variable-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Variable-Costing Income Statement
For the First Year of Operations
Sales		$
Variable cost of goods sold	$
Add:
Underapplied variable overhead
Variable selling expense
Contribution margin		$
Less:
Fixed factory overhead	$
Selling and administrative expenses		$
Operating income		$

Feedback

Use a contribution margin format income statement that groups costs according to behavior (variable and fixed)

4. Reconcile the difference between the two income statements.
The absorption costing generates an income $more than variable co

Answer 1

1		Unit Cost
	Absorption costing	14.1
	Variable costing	11.7
2	Flaherty, Inc.
	Absorption-Costing Income Statement
	For the First Year of Operations
	Sales		858600
	Cost of goods sold	336285
	Less:
	Overapplied overhead	6900	329385
	Gross profit		529215
	Less: Selling and administrative expenses		263315
	Operating income		265900
3	Flaherty, Inc.
	Variable-Costing Income Statement
	For the First Year of Operations
	Sales		858600
	Variable cost of goods sold	279045
	Add:
	Underapplied variable overhead	5700
	Variable selling expense	45315	330060
	Contribution margin		528540
	Less:
	Fixed factory overhead	$	51000
	Selling and administrative expenses		218000
	Operating income		259540
4	Reconcilliation
	Operating Income as per absorpion costing	265900
	Less: Deferred in ending Inventory	6360
	Operating Income as per Variable costing	259540
	The absorption costing generates an income $more than variable costing
	by $6,360.