Question

Chataqua Can Company manufactures metal cans used in the food-processing industry. A case of cans sells for $25. The variable costs of production for one case of cans are as follows:

Direct material	$	8.00
Direct labor		2.00
Variable manufacturing overhead		6.50
Total variable manufacturing cost per case	$	16.50

Variable selling and administrative costs amount to $0.60 per case. Budgeted fixed manufacturing overhead is $300,000 per year, and fixed selling and administrative cost is $38,000 per year. The following data pertain to the company’s first three years of operation.

		Year 1			Year 2			Year 3
Planned production (in units)		75,000			75,000			75,000
Finished-goods inventory (in units), January 1		0			0			20,500
Actual production (in units)		75,000			75,000			75,000
Sales (in units)		75,000			54,500			85,250
Finished-goods inventory (in units), December 31		0			20,500			10,250

Actual costs were the same as the budgeted costs.

Required:

1. Prepare operating income statements for Chataqua Can Company for its first three years of operations using:

1. Absorption costing.

2. Variable costing.

2. Reconcile Chataqua Can Company’s operating income reported under absorption and variable costing for each of its first three years of operation. Use the shortcut method.

3. Suppose that during Chataqua’s fourth year of operation actual production equals planned production, actual costs are as expected, and the company ends the year with no inventory on hand.

1. What will be the difference between absorption-costing income and variable-costing income in year 4?

2. What will be the relationship between total operating income for the four-year period as reported under absorption and variable costing?

Answer 1

Absorption Costing Income Statement

Particulars	Year 1	Year 2	Year 3
Sales Revenue	18,75,000	13,62,500	21,31,250
Less: Cost of Goods Sold	(15,37,500)	(11,17,250)	(17,47,625)
Gross Margin
Less: Selling and Administrative Expenses	3,37,500	2,45,250	3,83,625
Variable Selling and Administrative Expenses	(45,000)	(32,700)	(51,150)
Fixed Selling and Administrative Expenses	(38,000)	(38,000)	(38,000)
Total Selling and Administrative Expenses	(83,000)	(70,700)	(89,150)
Operating Income / (Loss)	254,500	174,550	294,475

Notes

Total Selling and Administrative Expenses = Variable Selling and Administrative Expenses + Fixed Selling and Administrative Expenses

Operating Income / (Loss) = Gross Profit - Total Selling and Administrative Expenses

Sales Revenue = Units Sold * Sales Price per Unit

For Year 1 75,000 Units * $ 25 per Unit = $ 18,75,000

For Year 2 54,500 Units * $ 25 per Unit = $ 13,62,500

For Year 3 85,250 Units * $ 25 Per Unit = $ 21,31,250

Variable Selling and Administrative Expenses = Units Sold * $ 0.60 per Unit

For Year 1 75,000 Units * $ 0.60 per Unit = $ 45,000

For Year 2 54,500 Units * $ 0.60 per Unit = $ 32,700

For Year 3 85,250 Units * $ 0.60 per Unit = $ 51,150

Cost of Goods Sold = Units Sold * Units Product Cost as per Absorption Costing

Particulars	Year 1	Year 2	Year 3
Units Sold	75,000	54,500	85,250
* Unit Product Cost	20.50	20.50	20.50
Cost of Goods Sold	15,37,500	11,17,250	17,47,625

Unit Product Cost = Total Variable Manufacturing Costs + Fixed Overhead Cost per Unit

= 16.50 + 4

= $ 20.50 per Unit

Fixed Manufacturing Overhead per Unit = 300,000 / 75,000 = $ 4 per Unit

Unit Product Cost is same for all three Years.

Variable Costing Income Statement

Particulars	Year 1	Year 2	Year 3
Sales Revenue	18,75,000	13,62,500	21,31,250
Less: Variable Costs	(12,82,500)	(9,31,950)	(14,57,775)
Contribution Margin	5,92,500	4,30,550	6,73,475
Less:Fixed Costs
Fixed Selling and Administrative Expenses	(38,000)	(38,000)	(38,000)
Fixed Manufacturing Overhead	(300,000)	(300,000)	(300,000)
Total Fixed Costs	(338,000)	(338,000)	(338,000)
Operating Income / (Loss)	254,500	92,550	335,475

Variable Cost per Unit = Total Variable Manufacturing Costs + Variable Selling and Administrative Expenses per Unit

= 16.50 + 0.60

= $ 17.10 per Unit

Particulars	Year 1	Year 2	Year 3
Units Sold	75,000	54,500	85,250
* Variable Cost per Unit	17.10	17.10	17.10
Variable Cost	12,82,500	9,31,950	14,57,775

Question 2

Particulars	Year 1	Year 2	Year 3
Variable Costing Income	254,500	92,550	335,475
Add: Fixed Costs Deferred	0	82,000	0
Less: Fixed Costs Released	0	0	(41,000)
Absorption Costing Income	254,500	174,550	294,475

Fixed Costs Deferred in Year 2 = Units In Ending Inventory * Fixed Overhead per Unit

= 20500 * 4

= 82,000

Fixed Costs got released in Year 3 = 10,250 Units * $ 4 per Unit

= $ 41,000

Question 3

As all the units good sold which means Units in Ending Inventory on Year 3 will also be sold due to which Fixed Overhead Cost which git Deferred on 10,250 Units get released in Year 4 and Absorption Costing Income will be less than Variable Costing Income.

Difference between Variable Costing and Absorption Costing Income = 10,250 Units * Fixed Manufacturing Overhead per Unit

= 10,250 * 4

= $ 41,000

Question 4

During the Four Year Period the following relation wil exist

When Sales Level are more than Production Level then Variable Costing Income will be more than that of Absorption Costing Income because the Deferred Fixed Costs of previous year got released in further years which results in lower absorption costing income.

When Sales Level are less than that of Production Level then Absorption Costing Income will be more than that of Variable Costing Income because the entire Overhead got expensed out in Variable Costing whereas in Absorption Costing it will get deferred which will increase the absorption costing income.