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)	$	976,000		$	1,586,000
Cost of goods sold (@ $38 per unit)		608,000			988,000
Gross margin		368,000			598,000
Selling and administrative expenses*		297,000			327,000
Net operating income	$	71,000		$	271,000

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

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

Direct materials	$	8
Direct labor		12
Variable manufacturing overhead		2
Fixed manufacturing overhead ($336,000 ÷ 21,000 units)		16
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	21,000	21,000
Units sold	16,000	26,000

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

SOLUTION

1.

	Year 1	Year 2
Direct materials	8	8
Direct labor	12	12
Variable manufacturing overhead	2	2
Unit product cost	22	22

2.

	Year 1	Year 2
Sales	976,000	1,586,000
Variable expenses:
Variable cost of goods sold @ $22 per unit	352,000	572,000
Variable selling and administrative expenses @ $3 per unit	48,000	78,000
Total Variable expenses	400,000	650,000
Contribution margin	576,000	936,000
Fixed expenses:
Fixed manufacturing overhead	336,000	336,000
Fixed selling and administrative expenses	249,000	249,000
Total Fixed expenses	585,000	585,000
Net Operating income / (loss)	(9,000)	351,000

3.

	Year 1	Year 2
Variable costing Net Operating income / (loss)	(9,000)	351,000
Add/(deduct): Fixed manufacturing overhead deferred in(released) from inventory under absorption costing (5,000*16)	80,000	(80,000)
Absorption costing Net Operating income	71,000	271,000