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)	$	1,159,000		$	1,769,000
Cost of goods sold (@ $39 per unit)		741,000			1,131,000
Gross margin		418,000			638,000
Selling and administrative expenses*		311,000			341,000
Net operating income	$	\107,000\		$	297,000

* $3 per unit variable; $254,000 fixed each year.

The company’s $39 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		13
Variable manufacturing overhead		3
Fixed manufacturing overhead ($384,000 ÷ 24,000 units)		16
Absorption costing unit product cost	$	39

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	24,000	24,000
Units sold	19,000	29,000

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
	Year 1	Year 2
Direct materials	7	7
Direct labor	13	13
Variable manufacturing overhead	3	3
Unit product cost	23	23
Unit product cost = $23
2
	Year 1	Year 2
Sales	1159000	1769000
Variable expenses:
Variable cost of goods sold	437000	667000
Variable selling and administrative expenses	57000	87000
Total Variable expenses	494000	754000
Contribution margin	665000	1015000
Fixed expenses:
Fixed manufacturing overhead	384000	384000
Fixed selling and administrative expenses	254000	254000
Total Fixed expenses	638000	638000
Net operating income(loss)	27000	377000
3
	Year 1	Year 2
Variable costing net income (loss)	27000	377000
Add: Fixed manufacturing overhead deferred in inventory under absorption costing	80000
Deduct Fixed manufacturing overhead (released from) inventory under absorption costing		(80000)
Absorption costing net operating income	107000	297000