Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows:

	Year 1			Year 2
Sales (@ $63 per unit)	$	1,071,000		$	1,701,000
Cost of goods sold (@ $29 per unit)		493,000			783,000
Gross margin		578,000			918,000
Selling and administrative expenses*		301,000			331,000
Net operating income	$	\277,000\		$	587,000

* $3 per unit variable; $250,000 fixed each year.

The company’s $29 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		8
Variable manufacturing overhead		2
Fixed manufacturing overhead ($286,000 ÷ 22,000 units)		13
Absorption costing unit product cost	$	29

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
	Year 1	Year 2
Direct materials	6	6
Direct labor	8	8
Variable manufacturing overhead	2	2
Unit product cost	16	16
Unit product cost = $16
2
	Year 1	Year 2
Sales	1071000	1701000
Variable expenses:
Variable cost of goods sold	272000	432000
Variable selling and administrative expenses	51000	81000
Total Variable expenses	323000	513000
Contribution margin	748000	1188000
Fixed expenses:
Fixed manufacturing overhead	286000	286000
Fixed selling and administrative expenses	250000	250000
Total Fixed expenses	536000	536000
Net operating income(loss)	212000	652000
3
	Year 1	Year 2
Variable costing net income (loss)	212000	652000
Add: Fixed manufacturing overhead deferred in inventory under absorption costing	65000
Deduct: fixed manufacturing overhead (released from) inventory under absorption costing		(65000)
Absorption costing net operating income	277000	587000