Question

Case 6-29 Variable and Absorption Costing Unit Product Costs and Income Statements [LO6-1, LO6-2]

[The following information applies to the questions displayed below.]

O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$	27
Direct labor	$	15
Variable manufacturing overhead	$	4
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	580,000
Fixed selling and administrative expenses	$	110,000

During its first year of operations, O’Brien produced 91,000 units and sold 79,000 units. During its second year of operations, it produced 84,000 units and sold 91,000 units. In its third year, O’Brien produced 83,000 units and sold 78,000 units. The selling price of the company’s product is $78 per unit.

3. Assume the company uses absorption costing and a FIFO inventory flow assumption (FIFO means first-in first-out. In other words, it assumes that the oldest units in inventory are sold first):

b. Prepare an income statement for Year 1, Year 2, and Year 3.

Answer 1

1	Absorption costing	Year 1	Year 2	Year 3
	Variable manufacturing cost	46	46	46
	Fixed manufacturing	6.37	6.90	6.99
	Total product cost	52.37	52.90	52.99
	Units produced	91000	84000	83000
	Units sold	79,000	91,000	78000
	Income statement	1st year	2nd year	3rd year
	Sales revenue	6162000	7098000	6084000
	cost of goods sold
	Beginning inventory	0	628484	264524
	cost of goods manufactured	4766000	4444000	4398000
Add	Goods available for sale	4766000	5072484	4662524
	Ending inventory	628484	264524	529880
Less	Cost of goods sold	4137516	4807960	4132644
	Gross profit	2024484	2290040	1951356
	Selling and admin expenses
Less	Variable selling and admin expense	237000	273000	234000
	Fixed Admin expense	110000	110000	110000
	Total Selling and admin expenses	347000	383000	344000
	Net operating income	1677484	1907040	1607356
2	Variable costing	Year 1	Year 2	Year 3
	Variable manufacturing cost	46	46	46
	Units manufactured	91000	84000	83000
	Units sold	79000	91000	78000
	Income statement
	Sales revenue	6162000	7098000	6084000
Less	Variable expense
	Variable cost of goods sold	3634000	4186000	3588000
	Variable selling and admin expense	237000	273000	234000
	Total variable expense	3871000	4459000	3822000
	Contribution margin	2291000	2639000	2262000
Less	Fixed cost
	Fixed manufacturing expense	580000	580000	580000
	Fixed Admin expense	110000	110000	110000
	Total fixed expenses	690000	690000	690000
	Net operating income	1601000	1949000	1572000
3	Reconciliation
	Net operating income variable costing	1601000	1949000	1572000
Add	Ending inventory Fixed manufacturing	76484	-41960	35356
	Net operating income absorption costing	1677484	1907040	1607356