Question

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

Variable costs per unit:
Manufacturing:
Direct materials	$	25
Direct labor	$	10
Variable manufacturing overhead	$	4
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	400,000
Fixed selling and administrative expenses	$	70,000

During its first year of operations, Walsh produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $85 per unit.

Required:

1. Assume the company uses variable costing:

a. Compute the unit product cost for Year 1 and Year 2.

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

2. Assume the company uses absorption costing:

a. Compute the unit product cost for Year 1 and Year 2.

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

3. Reconcile the difference between variable costing and absorption costing net operating income in Year 1.

Answer 1

Given information

	$
Selling price per unit	$80
Variable cost per unit:
Manufacturing:
Direct materials	$25
Direct labor	$10
Variable manufacturing overhead	$4
Variable selling and administrative	$3
Fixed costs per year:
Fixed manufacturing overhead	$400,000
Fixed selling and administrative expenses	$70,000

	Year 1	Year 2
Beginning Inventory of Finished Goods	Nil	10,000
Add: Production for the Year (units)	50,000	40,000
Less: Finished Goods sold during the Year	40,000	50,000
Ending Finished Goods Inventory	10,000	Nil

Fixed manufacturing overhead per unit for Year 1 = Total Fixed manufacturing overhead / Units produced

= $400,000 / 50,000 = $8 per unit

Fixed manufacturing overhead per unit for Year 2 = $400,000 / 40,000 = $10 per unit

1a. Calculation of unit product cost under Variable Costing for Year 1 and Year 2:

	Year 1	Year 2
Direct material cost per unit	$25	$25
Direct labor cost per unit	$10	$10
Variable manufacturing overhead per unit	$4	$4
Total product cost per unit	$39	$39

1b. Income statement for Year 1 and Year 2 under Variable Costing system:

	Year 1
Particulars	Amount ($)	Amount ($)
A. Sales (40,000 units x $85 per unit )		$3,400,000
B. Less: Variabe Cost of Goods Sold
VariableCost of Goods Manufactured (50,000 units x $39 )	$1,950,000
Less: Ending Finished Goods Inventory (10,000 units x $39)	$390,000	$1,560,000
C. Less: Variable Selling and Administrative Expense (40,000 units x $3)	$120,000
D. Contribution Margin (A - B - C)		$1,720,000
E. Less: Fixed Costs
Fixed Manufacturing Overhead (Given)	$400,000
Fixed Selling and Administrative Expense (Given)	$70,000	$470,000
F. Income from Operations (D - E)		$1,250,000

	Year 2
Particulars	Amount ($)	Amount ($)
A. Sales (50,000 units x $85 per unit )		$4,250,000
B. Less: Variabe Cost of Goods Sold
Beginning Finished Goods Inventory (10,000 x $39)	$390,000
Add: VariableCost of Goods Manufactured (40,000 units x $39 )	$1,560,000	$1,950,000
C. Less: Variable Selling and Administrative Expense (50,000 units x $3)		$150,000
D. Contribution Margin (A - B - C)		$2,150,000
E. Less: Fixed Costs
Fixed Manufacturing Overhead (Given)	$400,000
Fixed Selling and Administrative Expense (Given)	$70,000	$470,000
F. Income from Operations (D - E)		$1,680,000

2a. Calculation of unit product cost under Absorption Costing for Year 1 and Year 2:

	Year 1	Year 2
Direct material cost per unit	$25	$25
Direct labor cost per unit	$10	$10
Variable manufacturing overhead per unit	$4	$4
Fixed manufacturing overhead per unit	$8	$10
Total product cost per unit	$47	$49

Fixed manufacturing overhead per unit for Year 1 = Total Fixed manufacturing overhead / Units produced

= $400,000 / 50,000 = $8 per unit

Fixed manufacturing overhead per unit for Year 2 = $400,000 / 40,000 = $10 per unit

2b. Income statement for Year 1 and Year 2 under Absorption Costing system:

	Year 1
Particulars	Amount ($)	Amount ($)
A. Sales (40,000 units x $85 per unit )		$3,400,000
B. Less: Cost of Goods Sold
Cost of Goods Manufactured (50,000 units x $47 )	$2,350,000
Less: Ending Finished Goods Inventory (10,000 units x $47)	$470,000	$1,880,000
C. Gross Profit (A - B)		$1,520,000
D. Less: Fixed Costs
Variable Selling and Administrative Expense (40,000 x $3)	$120,000
Fixed Selling and Administrative Expense (Given)	$70,000	$190,000
E. Income from Operations (C - D)		$1,330,000

	Year 2
Particulars	Amount ($)	Amount ($)
A. Sales (50,000 units x $85 per unit )		$4,250,000
B. Less: Cost of Goods Sold
Beginning Finished Goods Inventory (10,000 x $47)	$470,000
Add: Cost of Goods Manufactured (40,000 units x $49)	$1,960,000	$2,430,000
C. Gross Profit (A - B)		$1,820,000
D. Less: Fixed Costs
Variable Selling and Administrative Expense (50,000 x $3)	$150,000
Fixed Selling and Administrative Expense (Given)	$70,000	$220,000
E. Income from Operations (C - D)		$1,600,000

3. Reconciliation between the variable costing and absorption costing net operating income in Year 1:

Item	Year 1
Net Operating Income under Variable Costing for Year 1	$1,250,000
Fixed manufacturing overhead deferred in inventory (10,000 units x $8)	$80,000
Net Operating Income under Absorption Costing for Year 1	$1,330,000