Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows: Year 1 Year 2 Sales (@ $60 per unit) $ 1,080,000 $ 1,680,000 Cost of goods sold (@ $35 per unit) 630,000 980,000 Gross margin 450,000 700,000 Selling and administrative expenses* 301,000 331,000 Net operating income $ \149,000\ $ 369,000 * $3 per unit variable; $247,000 fixed each year. The company’s $35 unit product cost is computed as follows: Direct materials $ 7 Direct labor 11 Variable manufacturing overhead 1 Fixed manufacturing overhead ($368,000 ÷ 23,000 units) 16 Absorption costing unit product cost $ 35 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 23,000 23,000 Units sold 18,000 28,000 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:

Computation of Unit Product cost - Heaton Company
Particulars	Year 1	Year 2
Direct Material	$7	$7
Direct Labor	$11	$11
Variable manufacturing overhead	$1	$1
Unit Product cost	$19	$19

Solution 2:

Income Statement - Variable Costing - Heaton Company
Particulars	Year 1	Year 2
Sales	$10,80,000	$16,80,000
Variable Costs:
Variable cost of goods sold (units sold*$19)	$3,42,000	$5,32,000
Variable Selling and administrative expenses ($3*units sold)	$54,000	$84,000
Total Variable Costs	$3,96,000	$6,16,000
Contribution Margin	$6,84,000	$10,64,000
Fixed Expenses:
Fixed manufacturing overhead	$3,68,000	$3,68,000
Fixed Selling & Administrative Expenses	$2,47,000	$2,47,000
Net Operating Income	$69,000	$4,49,000

Solution 3:

Reconciliation of Net Operating income under absorption costing & Variable Costing
Particulars	Year 1	Year 2
Variable Costing Income (Loss)	$69,000	$4,49,000
Add : Fixed manufacturing overhead deferred in ending inventory ($16*5000)	$80,000	$0
Less: Fixed manufacturing overhead released in beginning inventory ($16*5000)	$0	$80,000
Absorption Costing Income (Loss)	$1,49,000	$3,69,000