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)	$	1,037,000		$	1,647,000
Cost of goods sold (@ $36 per unit)		612,000			972,000
Gross margin		425,000			675,000
Selling and administrative expenses*		297,000			327,000
Net operating income	$	\128,000\		$	348,000

* $3 per unit variable; $246,000 fixed each year.

The company’s $36 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		12
Variable manufacturing overhead		3
Fixed manufacturing overhead ($308,000 ÷ 22,000 units)		14
Absorption costing unit product cost	$	36

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) Unit product cost

Direct material	7
Direct labour	12
Variable manufacturing overhead	3
Unit product cost	22

2. What is the variable costing net operating income in Year 1 and in Year 2?

	Year 1	Year 2
Sales	1037000	1647000
Less: Variable cost of goods sold	374000	594000
Manufacturing margin	663000	1053000
Less; Variable selling and administrative expense	51000	81000
Contribution margin	612000	972000
Less; Fixed cost
Fixed manufacturing cost	308000	308000
Fixed selling and administrative expense	246000	246000
Total fixed cost	554000	554000
Net operating income	58000	418000

3. Reconcile the absorption costing and the variable costing net operating income figures for each year.

	Year 1	Year 1
Variable costing net operating income	58000	418000
Add: Fixed manufacturing overhead cost deferred in ending inventory (5000*14)	70000
Less; Fixed manufacturing overhead released from inventory (5000*14)		-70000
Absorption costing net operating income	128000	348000