Question

Data:

Selling price $275
Manufacturing Cost:
Variable per unit produced:
Direct materials $104
Direct labor 63
Variable manufacturing overhead 33
Fixed manufacturing overhead per year $113,400
Selling and Administrative expenses:
Variable per unit sold $4
Fixed per year 58,000

Year 1 Year 2
Units in beginning inventory 0   
Units produced during the year 2,700 2,100
Units sold during the year 2,300 2,300

1. What is the net operating income (loss) in Year 2 under absorption costing? 2. Make a note of the absorption costing net operating income (loss) in Year At the end of Year 1, the company’s board of directors set a target for Year 2 of net operating income of $40,000 under absorption costing. If this target is met, a hefty bonus would be paid to the CEO of the company. Keeping everything else the same from part (2) above, change the units produced in Year 2 to 4,200 units. What is the net operating income (loss) in Year 2 under absorption costing?

Answer 1

It should be noted that Under absorbtion costing method, Fixed manufacturing overheads are charged on production and are not charged as period cost unlike Marginal costing approach. Closing inventiry will always be having some part of fixed manufacturing overhead.

Let's prepare the inventory statement and Cost of preoduction per unit for both the years:

Please note that Fixed manufacturing overhead rate will be calculated based on production units not units sold.

Let's prepare the Income statement for both the years:

For year 2, Net Operating loss is $14,100

Solution 2:

If the units produced is changed to 4,200 units, Fixed overhead allocation will be $27 per unit ($113,400 / 4,200 ).

Revised Cost of Production will be as follows:

Inventory statement will look like below:

Revised Operating Income statement will show a profitof $37,200 as in statement below:

Note: Plesae be careful that Opening stock for Year 2 will always be valued at the price which was existing in Year 1.