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	$	21
Direct labor	$	14
Variable manufacturing overhead	$	2
Variable selling and administrative	$	1
Fixed costs per year:
Fixed manufacturing overhead	$	240,000
Fixed selling and administrative expenses	$	80,000

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 $90 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

1

a)

Under variable costing, only the variable manufacturing costs are included in product costs

	Year-1	Year-2
Direct materials	21	21
Direct labor	14	14
Variable manufacturing overhead	2	2
Variable costing unit product cost	37	37

b)

	Year 1	Year-2
Sales at $90	3600000	4500000
Less: variable Expanses
Variable cost of goods sold @ $37 per unit	1480000	1850000
Variable selling and administrative @ $1	40000	50000
Total variable expenses	1520000	1900000
Contribution margin	2080000	2600000
Less: Fixed cost
Fixed manufacturing overhead	240,000	240,000
Fixed selling and administrative	80,000	80,000
Total fixed expenses	320,000	320,000
Net operating income (loss)	1,760,000	2,280,000

2)

a)

The unit product costs under absorption costing

	Year-1	Year-2
Direct materials	21	21
Direct labor	14	14
Variable manufacturing overhead	2	2
Fixed manufacturing overhead ($240,000 ÷ 50,000 units)	4.8
($240,000 ÷ 40,000 units)		6
Absorption costing unit product cost	41.8	43

b)

The absorption costing income statements appears below:

	Year 1	Year-2
Sales at $90	3600000	4500000
Less:Cost of goods sold
(40,000 units × $41.8 per unit )	1672000
(40,000 units × $43 per unit) + (10,000 units × $41.8 per unit)		2,138,000
Gross prfit	1928000	2,362,000
Less: Selling and administrative expenses
variable	40000	50000
Fixed selling and administrative	80,000	80,000
Total Selling and administrative expenses	120,000	130,000
Net operating income (loss)	1,808,000	2,232,000

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

The net operating incomes are reconciled as follows

	Year 1	Year-2
Variable costing net operating income	1,760,000	2,280,000
Add: Fixed manufacturing overhead cost deferred in inventory under absorption Costing (10,000*4.8)	48000
Less: Fixed manufacturing overhead cost released in inventory under absorption Costing		-48000
Absorption costing net operating income ..	1,808,000	2,232,000