Question

Zachary Manufacturing pays its production managers a bonus based on the company’s profitability. During the two most recent years, the company maintained the same cost structure to manufacture its products.

Year	Units Produced			Units Sold
Production and Sales
Year 2		4,000			4,000
Year 3		6,000			4,000
Cost Data
Direct materials				$	14.80	per unit
Direct labor				$	22.50	per unit
Manufacturing overhead—variable				$	10.90	per unit
Manufacturing overhead—fixed				$	103,200
Variable selling and administrative expenses				$	7.40	per unit sold
Fixed selling and administrative expenses				$	59,000

(Assume that selling and administrative expenses are associated with goods sold.)

Zachary sells its products for $109.90 per unit.

Required

1. Prepare income statements based on absorption costing for Year 2 and Year 3.

2. Since Zachary sold the same number of units in Year 2 and Year 3, why did net income increase in Year 3?

4. Determine the costs of ending inventory for Year 3.

5. Prepare income statements based on variable costing for Year 2 and Year 3.

Answer 1

	Income Statement as per Absorption Costing(For Year 2)
	Sales(4,000 units*$109.9)		$        4,39,600
	Less:Cost of goods sold:
	Opening Inventory	$                        -
	Add:Cost of goods manufactured(Note)	$             2,95,800
	Cost of goods available for sale	$             2,95,800
	Less:Closing Inventory	$                        -	$        2,95,800
	Gross Profit		$        1,43,800
	Less:Selling and admin expenses[$59,000+(4,000*$7.40)]		$           88,600
	Net Operating Income		$           55,200
	Computation of Cost per unit of Finished goods
	Units Produced	4000	units
	Direct Materials per unit	$                  14.80
	Direct labor per unit	$                  22.50
	Variable Manufacturing overhead per unit	$                  10.90
	Fixed Manufacturing overhead per unit($103,200/4,000)	$                  25.75
	Cost of goods manufactured per unit	$                  73.95
	Total Cost of goods manufactured	$             2,95,800
	Income Statement as per Absorption Costing(For Year 3)
	Sales		$        4,39,600
	Less:Cost of goods sold:
	Opening Inventory	$                        -
	Add:Cost of goods manufactured(Note)	$             3,92,220
	Cost of goods available for sale	$             3,92,220
	Less:Closing Inventory(2,000*$65.37)	$             1,30,740	$        2,61,480
	Gross Profit		$        1,78,120
	Less:Selling and admin expenses[$59,000+(4,000*$7.40)]		$           88,600
	Net Operating Income		$           89,520
	Computation of Cost per unit of Finished goods
	Units Produced	6000	units
	Direct Materials per unit	$                  14.80
	Direct labor per unit	$                  22.50
	Variable Manufacturing overhead per unit	$                  10.90
	Fixed Manufacturing overhead per unit($103,200/6,000)	$                  17.17
	Cost of goods manufactured per unit	$                  65.37
	Total Cost of goods manufactured	$             3,92,220
	Net Income increase in Year 3 because the Production has increased by 2000 units and hence there is closing inventory of 2,000 units
	Cost of Inventory is calculated above at $130,740
	Income Statement as per Variable Costing
	Sales		$        4,39,600
	Less:Variable expenses:
	Direct Materials	$                59,200
	Direct labor	$                90,000
	Manufacturing Overhead	$                43,600
	Selling and administrative expenses	$                29,600
	Total Variable Costs		$        2,22,400
	Contribution Margin		$        2,17,200
	Less:Fixed expenses:
	Manufacturing Overhead	$             1,03,200
	Selling and administrative expenses	$                59,000
	Total Fixed Costs		$        1,62,200
	Net Operating Income		$           55,000