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)	$	1,220,000		$	1,830,000
Cost of goods sold (@ $37 per unit)		740,000			1,110,000
Gross margin		480,000			720,000
Selling and administrative expenses*		314,000			344,000
Net operating income	$	\166,000\		$	376,000

* $3 per unit variable; $254,000 fixed each year.

The company’s $37 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		11
Variable manufacturing overhead		3
Fixed manufacturing overhead ($425,000 ÷ 25,000 units)		17
Absorption costing unit product cost	$	37

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	25,000	25,000
Units sold	20,000	30,000

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 under variable costing
	Direct materials				6
	direct labor				11
	variable manufacturing overhead				3
	unit product cost under variable costing				20
	for both years $20 is the unit product cost
2)		Heaton /company
	Varible costing income statement
					year 1	year 2
	Sales				1,220,000	1,830,000
	Variable expenses:
	Variable cost of goods sold				400000	600000
	Variable selling & adm expense				60000	90000
	total variable expense				460000	690000
	Contribution margin				760,000	1,140,000
	fixed expenses:
	fixed manufacturing overhead				425,000	425,000
	Fixed selling and adm expense				254,000	254,000
	total fixed expense				679,000	679,000
	net operating income				81,000	461,000
3)
	Reconcilation
						year 1	year 2
	Variable costing net income					81,000	461,000
	Add Fixed oh deferred(released) in ending inventory					85000	-85,000
	Absorption costing net income					166,000	376,000
	fixed overhead deferred (released)= ending inventory *FOH per unit
				5000*17 = 85000