Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows:

	Year 1			Year 2
Sales (@ $63 per unit)	$	1,197,000		$	1,827,000
Cost of goods sold (@ $42 per unit)		798,000			1,218,000
Gross margin		399,000			609,000
Selling and administrative expenses*		306,000			336,000
Net operating income	$	93,000		$	273,000

* $3 per unit variable; $249,000 fixed each year.

The company’s $42 unit product cost is computed as follows:

Direct materials	$	10
Direct labor		9
Variable manufacturing overhead		4
Fixed manufacturing overhead ($456,000 ÷ 24,000 units)		19
Absorption costing unit product cost	$	42

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	24,000	24,000
Units sold	19,000	29,000

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

Ans. 1	In variable costing method, the unit product cost is the sum of only variable
	manufacturing costs per unit
	Unit product cost under Variable Costing:
	Direct materials	$10.00
	Direct labor	$9.00
	Variable manufacturing overhead	$4.00
	Total unit product cost	$23.00
	*Variable unit product cost will remian same in both years 1 and 2.
Ans. 2	HEATON COMPANY
	Variable Costing
	Income Statement
	PARTICULARS	Year 1	Year 2
	Sales		$1,197,000		$1,827,000
	Less: Variable cost of goods sold:
	Opening inventory	$0		$115,000
	Add: Cost of goods produced	$552,000		$552,000
	Variable cost of goods available for sale	$552,000		$667,000
	Less: Ending inventory	-$115,000		$0
	Variable cost of goods sold		$437,000		$667,000
	Gross Contribution Margin		$760,000		$1,160,000
	Less: Variable Selling and Administrative expenses		$57,000		$87,000
	Contribution Margin		$703,000		$1,073,000
	Less: Fixed expenses:
	Fixed manufacturing overhead	$456,000		$456,000
	Fixed selling and adm. expenses	$249,000	$705,000	$249,000	$705,000
	Net operating income		($2,000)		$368,000
	*Sales   =   Units sold * Selling price
	Year 1 (19,000 * $63)	$1,197,000
	Year 2 (29,000 * $63)	$1,827,000
	*Cost of goods produced = Units produced * Unit product cost
	Year 1 (24,000 * $23)	$552,000
	Year 2 (24,000 * $23)	$552,000
	Ending inventory units = Beginning inventory + Units produced - Units sold
	Year 1 =   0 + 24,000 - 19,000   =   5,000 units
	Year 2 = 5,000 + 24,000 - 29,000   =   0 units
	(Ending inventory of Year 1 = Beginning inventory for Year 2)
	Cost of ending inventory = Ending inventory units * Unit product cost
	Year 1 (5,000 * $23)	$115,000
	Year 2 (0 * $23)	$115,000
	*Variable selling and administrative cost = Variable marketing cost per unit * Units sold
	Year 1 (19,000 * $3)	$57,000
	Year 2 (29,000 * $3)	$87,000
Ans. 3	HEATON COMPANY
	Reconciling Difference in Operating Income
	Between Absorption and Variable Costing
		Year 1	Year 2
	Variable costing net operating income	-$2,000	$368,000
	Add (Deduct) : Fixed manufacturing overhead deferred in (released from)	$95,000	-$95,000
	inventory under absorption costing
	Absorption costing net operating income	$93,000	$273,000
Year 1	Add: Fixed manufacturing overhead deferred in inventory = Ending inventory units * Fixed overhead per unit
	5,000 * $19 = $95,000
Year 2	Deduct: Fixed manufacturing overhead released from inventory = Beginning inventory units * Fixed overhead per unit
	5,000 * $19 = $95,000