Question

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

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,178,000		$	1,798,000
Cost of goods sold (@ $32 per unit)		608,000			928,000
Gross margin		570,000			870,000
Selling and administrative expenses*		311,000			341,000
Net operating income	$	259,000		$	529,000

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

The company’s $32 unit product cost is computed as follows:

Direct materials	$	5
Direct labor		12
Variable manufacturing overhead		3
Fixed manufacturing overhead ($288,000 ÷ 24,000 units)		12
Absorption costing unit product cost	$	32

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	$5.00
	Direct labor	$12.00
	Variable manufacturing overhead	$3.00
	Total unit product cost	$20.00
	*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		$1,178,000		$1,798,000
	Less: Variable cost of goods sold:
	Opening inventory	$0		$100,000
	Add: Cost of goods produced	$480,000		$480,000
	Variable cost of goods available for sale	$480,000		$580,000
	Less: Ending inventory	-$100,000		$0
	Variable cost of goods sold		$380,000		$580,000
	Gross Contribution Margin		$798,000		$1,218,000
	Less: Variable Selling and Administrative expenses		$57,000		$87,000
	Contribution Margin		$741,000		$1,131,000
	Less: Fixed expenses:
	Fixed manufacturing overhead	$288,000		$288,000
	Fixed selling and adm. expenses	$254,000	$542,000	$254,000	$542,000
	Net operating income		$199,000		$589,000
	*Sales   =   Units sold * Selling price
	Year 1 (19,000 * $62)	$1,178,000
	Year 2 (29,000 * $62)	$1,798,000
	*Cost of goods produced = Units produced * Unit product cost
	Year 1 (24,000 * $20)	$480,000
	Year 2 (24,000 * $20)	$480,000
	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 * $20)	$100,000
	Year 2 (0 * $23)	$0
	*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	$199,000	$589,000
	Add (Deduct) : Fixed manufacturing overhead deferred in (released from)	$60,000
	inventory under absorption costing		-$60,000
	Absorption costing net operating income	$259,000	$529,000
Year 1	Add: Fixed manufacturing overhead deferred in inventory = Ending inventory units * Fixed overhead per unit
	5,000 * $12 = $60,000
Year 2	Deduct: Fixed manufacturing overhead released from inventory = Beginning inventory units * Fixed overhead per unit
	5,000 * $12 = $60,000