Question

QUESTION ONE:

Absorption and Variable Costing: Prepare and Reconcile Variable costing Statements

Audiophonics Limited manufactures and sells high-quality and durable ear buds for use with personal electronics that are custom moulded to each customer’s ear. Cost data for the product follows:

Variable costs per unit:

            Direct materials                                            $12

            Direct labour                                                   24

            Variable factory overhead                              8

            Variable selling and administrative              6

Total variable costs per unit                                   $50

Fixed costs per month:

            Fixed manufacturing overhead                  $240,000

            Fixed selling and administrative                  180,000

Total fixed costs per month                                    $420,000

The product sells for $80 per unit. Production and sales data for May and June, the first two months of operations, are as follows:

Units Produced                  Units Sold

May                            15,000                        13,000

June                           15,000                        17,000

Income statements prepared by the Accounting Department using absorption costing are presented below:

May                June

Sales                                                                    $1,040,000         $1,360,000

Cost of goods sold:

            Beginning inventory                                                 0              120,000

            Add cost of goods manufactured              900,000             900,000

            Goods available for sale                             900,000          1,020,000

            Less ending inventory                                 120,000                          0

Cost of goods sold                                                   780,000          1,020,000

Gross margin                                                            260,000             340,000

Selling and administrative expenses                    258,000             282,000

Operating income                                                      $2,000             $58,000

REQUIRED:

1. Determine the unit cost under
   1. Absorption costing.
   2. Variable costing.

2. Prepare variable costing income statements for May and June using the contribution approach.

3. Reconcile the variable costing and absorption costing operating income figures.

4. The company’s Accounting Department has determined the break-even point to be 14,000 units per month, computed as follows:

Fixed cost per month           =          $420,000       = 14,000 units

Unit contribution margin                  $30 per unit

On receiving this figure, the president commented, “There’s something peculiar here. The comptroller says that the break-even point is 14,000 units per month. Yet we sold only 13,000 units in May, and the income statement we received showed a $2,000 profit. Which figure do we believe?” Prepare a brief explanation of what happened on the May income statement.

Answer 1

Unit cost
a.

Direct Material	$                    12
Direct Labor	$                    24
Variable factory overhead	$                      8
Fixed Manufacturing Overhead	$                    16
Total Product Cost	$                    60

b.

Direct Material	$                    12
Direct Labor	$                    24
Variable factory overhead	$                      8
Total Product Cost	$                    44

Variable Costing Income Statement

	May	June
Sales Revenue	$       10,40,000	$          13,60,000
Variable Costs
Cost of Goods Sold	$         5,72,000	$            7,48,000
Selling and administrative	$            78,000	$            1,02,000
Total Variable Costs	$         6,50,000	$            8,50,000
Contribution Margin	$         3,90,000	$            5,10,000
Fixed Costs
Manufacturing Overhead	$         2,40,000	$            2,40,000
Selling and administrative	$         1,80,000	$            1,80,000
Total Fixed Costs	$         4,20,000	$            4,20,000
Net Operating Income	$          -30,000	$               90,000

Reconciliation
	May	June
Income as per Variable Costing	$           -30,000	$                90,000
Add : Fixed Manufacturing Overhead carried forward	$            32,000
Less : Fixed Manufacturing Overhead released		$                32,000
Income as per Absorption Costing	$              2,000	$                58,000

Break even point is as per variable costing, in which fixed overhead is expensed completely and in absorption costing fixed overhead is carried forward in inventory due to which it shows profit