Question

Walsh Company manufactures and sells one product. The following information pertains to each of the company’s first two years of operations: Variable costs per unit: Manufacturing: Direct materials $ 23 Direct labor $ 16 Variable manufacturing overhead $ 4 Variable selling and administrative $ 3 Fixed costs per year: Fixed manufacturing overhead $ 320,000 Fixed selling and administrative expenses $ 50,000 During its first year of operations, Walsh produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $56 per unit. Required: 1. Assume the company uses variable costing: a. Compute the unit product cost for Year 1 and Year 2. b. Prepare an income statement for Year 1 and Year 2. 2. Assume the company uses absorption costing: a. Compute the unit product cost for Year 1 and Year 2. b. Prepare an income statement for Year 1 and Year 2. 3. Reconcile the difference between variable costing and absorption costing net operating income in Year 1.

Answer 1

Answer

Under Variable Costing

	Year 1	Year 2
Direct Material	23	23
Direct Labor	16	16
Variable Manufacturing Overhead	4	4
Unit Cost	43	43

Under Variable Costing, we will include only Variable manufacturing expenses while calculating Unit cost

Income Statement

Sales	2,240,000	2,800,000
Variable Expenses
Cost of Goods Sold
Opening Inventory	-	430,000 (10,000 units *$43)
Add: Cost of Goods Manufactured	2,150,000 (50,000 units *$43)	1,720,000 (40,000 units *$43)
Less: Closing Inventory	430,000 (10,000 units *$43)	-
Cost of Goods Sold	1,720,000	2,150,000
Variable Selling and Adm. expenses @ $3	120,000	150,000
Total Variable Expenses	1,840,000	2,300,000
Contribution Margin	400,000	500,000
Fixed Expenses
Fixed Manufacturing Overhead	320,000	320,000
Fixed Selling and Adm. Expenses	50,000	50,000
Total Fixed expenses	370,000	370,000
Net operating income	30,000	130,000

Under Absorption Costing

Fixed Manufacturing Overhead per unit = Fixed Manufacturing Overhead / No. of Unit Produced

While calculating Unit cost under Absorption costing, we will include Fixed Manufacturing overhead per unit while calculating Unit Cost.

	Year 1	Year 2
Direct Material	23	23
Direct Labor	16	16
Variable Manufacturing Overhead	4	4
Fixed Manufacturing overhead	6.4 ($320,000 / 50,000 Units)	8 ($320,000 / 40,000 Units)
Unit Cost	49.4	51

Income Statement

Sales	2,240,000	2,800,000
Variable Expenses
Cost of Goods Sold
Opening Inventory	-	494,000 (10,000 units *$49.4)
Add: Cost of Goods Manufactured	2,470,000 (50,000 units *$49.4)	2,040,000 (40,000 units *$51)
Less: Closing Inventory	494,000 (10,000 units *$49.4)	-
Cost of Goods Sold	1,976,000	2,534,000
Variable Selling and Adm. expenses @ $3	120,000	150,000
Total Variable Expenses	2,096,000	2,684,000
Contribution Margin	144,000	116,000
Fixed Expenses
Fixed Selling and Adm. Expenses	50,000	50,000
Total Fixed expenses	50,000	50,000
Net operating income	94,000	66,000

Reconciliation between variable and absorption costing

The difference between profits is $64,000; this is because the production is more than sales, as Fixed cost is defered in closing inventory under Absorption costing, thatswhy the profit under Absorption costing is higher than Variable costing

Net profit under Variable costing	30,000
Add: Fixed manufacturing overhead differed in Closing Inventory (10,000 Units * $6.4)	64,000
Profit under Absorption costing	94,000