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 (@ $30 per unit)		600,000			900,000
Gross margin		620,000			930,000
Selling and administrative expenses*		310,000			340,000
Net operating income	$	\310,000\		$	590,000

* $3 per unit variable; $250,000 fixed each year.

The company’s $30 unit product cost is computed as follows:

Direct materials	$	9
Direct labor		8
Variable manufacturing overhead		2
Fixed manufacturing overhead ($275,000 ÷ 25,000 units)		11
Absorption costing unit product cost	$	30

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 operatons are:

	Year 1	Year 2
Units produced	25,000	25,000
Units sold	20,000	30,000

Required:

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

Answer 2
Calculation of variable costing net operating income
	Year 1	Year 2
Sales	$1,220,000	$1,830,000
Less : Variable costs
- Production costs [$19 per unit]	$380,000	$570,000
- Selling and admin costs [$3 per unit]	$60,000	$90,000
Contribution Margin	$780,000	$1,170,000
Less : Fixed Costs
- Production costs	$275,000	$275,000
- Selling and admin costs	$250,000	$250,000
Net Operating Income	$255,000	$645,000
Answer 3
Reconcile the absorption costing and the variable costing net operating income figures for each year.
	Year 1	Year 2
Absorption costing net operating income	$310,000	$590,000
Less : Fixed manufacturing overheads included in closing inventories [5000 units * $11]	$55,000	$0
Add : Fixed manufacturing overheads included in opening inventories	$0	$55,000
Variable costing net operating income	$255,000	$645,000