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	$	17
Variable manufacturing overhead	$	5
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	320,000
Fixed selling and administrative expenses	$	80,000

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 $54 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

Requirement 1a

	Year 1	Year 2
Direct materials	$23	$23
Direct labor	17	17
Variable manufacturing overhead	5	5
Unit product cost	$45	$45

1(b)

	Variable costing Income Statement
	Year 1	Year 2
Sales	$2,160,000 (40,000*$54)	$2,700,000 (50,000*$54)
Less: Variable costs:
Variable cost of goods sold	1,800,000 (40,000*$45)	2,250,000 (50,000*$45)
Variable selling and administrative expenses	160,000 (40,000*$4)	200,000 (50,000*$4)
Total variable costs	1,960,000	2,450,000
Contribution margin	200,000	250,000
Less: Fixed costs:
Fixed manufacturing overhead	320,000	320,000
Fixed selling and administrative expenses	80,000	80,000
Total fixed costs	400,000	400,000
Net opearting income	$(200,000)	$(150,000)

Requirement 2:-

	Year 1	Year 2
Direct materials	$23	$23
Direct labor	17	17
Variable manufacturing overhead	5	5
Fixed manufacturing overhead	6.4 (320,000/50,000)	8 (320,000/40,000)
Unit product cost	$51.4	$53

	Absorption Costing Income Statement
	Year 1	Year 2
Sales	$2,160,000	$2,700,000
Cost of goods sold:
Beginning inventory	0	514000
Add: Cost of goods manufactured	2,570,000(50,000*$51.4)	2,120,000(40,000*$53)
Less: Ending inventory	514,000 (10,000*$51.4)	0
Cost of goods sold	2,056,000	2,634,000
Gross profit	104,000	66000
Selling and administrative expenses:
Variable selling and administrative expenses	160,000 (40,000*$4)	200,000 (50,000*$4)
Fixed selling and administrative expenses	80,000	80,000
Total selling and administrative expenses	240,000	280,000
Net operating income	$(136,000)	$(214000)

Requirement 3:-

	Year 1	Year 2
Net operating income as per variable costing income statement	$(200,000)	$(150,000)
Add: Fixed manufacturing overhead deferred in ending inventory (10,000*$6.4)	64,000
Less: Fixed manufacturing overhead released from ending inventory		(64,000)
Net operating income as per absorption costing income statement	$(136,000)	$(214,000)