Question

Lynch Company manufactures and sells a single product. The following costs were incurred during the company’s first year of operations: Variable costs per unit: Manufacturing: Direct materials $ 12 Direct labor $ 9 Variable manufacturing overhead $ 2 Variable selling and administrative $ 2 Fixed costs per year: Fixed manufacturing overhead $ 403,000 Fixed selling and administrative $ 313,000 During the year, the company produced 31,000 units and sold 26,000 units. The selling price of the company’s product is $55 per unit. Required: 1. Assume that the company uses absorption costing: a. Compute the unit product cost. b. Prepare an income statement for the year. 2. Assume that the company uses variable costing: a. Compute the unit product cost. b. Prepare an income statement for the year.

Answer 1

1a . Calculation of unit product cost using absorption costing method :

Unit product cost using :	Absorption costing
Direct material per unit	$ 12
Direct labor per unit	9
Variable overhead per unit	2
Fixed overhead per unit **	13
Total product cost per unit	$ 36

** Fixed overhead per unit

= Total fixed overhead ÷ Total units produced

= $ 403,000 ÷ 31, 000 units = $ 13 per unit

1b. Income statement for the year ended (under absorption costing ) :

Lynch Company
Absorption Costing Income Statement
Particulars :	Amount	Amount
Sales revenue		$1,430,000
Less: Cost of goods sold		(936,000)
Contribution Margin		$ 494,000
Less : Selling & administrative costs :
Variable selling & administrative costs	52,000
Fixed selling & administrative costs	313,000	(365,000)
Net Income / (Loss)		$ 129,000

Working Notes :

1.Sales revenue = 26,000 × $ 55 = $ 1,430,000

2. Cost of Goods sold = 26,000 × 36 (from above (1a)) = $936,000

3. Variable selling & administrative costs = 26,000 × 2 = $ 52,000

2a. Calculation of unit product cost using variable costing method :

Per unit product cost using :	Variable costing
Direct material per unit	$ 12
Direct Labor per unit	9
Variable Overhead per unit	2
Total product cost per unit	$ 23

2b. Income statement for the year ended (under variable costing )

Lynch Company
Variable Costing Income Statement
Particulars :	Amount	Amount
Sales revenue		$1,430,000
Less : Variable Costs
Variable production cost	598,000
Variable selling & administrative costs	52,000
Total Variable Costs		(650,000)
Contribution Margin		$ 780,000
Less : Fixed Costs
Fixed production costs	403,000
Fixed selling & administrative costs	313,000
Total Fixed Expenses		(716,000)
Net Income / (Loss)		$ 64,000

Working Notes :

1. Variable production cost = 26,000 × 23 = $598,000

2. Variable selling & administrative costs = 26,000 × 2 = $ 288,000

[Reconciliation -

Profit under absorption costing	$129,000
Less : Fixed overhead in closing inventory**	(65,000)
Add : Fixed overhead in opening inventory	-
Profit under variable costing	$64,000

** Closing Inventory = 31,000 - 26,000 = 5,000 units

Fixed overhead in closing inventory = 5,000*13 =$65,000

Opening inventory assumed to be NIL ]