Question

Chataqua Can Company manufactures metal cans used in the food-processing industry. A case of cans sells for $30. The variable costs of production for one case of cans are as follows:

Direct material	$	7.00
Direct labor		2.00
Variable manufacturing overhead		6.50
Total variable manufacturing cost per case	$	15.50

Variable selling and administrative costs amount to $0.90 per case. Budgeted fixed manufacturing overhead is $588,000 per year, and fixed selling and administrative cost is $42,500 per year. The following data pertain to the company’s first three years of operation.

		Year 1			Year 2			Year 3
Planned production (in units)		84,000			84,000			84,000
Finished-goods inventory (in units), January 1		0			0			25,000
Actual production (in units)		84,000			84,000			84,000
Sales (in units)		84,000			59,000			96,500
Finished-goods inventory (in units), December 31		0			25,000			12,500

Actual costs were the same as the budgeted costs.

Required:

1. Prepare operating income statements for Chataqua Can Company for its first three years of operations using:

1. Absorption costing.

2. Variable costing.

2. Reconcile Chataqua Can Company’s operating income reported under absorption and variable costing for each of its first three years of operation. Use the shortcut method.

3. Suppose that during Chataqua’s fourth year of operation actual production equals planned production, actual costs are as expected, and the company ends the year with no inventory on hand.

1. What will be the difference between absorption-costing income and variable-costing income in year 4?

2. What will be the relationship between total operating income for the four-year period as reported under absorption and variable costing?

Answer 1

Computation of Cost of Goods Sold for Absorption costing
	Year 1	Year 2	Year 3
Variabel Manufacturign Cost per Case	$15.50	$15.50	$15.50
Fixed Manufacturign Overhead per case	$7.00	$7.00	$7.00
	(588000/84000)	(616000/88000)	(616000/88000)
	$22.50	$22.50	$22.50
Chataqua Company
Income Statement as per Absorption costing
	Year 1	Year 2	Year 3
Sales Unit	84000	59000	96500
Sales Revenue	$2,520,000.00	$1,770,000.00	$2,895,000.00
Less: Cost Of Goods Sold	$1,890,000.00	$1,327,500.00	$2,171,250.00
Gross Margin	$630,000.00	$442,500.00	$723,750.00
Selling And Administrative Expenses
Variable Selling And Administrative	$75,600.00	$53,100.00	$86,850.00
Fixed Selling And Administrative	$42,500.00	$42,500.00	$42,500.00
Total Selling And Administrative Expenses	$118,100.00	$95,600.00	$129,350.00
Operating Income	$511,900.00	$346,900.00	$594,400.00
Chataqua Company
Income Statement as per Variable costing
	Year 1	Year 2	Year 3
Sales Unit	84000	59000	96500
Sales Revenue	$2,520,000.00	$1,770,000.00	$2,895,000.00
Variable Expenses
Variable Cost of Goods Sold	$1,302,000.00	$914,500.00	$1,495,750.00
Variable Selling and Administrative Expenses	$75,600.00	$53,100.00	$86,850.00
Total Variable Expenses	$1,377,600.00	$967,600.00	$1,582,600.00
Contribution Margin	$1,142,400.00	$802,400.00	$1,312,400.00
Fixed Expenses
Fixed Manufacturing	$588,000.00	$588,000.00	$588,000.00
Fixed Selling and Administrative	$42,500.00	$42,500.00	$42,500.00
Total Fixed Expenses	$630,500.00	$630,500.00	$630,500.00
Operating Income	$511,900.00	$171,900.00	$681,900.00

Year	Change in Inventory ( in units )	x	Predetermined Fixed Overhead Rate	Difference in Fixed Overhead Expensed under Absorption and Variable Costing
1	0		$7.00	$0.00
2	25,000		$7.00	$175,000.00
3	-12,500		$7.00	-$87,500.00

Difference in reported income

$87,500

3.b.:- Total operating income will be same under absorption and variable costing.