Question

Denton Company manufactures and sells a single product. Cost data for the product are given: Variable costs per unit: Direct materials $ 5 Direct labor 9 Variable manufacturing overhead 3 Variable selling and administrative 1 Total variable cost per unit $ 18 Fixed costs per month: Fixed manufacturing overhead $ 72,000 Fixed selling and administrative 172,000 Total fixed cost per month $ 244,000 The product sells for $52 per unit. Production and sales data for July and August, the first two months of operations, follow: Units Produced Units Sold July 18,000 14,000 August 18,000 22,000 The company’s Accounting Department has prepared the following absorption costing income statements for July and August: July August Sales $ 728,000 $ 1,144,000 Cost of goods sold 294,000 462,000 Gross margin 434,000 682,000 Selling and administrative expenses 186,000 194,000 Net operating income $ 248,000 $ 488,000 Required: 1. Determine the unit product cost under: a. Absorption costing. b. Variable costing. 2. Prepare contribution format variable costing income statements for July and August. 3. Reconcile the variable costing and absorption costing net operating incomes.

Answer 1

1) a & b) Under absorption costing, fixed manufacturing overheads are considered as product cost and included in the unit product cost whereas under variable costing, fixed manufacturing overheads are considered as period cost and not included in unit product cost.

Fixed manufacturing overheads per unit = Total Fixed Manufacturing overhead/Unit produced

= $72,000/18,000 = $4 per unit

Calculation of Unit product cost under absorption and variable costing (Amounts in $)

	a) Absorption Costing	b) Variable Costing
Direct Materials	5	5
Direct Labor	9	9
Variable Manufacturing Overhead	3	3
Fixed Manufacturing Overhead	4	-
Total Unit Product Cost	21	17

2) Contribution Format Variable Costing Income Statements (Amounts in $)

	July	August
Sales (A)	728,000 (14,000*$52)	1,144,000 (22,000*$52)
Variable Costs:
Variable cost of goods sold	238,000 (14,000*$17)	374,000 (22,000*$17)
Variable selling and administrative	14,000 (14,000*$1)	22,000 (22,000*$1)
Total Variable Costs (B)	252,000	396,000
Contribution Margin (C = A-B)	476,000	748,000
Fixed Costs:
Fixed manufacturing overhead	72,000	72,000
Fixed selling and administrative	172,000	172,000
Total Fixed costs (D)	244,000	244,000
Net Operating Income (C-D)	232,000	504,000

3) Reconciliation of variable costing and absorption costing net operating incomes (Amounts in $)

	July	August
Net Operating Income Under Absorption Costing	248,000	488,000
Less: Fixed Manufacturing overhead deferred in ending inventory	(16,000)	0
Add: Fixed manufacturing overhead released from beginning inventory	0	16,000
Net Operating Income Under Variable Costing	232,000	504,000

Ending Inventory for July = Units produced - Units sold

= 18,000 - 14,000 = 4,000 units

Fixed manufacturing overhead deferred in ending inventory = Ending Inventory*Unit fixed manuf. OH

= 4,000 units*$4 per unit = $16,000

There is no ending inventory for August. (Beg inventory 4,000 +Units produced 18,000 - Units sold 22,000 = 0).