Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows:

	Year 1			Year 2
Sales (@ $64 per unit)	$	1,280,000		$	1,920,000
Cost of goods sold (@ $40 per unit)		800,000			1,200,000
Gross margin		480,000			720,000
Selling and administrative expenses*		309,000			339,000
Net operating income	$	\171,000\		$	381,000

* $3 per unit variable; $249,000 fixed each year.

The company’s $40 unit product cost is computed as follows:

Direct materials	$	9
Direct labor		11
Variable manufacturing overhead		3
Fixed manufacturing overhead ($425,000 ÷ 25,000 units)		17
Absorption costing unit product cost	$	40

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 operations are:

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

Required:

1. Using variable costing, what is the unit product cost for both years?

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

Compute the Variable costing Unit Product cost
				Year 1	Year 2
Direct Material				9	9
Direct labour				11	11
Variable Manufacturing overheads				3	3
Variable costing unit prroduct cost				23	23
Construct The Variable Costing Income Statement under FIFO
				YEAR 1		YEAR 2
Sales					1,280,000		1,920,000
Less: Variable cost
variable cost of goods sold				460,000		690,000
Variable selling expense				60,000	520,000	90,000	780,000
Contribution margin					760,000		1,140,000
Fixed expense:
Fixed Manufacturing overheads					425,000		425,000
Fixed selling expense					249,000		249,000
Net operating Income					86,000		466,000
Reconciliation Statement:
Year-1
Net income as per Variable costing				86000
Add: Fixed OH Deffered (5000 units @17)				85000
Net income as per Absorption costing				171000
Year-2
Net income as per Variable costing				466000
Less: Fixed OH released (5000 units @17)				85000
Net income as per Absorption costing				381000