Question

Exercise 7-9 Variable and Absorption Costing Unit Product Costs and Income Statements [LO7-1, LO7-2, LO7-3]

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	$	25
Direct labor	$	15
Variable manufacturing overhead	$	5
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	400,000
Fixed selling and administrative expenses	$	70,000

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 $82 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

Computation of Unit Product Cost
	Year 1	Year 2
Direct material	$25.00	$25.00
Direct labour	$15.00	$15.00
Variable manufacturing overhead	$5.00	$5.00
Product cost	$45.00	$45.00
1b
WALSH COMPANY
Income Statement (Variable costing)
	Year 1	Year 2
Sales Unit	40000	50000
Sales@$82	$3,280,000.00	$4,100,000.00
Less: Variable Expenses
Variable cost of goods sold  @$45	$1,800,000.00	$2,250,000.00
Variable selling administrative expenses @$4	$160,000.00	$200,000.00
Tototal Variable expenses (b)	$1,960,000.00	$2,450,000.00
Contribution margin (c=a-b)	$1,320,000.00	$1,650,000.00
Fixed Expenses
Fixed Manufacturing overhead	$400,000.00	$400,000.00
Fixed selling and administrative expenses	$70,000.00	$70,000.00
Tototal Fixed Expenses (d)	$470,000.00	$470,000.00
Net Operating Income / Loss (c-d)	$850,000.00	$1,180,000.00
Computation of Unit Product Cost
	Year 1	Year 2
Direct material	$25.00	$25.00
Direct labour	$15.00	$15.00
Variable manufacturing overhead	$5.00	$5.00
Fixed Manufacturing overhead (400000/50000), (400000/40000)	$8.00	$10.00
Product cost	$53.00	$55.00
1b
WALSH COMPANY
Income Statement as per absorption costing
	Year 1	Year 2
Sales Unit	40000	50000
Sales@$82	$3,280,000.00	$4,100,000.00
Less: Cost of Goods Sold
cost of goods sold  @$53 , $55	$2,120,000.00	$2,750,000.00
Gross margin (c=a-b)	$1,160,000.00	$1,350,000.00
Sslling & Admin Eexpense
Variable selling administrative expenses @$4	$160,000.00	$200,000.00
Fixed selling and administrative expenses	$70,000.00	$70,000.00
Totota selling & Amdin Expenses (d)	$230,000.00	$270,000.00
Net Operating Income / Loss (c-d)	$930,000.00	$1,080,000.00

Reconciliation
	Year 1	Year 2
Variable Costing Net Operating Income	$850,000.00	$1,180,000.00
Add: Fixed Manufacturing Overhead Cost deferred in Inventory under absorption costing (10000*8) (10000*10)	$80,000.00	$100,000.00
Less: Fixed Manufacturing Overhead Cost released in Inventory under absorption costing		$100,000.00
Absorption Costing Net Operating Income	$930,000.00	$1,080,000.00