Question

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

	Year 1			Year 2
Sales (@ $63 per unit)	$	1,134,000		$	1,764,000
Cost of goods sold (@ $38 per unit)		684,000			1,064,000
Gross margin		450,000			700,000
Selling and administrative expenses*		303,000			333,000
Net operating income	$	147,000		$	367,000

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

The company’s $38 unit product cost is computed as follows:

Direct materials	$	9
Direct labor		13
Variable manufacturing overhead		3
Fixed manufacturing overhead ($299,000 ÷ 23,000 units)		13
Absorption costing unit product cost	$	38

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	23,000	23,000
Units sold	18,000	28,000

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

1
	Year 1	Year 2
Direct materials	9	9
Direct labor	13	13
Variable manufacturing overhead	3	3
Unit product cost	25	25
Unit product cost = 25
2
	Year 1	Year 2
Sales	1134000	1764000
Variable expenses:
Variable cost of goods sold	450000	700000
Variable selling and administrative expenses	54000	84000
Total Variable expenses	504000	784000
Contribution margin	630000	980000
Fixed expenses:
Fixed manufacturing overhead	299000	299000
Fixed selling and administrative expenses	249000	249000
Total Fixed expenses	548000	548000
Net operating income(loss)	82000	432000
3
	Year 1	Year 2
Variable costing net income	82000	432000
Add: Fixed manufacturing overhead deferred in inventory under absorption costing	65000		=5000*13
Deduct: Fixed manufacturing overhead released from inventory under absorption costing		(65000)	=5000*13
Absorption costing net operating income	147000	367000