Question

Problem 5-41 (Algorithmic)
Absorption Costing vs. Variable Costing: Benefits and Calculation of Net Operating Income

Safety Shoes, Inc. produces a variety of products for the manufacturing industry. Hiking-style steel toe boots are among its most popular products. The company's controller spoke to the company's president at a meeting last week and told her that the company was doing well, but that the financial picture depended on how product costs and net operating income were calculated. The president did not realize that the company had options with regard to calculating these numbers, so she asked the controller to prepare some information and be ready to meet with her to talk more about this issue. In preparing for the meeting, the controller accumulated the following data:

Beginning inventory 27,000

Units produced 101,000

Units sold 112,000

Fixed manufacturing overhead $380,000

Direct materials per unit $22.00

Direct labor per unit $33.00

Variable manufacturing overhead per unit $15.00

A. Compute the cost per unit, using absorption costing. (Answer is 74)

B. Compute the cost per unit, using variable costing. (Answer is 70)

C. Compute the difference in net operating income between the two methods. If there is no difference in net income, enter "0". Do not round your interim calculations.

D. Assume that production was 101,000 units and sales were 70,000 units. What would be the difference in net operating income between the two methods? If there is no difference in net income, enter "0". Do not round your interim calculations.

Answer 1

• All working forms part of the answer
• Working & Answer for ‘A’ and ‘B’

A	Direct Material	$                22.00
B	Direct Labor	$                33.00
C	Variable manufacturing overhead	$                15.00
D = A+B+C	Cost per unit - Variable Costing	$                70.00
E	Fixed manufacturing Overhead	$      380,000.00
F	Units produced	101000
G = E/F	Fixed overhead per unit	$                   3.76
H = D + G	Cost per unit - Absorption Costing	$                73.76 or $ 74

• Based on above, Answer ‘C’ and ‘D’
• Answer ‘C’

Absorption Costing		Variable costing
Cost of Goods Sold [112,000 x $74]	$ 8,288,000.00	Total Variable cost [112,000 x $70]	$ 7,840,000.00
		Fixed manufacturing overhead	$      380,000.00
Total cost	$ 8,288,000.00	Total cost	$ 8,220,000.00
Difference in Net Operating Income (=Difference in cost)		$                                      68,000.00 [Net Income under Variable costing will be $ 68,000 more than Net Income under Absorption costing]

• Answer ‘D’

Absorption Costing		Variable costing
Cost of Goods Sold [70,000 x $74]	$ 5,180,000.00	Total Variable cost [70,000 x $70]	$ 4,900,000.00
		Fixed manufacturing overhead	$      380,000.00
Total cost	$ 5,180,000.00	Total cost	$ 5,280,000.00
Difference in Net Operating Income (=Difference in cost)		$                                   100,000.00 [Net Income under Variable costing will be $ 100,000 LESS than Net Income under Absorption costing]