Question

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Lehighton Chalk Company manufactures sidewalk chalk, which it sells online by the box at $26 per unit. Lehighton uses an actual costing system, which means that the actual costs of direct material, direct labor, and manufacturing overhead are entered into work-in-process inventory. The actual application rate for manufacturing overhead is computed each year; actual manufacturing overhead is divided by actual production (in units) to compute the application rate. Information for Lehighton’s first two years of operation is as follows:

Year 1

Year 2

Sales (in units)

2,800

2,800

Production (in units)

3,400

2,200

Production costs:

Variable manufacturing costs

$

17,680

$

11,440

Fixed manufacturing overhead

21,080

21,080

Selling and administrative costs:

Variable

11,200

11,200

Fixed

10,200

10,200

Selected information from Lehighton’s year-end balance sheets for its first two years of operation is as follows:

LEHIGHTON CHALK COMPANY

Selected Balance Sheet Information

Based on absorption costing

End of Year 1

End of Year 2

Finished-goods inventory

$

6,840

$

0

Retained earnings

13,980

23,320

Based on variable costing

End of Year 1

End of Year 2

Finished-goods inventory

$

3,120

$

0

Retained earnings

10,260

23,320

Required:

Lehighton Chalk Company had no beginning or ending work-in-process inventories for either year.

1. Prepare operating income statements for both years based on absorption costing.

2. Prepare operating income statements for both years based on variable costing.

3. Prepare a numerical reconciliation of the difference in income reported under the two costing methods used in requirements (1) and (2).

Answer 1

Under absorbtion Costing both fixed and variable costs are taken into consideration whereas under variable costing only variable cost is taken into account to calculate the product cost .

1) Operating Income Statement under absorbtion Costing

Particulars year 1 year 2

$ $

Sales 72800 72800

(2800*26) (2800*26)

Closing Finished Inventory 6840 -

less:Opening Inventory - (6840)

Manufacturing variable cost (17680) (11440)

  Manufacturing Fixed cost (21080) (21080)

Selling and admin variable cost (11200) (11200).

Selling Fixed cost (10200) (10200)

Net operating Income 19480 12040

2

Operating Income Statement under Variable Costing

Particulars year 1 year 2

$ $

Sales 72800 72800

(2800*26)   (2800*26)

Closing Finished Inventory 3120 -

less:Opening Inventory - (3120)

Manufacturing variable cost (17680) (11440)

Selling and admin variable cost (11200) (11200).

Net operating Income 47040 47040

3) Reconciliation Statement

year 1 year 2

Profit under Absorbtion costing 19480 12040

Add; Fixed Manufacturing cost 21080 21080

Add: Fixed Selling expense 10200 10200

Less: Diiference in retained earning is equal to

fixed cost difference (3720) -

Add: difference in fixed cost representing fixed cost effect in

opening stock 3720

Profit under variable cost 47040 47040