Question

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	$	26
Direct labor	$	11
Variable manufacturing overhead	$	5
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	320,000
Fixed selling and administrative expenses	$	60,000

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 $88 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

SOLUTION

1A.

	Year 1	Year 2
Direct materials	26	26
Direct labor	11	11
Variable manufacturing overhead	5	5
Total product cost per unit	42	42

1B. Variable costing income statement

	Year 1	Year 2
Units sold (a)	40,000	50,000
Sales (b=a*$88)	3,520,000	4,400,000
Variable product cost (a*42)	1,680,000	2,100,000
Variable selling and administrative cost (d=a*4)	160,000	200,000
Contribution margin (e=b-c-d)	1,680,000	2,100,000
Fixed manufacturing overhead (f)	320,000	320,000
Fixed selling and administrative cost (g)	60,000	60,000,
Net operating income (e-f-g)	1,300,000	1,720,000

2A.

	Year 1	Year 2
Direct materials	26	26
Direct labor	11	11
Variable manufacturing overhead	5	5
Fixed manufacturing overhead
Year 1- (320,000/50,000)	6.4
Year 2- (320,000/40,000)		8
Total product cost per unit	48.4	50

2B. Absorption costing income statement

	Year 1	Year 2
Number of units produced (a)	50,000	40,000
Units sold (b)	40,000	50,000
Sales (c=b*88)	3,520,000	4,400,000
Cost of goods sold-
Beginning inventory (d)
Year 1- No beginning inventory
Year 2 - (10,000 units * 48.40)	0	484,000
Cost of goods manufactured (e)
Year1 (a*48.40)	2,420,000
Year 2 - (a*50)		2,000,000
Ending inventory (f)
Year 1 - (10,000 units * 48.40)	484,000
Year 2 - No ending inventory		0
Cost of goods sold (g=d+e-f)	1,936,000	2,484,000
Gross margin (h=c-g)	1,584,000	1,916,000
Selling and administrative expenses (i)
((b*$4)+60,000)	220,000	260,000
Net operating income (h-i)	1,364,000	1,656,000

3.

	Year 1	Year 2
Net operating income as per variable costing	1,300,000	1,720,000
Add/Less: Difference in valuation of inventory due to fixed manufactuing overhead
Year 1 (50,000-40,000)*6.4	64,000
Year 2 (50,000-40,000)*6.4		(64,000)
Net operating income as per absorption costing	1,364,000	1,656,000