Question

Laura, Inc. manufactures and sells one product. The following information pertains to each of the company's first two years of operations:

Selling price per unit	$200
Variable costs per unit:
Manufacturing:
Direct materials	$86
Direct labor	$40
Variable manufacturing overhead	$11
Variable selling and administrative expense	$5
Fixed costs per year:
Fixed manufacturing overhead	$49,000
Selling and administrative expense	$87,000

Year	1	2
Production (units)	5,000	4,600
Sales (units)	4,500	5,100

(Q): What is net operating income under absorption costing in Year 2? (Do not round intermediate calculations. Round the final answer to the nearest dollars.)

(A): $

Answer 1

The major difference in calculating the cost of production in the absorption costing as compared to variable costing is that Absorption costing includes the fixed cost as per unit cost while calculating the per unit cost of prodution.

Thus while calculating the per unit cost of production in this question we shall also consider the fixed cost .

For 1st year per unit cost of production is calculated as follows:

Variable Cost : Direct material $86

+ Direct Labour $40

+ Variable Manufacturing Overhead $11

TOTAL VARIABLE COST PER UNIT $137

Fixed Cost: Fixed manufacturing overhead $49,000

Selling and administrative expense   $87,000

TOTAL FIXED COST PER YEAR $1,36,000

No of Units produced in 1st year 5000

Fixed Cost per unit $27.2

Thus Total Cost per Unit for 1st year as per Absorption Costing Method

= Total Variable Cost per Unit + Total Fixed Cost per Unit

= $137+ $27.2

= $164.2

Out of 5000 units produced in the 1st year 4500 are sold during 1st year and remaining 500 units are sold during 2nd year. This 164.2 shall be used while calculating cost of this 500 units in the 2nd year

In the 2nd year there is production of 4600 units and 5100 units are sold during the year. This means 500 units of previous year has been sold in this year.

The Variable Cost per unit shall be same in the 2nd year as the 1st year i.e $137

Total Fixed cost shall also remain same i.e $1,36,000 However No of units produced during the year has changed thus Fixed Cost per year shall also change in the 2nd year.

Fixed Cost per unit for 2nd year = 136000/4500 = 30.22

Thus Total Cost per unit for 2nd year = 137+30.22 = 167.22

Now let us calculate the Net Operating Income for the 2nd year:

a) Total Sale in the 2nd Year (5100 units * $200 per unit) $10,20,000

Less: b) Cost of 500 units produced in 1st year (500 units * $164.2 per unit) $82,100

Less: c) Cost of 4600 units produced in 2nd year (4600 units * $167.22 per unit) $7,69,212

Net Operating Income for 2nd Year (a-b-c)       $1,68,688