Question

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

	Year 1			Year 2
Sales (@ $61 per unit)	$	1,220,000		$	1,830,000
Cost of goods sold (@ $36 per unit)		720,000			1,080,000
Gross margin		500,000			750,000
Selling and administrative expenses*		313,000			343,000
Net operating income	$	\187,000\		$	407,000

* $3 per unit variable; $253,000 fixed each year.

The company’s $36 unit product cost is computed as follows:

Direct materials	$	9
Direct labor		11
Variable manufacturing overhead		1
Fixed manufacturing overhead ($375,000 ÷ 25,000 units)		15
Absorption costing unit product cost	$	36

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 operatons are:

	Year 1	Year 2
Units produced	25,000	25,000
Units sold	20,000	30,000

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.

Using variable costing, what is the unit product cost for both years?

	Unit product cost

What is the variable costing net operating income in Year 1 and in Year 2?

	Year 1 Year 2 Net operating income (loss)

Reconcile the absorption costing and the variable costing net operating income figures for each year. (Enter any losses or deductions as a negative value.)

	Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes Year 1 Year 2 Variable costing net operating income (loss) Absorption costing net operating income

Answer 1

Answer 1 : Unit product cost = $21

Explanation:

Direct materials	$9
Direct labor	$11
Variable manufacturing overhead	$1
Unit product cost	$21

Answer 2 :  

	Year 1	Year 2
Net operating income (loss)	$112,000	$482,000

Explanation:

	Year 1	Year 2
Sales units	($1,220,000 / $61) = 20,000 units	($1,830,000 / $61) = 30,000 units
Sales value	$1,220,000	$1,830,000
Less : Variable costs [($21 + $3)	[($21 + $3) * 20,000 units] = $480,000	[($21 + $3) * 30,000 units] = $720,000
Contribution margin	$740,000	$1,110,000
Less : Fixed costs ($253,000 + $375,000)	$628,000	$628,000
Net operating income (loss)	$112,000	$482,000

Answer 3:

Reconcile the absorption costing and the variable costing net operating income

	Year 1	Year 2
Variable costing net operating income (loss)	$112,000	$482,000
Add (Less): Fixed manufacturing overhead costs deferred in (released from) inventory under absorption costing (Note 1)	$75,000	($75,000)
Absorption costing net operating income	$187,000	$407,000

Note 1 :

Since in Year 1 , Units produced > Units sold by 5,000 unit, Fixed manufacturing overhead costs deferred in inventory under absorption costing = 5,000 units * $15 = $75,000

Since in Year 2 , Units produced < Units sold by 5,000 unit, Fixed manufacturing overhead costs released from inventory under absorption costing = 5,000 units * $15 = ($75,000)