Question

Hi, I'm just really lost on where to start and would really appreciate a step-by-step solution. Thanks

Lehighton Chalk Company manufactures sidewalk chalk, which it sells online by the box at $22 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:

	Years 1	Year 2
Sales (in units)	2,400	2,400
Production (in units)	3,000	1,800
Production Costs:
Variable manufacturing costs	11,100	6,660
Fixed manufacturing overhead	14,100	14,100
Selling and administrative costs:
Variable	9,600	9,600
Fixed	8,600	8,600

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

Based on absorption costing	End of Year 1	End of Year 2
Finished-Goods Inventory	5,040	0
Retained earnings	8,940	15,040
Based on variable costing	End of Year 1	End of Year 2
Finished-goods inventory	2,220	0
Retained Earnings	6,120	15,040

1. Reconcile Lehighton's operating income reported under absorption and variable, during each year, by comparing the following two amounts on each income statement:

- Costs of goods sold

- Fixed cost (expensed as a period expense)

2. What was Lehighton's total operating income across both years under absorption costing and under variable costing?

3. What was the total sales revenue across both years under absorption costing and under variable costing?

4. What was the total of all costs expensed on the operating income statements across both years under absorption costing and under variable costing?

5. Subtract the total costs expensed across both years [requirement (4)] from the total sales revenue across both years [requirement (3)]: (a) under absorption costing and (b) under variable costing.

Answer 1

Solution

Leighton Chalk Company

Absorption Costing Income Statement
		Year 1			Year 2
Sales (2,400 units)			52,800	Sales (2,400 units)			$52,800
Less: Cost of Goods Sold				Less: Cost of Goods Sold
Beginning inventory		$0		Beginning inventory	(600 x $8.40)	$5,040
Add: cost of goods manufactured	(3,000 x 8.40)	$25,200		Add: cost of goods manufactured	(1,800 x 11.53)	$20,760
Goods Available for Sale		$25,200		Goods Available for Sale		$25,800
Less: ending inventory	(600 x $8.40)	$5,040		Less: ending inventory	0	$0
Cost of goods sold			$20,160	Cost of goods sold			$25,800
Gross Margin			$32,640	Gross Margin			$27,000
Less: selling and administrative expenses				Less: selling and administrative expenses
Variable selling expenses		$9,600		Variable selling expenses		$9,600
Fixed Selling expenses		$8,600		Fixed Selling expenses		$8,600
Total selling and administrative expenses			$18,200	Total selling and administrative expenses			$18,200
Net Income			$14,440	Net Income			$8,800

Computations:

Cost of goods manufactured, Year 1 –

Variable + fixed overhead

Variable overhead = 11,100/3,000 = $3.70

Fixed overhead = 14,100/3,000 = $4.7

Total cost of goods manufactured per unit = 8.40

Cost of goods manufactured, Year 2 –

Variable = $3.7

Fixed = 14,100/1,800 units = $7.83

Total cost of goods manufactured per unit = 11.53

1. Operating income statements for both years using variable costing method:

Variable Costing Income Statement
	Year 1			Year 2
sales		$52,800	sales		$52,800
Variable expenses:			Variable expenses:
Variable cost of goods manufactured			Variable cost of goods manufactured
Beg. Inventory	0		Beg. Inventory	$2,220
Variable cost of goods manufactured	$11,100		Variable cost of goods manufactured	$6,660
Less: ending inventory	$2,220		Less: ending inventory	0
Variable cost of goods sold		$8,880	Variable cost of goods sold		$8,880
Manufacturing margin		$43,920	Manufacturing margin		$43,920
Less: Variable selling expenses		$9,600	Less: Variable selling expenses		$9,600
Contribution margin		$34,320	Contribution margin		$34,320
Fixed costs:			Fixed costs:
Manufacturing overhead	$14,100		Manufacturing overhead	$14,100
Selling expenses	$8,600		Selling expenses	$8,600
Total fixed expenses		$22,700	Total fixed expenses		$22,700
Net Income		$11,620	Net Income		$11,620

Reconciliation:

Year	Change in inventory in units		Actual fixed overhead	Difference in fixed overhead	Absorption - variable costing operating income
1	600	+	$4.70	$2,820	$2,820
2	-600	-	$4.70	($2,820)	($2,820)

Comparison of cost of goods sold –

Cost of Goods Sold	Absorption Costing	Variable Costing	Difference due to fixed cost deferral
Year 1	$20,160	$8,880	$11,280
Year 2	$25,800	$8,880	$16,920

1. Total operating income across both years under absorption costing and variable costing:

Operating income	Absorption Costing	Variable Costing	Difference due to fixed cost deferral
Year 1	$14,440	$11,620	$2,820
Year 2	$8,800	$11,620	($2,820)

1. Sales revenue –

SalesReveue	Absorption Costing	Variable Costing
Year 1	$52,800	$52,800
Year 2	$52,800	$52,800

4 . Total costs –

Total Costs	Absorption Costing	Variable Costing	Difference due to fixed cost deferral
Year 1	$38,360	$41,180	($2,820)
Year 2	$44,000	$41,180	$2,820

Net operating income –

Year 1	Absorption Costing	Variable Costing
Sales Revenue	$52,800	$52,800
total costs	$38,360	$41,180
	$14,440	$11,620
Year 2
Sales Revenue	$52,800	$52,800
total costs	$44,000	$41,180
net operating income	$8,800	$11,620