Question

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

  

	Year 1		Year 2
Sales (@ $63 per unit)	$	1,008,000	$	1,638,000
Cost of goods sold (@ $37 per unit)		592,000		962,000
Gross margin		416,000		676,000
Selling and administrative expenses*		297,000		327,000
Net operating income	$	119,000	$	349,000

   

* $3 per unit variable; $249,000 fixed each year.

  

The company’s $37 unit product cost is computed as follows:

  

Direct materials	$	9
Direct labor		9
Variable manufacturing overhead		3
Fixed manufacturing overhead ($336,000 ÷ 21,000 units)		16
Absorption costing unit product cost	$	37

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 two years are:

  

	Year 1	Year 2
Units produced	21,000	21,000
Units sold	16,000	26,000

  

Required:

1.	Prepare a variable costing contribution format income statement for each year.

     

2.	Reconcile the absorption costing and the variable costing net operating income figures for each year. (Losses should be indicated by a minus sign.)

     

Answer 1

1.

Heaton Company
Income Statement (Variable costing)
	Year 1	Year 2
Sales	$                       1,008,000	$                       1,638,000
Variable Expenses
Direct Material	16,000*$9 = $144,000	26,000*$9 = $234,000
Direct Labour	16,000*$9 = $144,000	26,000*$9 = $234,000
Variable Manufacturing overhead	16,000*$3 = $48,000	26,000*$3 = $78,000
Variable selling administrative expenses	16,000*$3 = $48,000	26,000*$3 = $78,000
Total Variable expenses	$                           384,000	$                           624,000
Contribution margin	$                           624,000	$                       1,014,000
Fixed Expenses
Fixed Manufacturing overhead	$                           336,000	$                           336,000
Fixed selling and administrative expenses	$                           249,000	$                           249,000
Total Fixed Expenses	$                           585,000	$                           585,000
net operating income (Loss)	$                             39,000	$                           429,000

2.

Reconciliation
Net Income (Variable costing)	$                           39,000	$                        429,000
Add: Fixed Manufacturing overhead carried forward (closing inventories)	5,000*$16 = $80,000
Less: Fixed Manufacturing overhead brought in (opening inventories)		5,000*$16 = $80,000
Net Income (Absorption Costing)	$                        119,000	$                        349,000