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 (@ $64 per unit)	$	1,280,000			$	1,920,000
Cost of goods sold (@ $35 per unit)		700,000				1,050,000
Gross margin		580,000				870,000
Selling and administrative expenses*		307,000				337,000
Net operating income	$	273,000			$	533,000

* $3 per unit variable; $247,000 fixed each year.

The company’s $35 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		12
Variable manufacturing overhead		2
Fixed manufacturing overhead ($350,000 ÷ 25,000 units)		14
Absorption costing unit product cost	$	35

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		25,000				25,000
Units sold		20,000				30,000

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.

Answer 1

1		Variable costing income statement
					Year 1	Year 2
	Sales					1280000		1920000
	Less: Variable cost of goods sold (Note:1)					420000		630000
	Gross contribution margin					860000		1290000
	Less:Variable selling and administrative expenses					60000		90000
						(20000*3)		(30000*3)
	Contribution margin					800000		1200000
	Less: Fixed expenses
	Manufacturing overhead				350000		350000
	selling and administrative expenses				247000	597000	247000	597000
	Net income/(loss)					203000		603000
	Note:1
	Product cost under variable costing
				$
	Direct material			7
	Direct labor			12
	Variable manufacturing overhead			2
	Total			21
	Year 1
	Units sold=20000 units
	Cost of goods sold=20000*21=$420000
	2017
	Units sold=30000 units
	Cost of goods sold=30000*21=$630000
2		Reconcilation of variable costing income to absorption costing income
					Year 1	Year 2
	Variable costing income (loss)				203000	603000
	Add:Fixed manufacturing overhead deferred in inventory
	(Note:2)				70000
	Less:Fixed manufacturing overhead released from inventory					70000
	(Note:2)
	Absorption costing income (loss)				273000	533000
	Note:2
	Units produced	25000
	Less: units sold	20000
	Ending inventory	5000
	Fixed overhead per unit=$ 14
	Fixed manufacturing overhead deferred in ending inventory=70000
	This will have a reverse effect in year 2.