Question

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

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,116,000		$	1,736,000
Cost of goods sold (@ $39 per unit)		702,000			1,092,000
Gross margin		414,000			644,000
Selling and administrative expenses*		306,000			336,000
Net operating income	$	\108,000\		$	308,000

* $3 per unit variable; $252,000 fixed each year.

The company’s $39 unit product cost is computed as follows:

Direct materials	$	8
Direct labor		13
Variable manufacturing overhead		2
Fixed manufacturing overhead ($368,000 ÷ 23,000 units)		16
Absorption costing unit product cost	$	39

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	23,000	23,000
Units sold	18,000	28,000

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.

Answer 1

1
	Year 1	Year 2
Direct materials	8	8
Direct labor	13	13
Variable manufacturing overhead	2	2
Unit product cost	23	23
Unit product cost = 23
2
	Year 1	Year 2
Sales	1116000	1736000
Variable expenses:
Variable cost of goods sold	414000	644000
Variable selling and administrative expenses	54000	84000
Total Variable expenses	468000	728000
Contribution margin	648000	1008000
Fixed expenses:
Fixed manufacturing overhead	368000	368000
Fixed selling and administrative expenses	252000	252000
Total Fixed expenses	620000	620000
Net operating income	28000	388000
3
	Year 1	Year 2
Variable costing net operating income	28000	388000
Add: Fixed manufacturing overhead deferred in inventory under absorption costing	80000		=5000*16
Deduct: Fixed manufacturing overhead released from inventory under absorption costing		(80000)
Absorption costing net operating income	108000	308000