Question

Tom Nook Inc. is selling brand new island homes to customers of Dodo Airlines. Operating data for the company and its absorption costing income statements for the last two years are presented below. Monetary units have been converted from Bells to US Dollars.

	Year 1	Year 2
Units in beginning inventory	0	10
Units produced	50	50
Units sold	40	60
Sales	$350,000	$525,000
Cost of goods sold	$240,000	$360,000
Gross Margin	$110,000	$165,000
Selling and administrative expenses	$60,000	$80,000
Net operating income	$50,000	$85,000

For both years: $85,000 Variable manufacturing costs are $4,000 per unit. Fixed manufacturing overhead was $100,000 in each year. This fixed manufacturing overhead was applied at a rate of $2,000 per unit. Variable selling and administrative expenses were $1 per unit sold.

a) Compute the unit product cost in Year 2 under variable costing.

b) Compute the unit product cost in Year 1 under absorption costing.

Answer 1

Marginal costing values inventory at the total variable production cost of a unit of product.

Absorption costing values inventory at the full production cost of a unit of product.

• Inventory values will therefore be different at the beginning and end of a period under marginal and absorption costing.
• If inventory values are different, then this will have an effect on profits reported in the income statement in a period. Profits determined using marginal costing principles will therefore be different to those using absorption costing principles.

For Year 2

under marginal costing unit product cost is equal to variable manufacturing cost and Variable selling and marketing cost and fixed cost are not included.

Variable manufacturing cost of product = $4000

there fore product unit cost under marginal costing = 4000

For Year 1

Under absorption costing unit product cost = cost of goods sold / no of unit sold

=240000/40

= 6000