Question

Lehighton Chalk Company manufactures sidewalk chalk, which it sells online by the box at $25 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:

	Year 1			Year 2
Sales (in units)		2,900			2,900
Production (in units)		3,300			2,500
Production costs:
Variable manufacturing costs	$	13,860		$	10,500
Fixed manufacturing overhead		17,160			17,160
Selling and administrative costs:
Variable		11,600			11,600
Fixed		10,600			10,600

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

LEHIGHTON CHALK COMPANY
Selected Balance Sheet Information
Based on absorption costing	End of Year 1			End of Year 2
Finished-goods inventory	$	3,760		$	0
Retained earnings		17,540			33,720
Based on variable costing	End of Year 1			End of Year 2
Finished-goods inventory	$	1,680		$	0
Retained earnings		15,460			33,720

Required:

Lehighton Chalk Company had no beginning or ending work-in-process inventories for either year.

Prepare operating income statements for both years based on absorption costing.

Prepare operating income statements for both years based on variable costing.

Prepare a numerical reconciliation of the difference in income reported under the two costing methods used in requirements (1) and (2).

Answer 1

working
	Year 1	Year 2
Sales (in units)	2,900	2,900
Production (in units)	3,300	2,500
Production costs:
Variable manufacturing costs	13,860	10,500
Fixed manufacturing overhead	17,160	17,160
	31,020	27,660
Selling and administrative costs:
Variable	11,600	11,600
Fixed	10,600	10,600
	22,200	22,200
Absorption Costing
Year 1
Sales (2900*$25)		72500
Less: Cost of good sold
Total manufacturing cost	31,020
Less: ending Inventory	3760
Cost of good sold		27,260
Gross profit		45,240
Less: selling & adm expenses		22,200
Net operating income		23,040
Year 2
Sales (2900*$25)		72500
Less: Cost of good sold
Beginning Inventory	3760
Total manufacturing cost	27,660
Less: ending Inventory	0
Cost of good sold		31,420
Gross profit		41,080
Less: selling & adm expenses		22,200
Net operating income		18,880
Variable costing
Yaer 1
Sales (2900*$25)			72500
Less: Variable cost
Variable manufacturing costs	13,860
Less: ending Inventory	1680	12,180
Variable Selling and administrative costs		11600
Total variable cost			23,780
Contribution margin			48,720
Fixed manufacturing overhead		17,160
Fixed selling & adm expenses		10,600
Total fixed expenses			27,760
Net operating income			20,960
Year 2
Sales (2900*$25)			72500
Less: Variable cost
Beginning Inventory	1680
Variable manufacturing costs	13,860
Less: ending Inventory	0	15,540
Variable Selling and administrative costs		11600
Total variable cost			27,140
Contribution margin			45,360
Fixed manufacturing overhead		17,160
Fixed selling & adm expenses		10,600
Total fixed expenses			27,760
Net operating income			17,600
ans 3 Year 1]
Net operating Income as per absorption costing			23,040
Less: Fixed manufacturinbg overhead deferred in ending Inventory			-2,080
Net operating Income as per variable costing			20,960
Year 2
Net operating Income as per absorption costing			18,880
Less: Fixed manufacturinbg overhead deferred in beginning Inventory			-1,280
Net operating Income as per variable costing			17,600