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)		2,500			2,500
Production (in units)		3,100			1,900
Production costs:
Variable manufacturing costs	$	15,190		$	9,310
Fixed manufacturing overhead		18,290			18,290
Selling and administrative costs:
Variable		10,000			10,000
Fixed		9,000			9,000

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	$	6,480		$	0
Retained earnings		11,000			17,720
Based on variable costing	End of Year 1			End of Year 2
Finished-goods inventory	$	2,940		$	0
Retained earnings		7,460			17,720

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).

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

	LEHIGHTON CHALK COMPANY Income Statement Year 1 Year 2 Cost of goods sold: $0 $0 $0 $0 $0 $0

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

	LEHIGHTON CHALK COMPANY Income Statement Year 1 Year 2 Cost of goods sold: $0 $0 Total variable costs: $0 $0 $0 $0 Fixed costs: Total fixed costs $0 $0 $0 $0

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

	Year Change in Inventory (in units) Actual fixed-overhead rate Difference in fixed overhead expensed Absorption- minus variable-costing operating income 1 × 2 ×

Answer 1

a)
LEHIGHTON CHALK COMPANY
ABSORPTION-COSTING INCOME STATEMENT
FOR THE YEAR ENDED
	Year 1	Year 2
Sales Revenue	$62,500.00	$62,500.00
Less: Cost of Goods Sold:
Beginning finished-goods inventory	$0.00	$6,480.00
Cost of goods manufactured = Variable Manufacturing Cost + Fixed Manufacturing Cost	$33,480.00	$27,600.00
Cost of goods available for sale	$33,480.00	$34,080.00
Less: Ending finished-goods inventory =	$6,480.00	$0.00
Cost of Goods Sold	$27,000.00	$34,080.00
Gross Margin	$35,500.00	$28,420.00
Less: Selling and Administrative Expenses	$19,000.00	$19,000.00
Operating Income	$16,500.00	$9,420.00
2)
LEHIGHTON CHALK COMPANY
VARIABLE-COSTING INCOME STATEMENT
FOR THE YEAR ENDED
	Year 1	Year 2
Sales Revenue	$62,500.00	$62,500.00
Less: Cost of Goods Sold
Beginning finished-goods inventory	$0.00	$2,940.00
Cost of goods manufactured	$15,190.00	$9,310.00
Cost of goods available for sale	$15,190.00	$12,250.00
Less: Ending finished-goods inventory	$2,940.00	0
Cost of Goods Sold	$12,250.00	$12,250.00
Variable Selling and Administrative Costs	$10,000.00	$10,000.00
Total Variable Costs	$22,250.00	$22,250.00
Contribution Margin	$40,250.00	$40,250.00
Less:
Fixed Manufacturing Overhead	$18,290.00	$18,290.00
Fixed Selling and Adminstrative Costs	$9,000.00	$9,000.00
Total Fixed Costs	$27,290.00	$27,290.00
Operating Income	$12,960.00	$12,960.00
3. Reconciliation of reported operating income under absorption and variable costing.
								Difference in
		Change in		Actual Fixed		Difference In Fixed		Absorption and
	Year	inventory (units)		Overhead Rate		Overhead Expensed		Variable Income
	1	3100	2500	5.9		3540		$3,540.00
	2	1900	2500	5.9		-3540		-$3,540.00
Fixed overhead Rate = (18290 /3100)	5.9