Question

O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$26
Direct labor	$18
Variable manufacturing overhead	$5
Variable selling and administrative	$3
Fixed costs per year:
Fixed manufacturing overhead	$530,000
Fixed selling and administrative expenses	$170,000

During its first year of operations, O’Brien produced 93,000 units and sold 77,000 units. During its second year of operations, it produced 78,000 units and sold 89,000 units. In its third year, O’Brien produced 84,000 units and sold 79,000 units. The selling price of the company’s product is $78 per unit.

4. Assume the company uses absorption costing and a LIFO inventory flow assumption (LIFO means last-in first-out. In other words, it assumes that the newest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3. (Round your intermediate calculations and final answers to 2 decimal places.)

b. Prepare an income statement for Year 1, Year 2, and Year 3. (Round your intermediate calculations to 2 decimal places.)

Answer 1

- It is worth to note that the question states Company used LIFO method for Inventory but at the same point of time, it incurs the same per unit cost throughout 3 years of operation. Which means that Method of inventory would be relevant for cost accounting purposes in our calculation since the fixed manufacturing overheads are loaded in no .of produced units not as period cost.

- Since Operation has started in Year 1, company would not be carrying any opening stock.

Solution 1:

For cost of production under absorbtion technique, Fixed overheads will be allocated to the units produced in factory. Before we calculate unit product cost, Let's compute fixed overhead per unit:

Fixed manufacturing overheads per unit
	Year 1	Year 2	Year 3
Fixed manufacturing overheads	530000	530000	530000
Production	93000	78000	84000
Manu Overhead per unit	5.70	6.79	6.31

Now we can compute Unit Product cost:

Unit Product Cost
	Year 1	Year 2	Year 3
Direct Material	26.00	26.00	26.00
Direct Labor	18.00	18.00	18.00
Variable Manufacturing overhead	5.00	5.00	5.00
Fixed Manufacturing overhead	5.70	6.79	6.31
Total	54.70	55.79	55.31

Solution B: We have to prepare Income statement as per Absorbtion costing.

For Income statement, we can present it as below:

Working Note:

1. Since Company is using LIFO method as inventory, Valaution of Opening stock and closing stock becomes key thing. Inventory records will look like below:

Inventory Statement
	Year 1	Year 2	Year 3
Opening Stock	0	16000	5000
Add: Actual Production	93000	78000	84000
Less: Sale	77000	89000	79000
Closing Stock	16000	5000	10000

2. Let's see how inventory rate flows for valuation:

1st year: There is a single rate and there is no pening stock, Closing stock would be valued at per unit cost of 54.7.

2nd year: Opening stock would be same as of previous year with same value. It should be noted that at the end of 2nd year, closing stock is 5000 units since company opening stock is 16000 units, As per LIFO method, rate for closing stock would be the rate used in opening stock since all the units remaining lies from old stock.

3rd Year: Closing stock is 10000 units while opening stock is 5000 units. It means that 5000 units are remaining from opening stock and 5000 from current production. So two different rates will be used for valuation. One is opoening stock rate and the other Yr 3 unitproduction rate

3. Variable selling overheads will be calculated for units sold.