Question

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

	Year 1			Year 2
Sales (@ $25 per unit)	$	1,000,000		$	1,250,000
Cost of goods sold (@ $18 per unit)		720,000			900,000
Gross margin		280,000			350,000
Selling and administrative expenses*		210,000			230,000
Net operating income	$	70,000		$	120,000

*$2 per unit variable; $130,000 fixed each year.

The company’s $18 unit product cost is computed as follows:

Direct materials	$	4
Direct labor		7
Variable manufacturing overhead		1
Fixed manufacturing overhead ($270,000 ÷ 45,000 units)		6
Absorption costing unit product cost	$	18

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 operations are:

	Year 1	Year 2
Units produced	45,000	45,000
Units sold	40,000	50,000

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