Question

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

	Year 1			Year 2
Sales (@ $64 per unit)	$	1,216,000		$	1,856,000
Cost of goods sold (@ $28 per unit)		532,000			812,000
Gross margin		684,000			1,044,000
Selling and administrative expenses*		310,000			340,000
Net operating income	$	374,000		$	704,000

* $3 per unit variable; $253,000 fixed each year.

The company’s $28 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		8
Variable manufacturing overhead		2
Fixed manufacturing overhead ($288,000 ÷ 24,000 units)		12
Absorption costing unit product cost	$	28

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	24,000	24,000
Units sold	19,000	29,000

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

1.

	Year 1	Year 2
Direct material	$         6	$         6
Direct labor	$         8	$         8
Variable manufacturing overhead	$         2	$         2
Unit product cost	$       16	$       16

2.

Heaton Company
Income Statement (Variable Costing)
	Year 1	Year 2
Sales	$                       1,216,000	$                       1,856,000
Less: Variable expenses
Direct material	19,000*$6 = $114,000	29,000*$6 = $174,000
Direct labor	19,000*$8 = $152,000	29,000*$8 = $232,000
Variable manufacturing overhead	19,000*$2 = $38,000	29,000*$2 = $58,000
Variable selling administrative expenses	19,000*$3 = $57,000	29,000*$3 = $87,000
Total variable expenses	$                           361,000	$                           551,000
Contribution margin	$                           855,000	$                       1,305,000
Fixed expenses
Fixed manufacturing overhead	$                           288,000	$                           288,000
Fixed selling and administrative expenses	$                           253,000	$                           253,000
Total fixed expenses	$                           541,000	$                           541,000
net operating income (Loss)	$                           314,000	$                           764,000

3.

Reconciliation
Net Income (Variable costing)	$                        314,000	$                        764,000
Add: Fixed Manufacturing overhead carried forward	5,000*$12 = $60,000
Less: Fixed Manufacturing overhead brought in		5,000*$12 = $60,000
Net Income (Absorption Costing)	$                        374,000	$                        704,000

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