Question

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

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,240,000		$	1,860,000
Cost of goods sold (@ $37 per unit)		740,000			1,110,000
Gross margin		500,000			750,000
Selling and administrative expenses*		309,000			339,000
Net operating income	$	\191,000\		$	411,000

* $3 per unit variable; $249,000 fixed each year.

The company’s $37 unit product cost is computed as follows:

Direct materials	$	5
Direct labor		9
Variable manufacturing overhead		4
Fixed manufacturing overhead ($475,000 ÷ 25,000 units)		19
Absorption costing unit product cost	$	37

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 operatons are:

	Year 1	Year 2
Units produced	25,000	25,000
Units sold	20,000	30,000

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.

Computation of Unit Product Cost
	Variable Costing
Direct Meterial	$                                        5.00
Direct Labour	$                                        9.00
Variable Manufactoring Overhead	$                                        4.00
Unit Product Cost	$                                      18.00

2.

Income Statement
Variable Costing
	Year 1	Year 2
Sales	20,000*$62 = $1,240,000	30,000*$62 = $1,860,000
Less: Variable Expenses:
Direct materials	20,000*$5 = $100,000	30,000*$5 = $150,000
Direct labour	20,000*$9 = $180,000	30,000*$9 = $270,000
Variable manufacturing overhead	20,000*$4 = $80,000	30,000*$4 = $120,000
Variable selling and administrative expenses	20,000*$3 = $60,000	30,000*$3 = $90,000
Contribution margin	$                                 820,000	$                             1,230,000
Less: Fixed Expenses:
Fixed manufacturing overhead	$                                 475,000	$                                 475,000
Fixed selling and administrative	$                                 249,000	$                                 249,000
Net Operating Income (loss)	$                                   96,000	$                                 506,000

3.

Reconciliation
	Year 1	Year 2
Net Income (Variable costing)	$                           96,000	$                        506,000
Add: Fixed Manufacturing overhead carried forward (closing inventories)	5,000*$19 = $95,000
Less: Fixed Manufacturing overhead brought in (opening inventories)		5,000*$19 = $95,000
Net Income (Absorption Costing)	$                        191,000	$                        411,000