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. Using variable costing, what is the unit product cost for both years?

	Year 1	Year 2
Direct material	5	5
Direct labour	9	9
Variable manufacturing overhead	4	4
Unit product cost	18	18

2. What is the variable costing net operating income in Year 1 and in Year 2?

	Year 1	Year 2
Sales	1240000	1860000
Variable cost of goods sold	360000	540000
Variable selling and administrative expense	60000	90000
Total variable cost	420000	630000
Contribution margin	820000	1230000
Fixed manufacturing overhead	475000	475000
Fixed selling and administrative expense	249000	249000
Total fixed cost	724000	724000
Net operating income	96000	506000

3. Reconcile the absorption costing and the variable costing net operating income figures for each year.

	Year 1	Year 2
Absorption costing net income	191000	411000
Fixed manufacturing overhead cost deferred or released in ending inventory (5000*19)	-95000	95000
Variable costing net income	96000	506000