Question

Haas 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	$	20
Direct labor	$	12
Variable manufacturing overhead	$	7
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	110,000
Fixed selling and administrative expenses	$	50,000

During its first year of operations, Haas produced 40,000 units and sold 40,000 units. During its second year of operations, it produced 55,000 units and sold 30,000 units. In its third year, Haas produced 20,000 units and sold 45,000 units. The selling price of the company’s product is $46 per unit.

Required:

1. Compute the company’s break-even point in unit sales.

2. Assume the company uses variable costing:

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

3. Assume the company uses absorption costing:

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

Answer 1

Solution:

Part 1 --- Break Even Point in unit sales

Break Even Point in unit sales = Total Fixed Cost / CM Ratio

CM Ratio = Contribution Margin / Sales x 100

Contribution Margin = Selling Price per unit $46 – Total Variable Cost per unit (20 + 12 + 7 + 3)

= $46 – 42

= $4

CM Ratio = Contribution Margin $4 / Sales 46 = 0.08695652 or 8.695652%

Break Even Point in unit sales = Total Fixed Cost (110,000 + 50,000) / CM Ratio 0.

= 160,000 / 0.08695652

= $1,840,000

Part 2(a) – Unit Product Cost for Year 1, 2 & 3 (Using Variable Costing)

Variable Costing System

1) Product Cost refers to the costs used to fabricate/make/produce a product.

2) Under Variable Costing System, product cost includes only following variable manufacturing costs:

- Cost of direct material used

- Direct labor cost

- Variable manufacturing overheads.

3) Under this system, fixed costs are not considered in product cost and for valuation of closing stock of finished goods. Fixed costs are treated as period cost in this system.

4) The value of finished goods and work in process is also comprised only of Manufacturing Variable Costs.

5) Selling and administrative expenses are not included because these are not the expenses incurred in production department. These expenses relate to selling and admin department.

Unit Product Cost	Year 1	Year 2	Year 3
Direct materials cost per unit	$20.00	$20.00	$20.00
Direct labor cost per unit	$12.00	$12.00	$12.00
Variable Manufacturing Overhead per unit	$7.00	$7.00	$7.00
Unit Product Cost	$39.00	$39.00	$39.00

Part 2(b) – Income Statement for Year 1, 2 & 3

Income Statement (Using Variable Costing)
	Year 1	Year 2	Year 3
Sales (Sold Units * $46)	$1,840,000	$1,380,000	$2,070,000
Variable Expenses:
Production Cost (Units Produced * Unit Product Cost)	$1,560,000	$2,145,000	$780,000
Plus: Beginning Inventory (ending inventory of last year)	$0		$975,000
Less: Ending Inventory (Ending Units x Unit Product Cost $39)	$0	-$975,000
Variable Cost of Goods Sold	$1,560,000	$1,170,000	$1,755,000
Add: Variable S&A Expenses (Unit Sold x $3)	$120,000	$90,000	$135,000
Total Variable Expenses	$1,680,000	$1,260,000	$1,890,000
Contribution Margin (Sales - Total Variable Expenses)	$160,000	$120,000	$180,000
Fixed Expenses:
Fixed Manufacturing Overhead	$110,000	$110,000	$110,000
Fixed S&A Expenses	$50,000	$50,000	$50,000
Total Fixed Expenses	$160,000	$160,000	$160,000
Net Operating Income (loss)	$0	-$40,000	$20,000

Calculation of Ending and Beginning Inventory

	Year 1	Year 2	Year 3
Produced Units	40000	55000	20000
Add: Beginning Inventory	0	0	25,000
Units Available for Sale	40000	55,000	45000
Less: Units Sold	40,000	30,000	45,000
Ending Inventory	0	25000	0

Part 3(a) – unit Product Cost using Absorption Costing

Unit Product Cost	Year 1	Year 2	Year 3
Direct materials cost per unit	$20.00	$20.00	$20.00
Direct labor cost per unit	$12.00	$12.00	$12.00
Variable Manufacturing Overhead per unit	$7.00	$7.00	$7.00
Applied Manufacturing Overhead (Total Fixed Manufacturing OH / Produced Units)	$2.75	$2.00	$5.50
Unit Product Cost	$41.75	$41.00	$44.50

Part 3(b) – Income Statement using Absorption Costing

Income Statement (Using Absorption Costing)
	Year 1	Year 2	Year 3
Sales (Sold Units * $46)	$1,840,000	$1,380,000	$2,070,000
Variable Expenses:
Production Cost (Units Produced * Unit Product Cost)	$1,670,000	$2,255,000	$890,000
Plus: Beginning Inventory	$0		$1,025,000
Less: Ending Inventory (Ending Units x Unit Product Cost)	$0	-$1,025,000 (25,000 Units*$41)
Cost of Goods Sold	$1,670,000	$1,230,000	$1,915,000
Gross Profit (Sales - COGS)	$170,000	$150,000	$155,000
Selling and Admn Expenses:
Variable S&A Expenses (Unit Sold x $3)	$120,000	$90,000	$135,000
Fixed S&A Expenses	$50,000	$50,000	$50,000
Total Fixed Expenses	$170,000	$140,000	$185,000
Net Operating Income (loss)	$0	$10,000	-$30,000

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