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) $ 1,024,000 $ 1,664,000 Cost of goods sold (@ $37 per unit) 592,000 962,000 Gross margin 432,000 702,000 Selling and administrative expenses* 296,000 326,000 Net operating income $ \136,000\ $ 376,000 * $3 per unit variable; $248,000 fixed each year. The company’s $37 unit product cost is computed as follows: Direct materials $ 7 Direct labor 11 Variable manufacturing overhead 2 Fixed manufacturing overhead ($357,000 ÷ 21,000 units) 17 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 operations are: Year 1 Year 2 Units produced 21,000 21,000 Units sold 16,000 26,000 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	7	7
Direct labour	11	11
Variable manufacturing overhead	2	2
Unit product cost	20	20

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

	Year 1	Year 2
Sales	1024000	1664000
Variable cost of goods sold	(320000)	(520000)
Variable selling and administrative expense	(48000)	(78000)
Contribution margin	656000	1066000
Fixed manufacturing overhead	(357000)	(357000)
Fixed selling and administrative expense	(248000)	(248000)
Net operating income	51000	461000

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

	Year 1	Year 2
Absorption costing net income	136000	376000
Fixed manufacturing overhead cost (deferred) Released in ending inventory (5000*17)	(85000)	85000
Variable costing net income	51000	461000