Question

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

	Year 1			Year 2
Sales (@ $60 per unit)	$	900,000		$	1,500,000
Cost of goods sold (@ $28 per unit)		420,000			700,000
Gross margin		480,000			800,000
Selling and administrative expenses*		290,000			320,000
Net operating income	$	\190,000\		$	480,000

* $3 per unit variable; $245,000 fixed each year.

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

Direct materials	$	6
Direct labor		8
Variable manufacturing overhead		1
Fixed manufacturing overhead ($260,000 ÷ 20,000 units)		13
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	20,000	20,000
Units sold	15,000	25,000

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

The Variable costing Unit Product cost
				Year 1	Year 2
Direct Material				6	6
Direct labour				8	8
Variable Manufacturing overheads				1	1
Variable costing unit prroduct cost				15	15
The Variable Costing Income Statement
				YEAR 1		YEAR 2
Sales					900,000		1,500,000
Less: Variable cost
variable cost of goods sold				225,000		375,000
Variable selling expense				45,000	270,000	75,000	450,000
Contribution margin					630,000		1,050,000
Fixed expense:
Fixed Manufacturing overheads					260,000		260,000
Fixed selling expense					245,000		245,000
Net operating Income					125,000		545,000
RECONCILIATION STATEMENT
				YEAR 1	YEAR2
Net income under variable costing				125000	545000
Add: Fixed manufacturing OH deferred				65000
Less: Fixed Manufacturing O released					-65000
Net Income under Absorption costing				190000	480000
Note:
In year-1, the ending inventory is of 5000 units on which the fixed Manufacturing OH @$13 per unit will be carried with ending inventory i.e. defferred.
Hence, the income under absorption costing will increase by the amount of $65000
In Year-2, Beginning inventory of 5000 units will be sold of, hence the fixed OH @$13 per unit included in it, will be released.
hence, the income under Absorption costing will decrease by amount of $65000