Question

Chenango Can Company manufactures metal cans used in the food-processing industry. A case of cans sells for $30. The variable costs of production for one case of cans are as follows:

Direct material	$	6.00
Direct labor		2.00
Variable manufacturing overhead		7.00
Total variable manufacturing cost per case	$	15.00

Variable selling and administrative costs amount to $.80 per case. Budgeted fixed manufacturing overhead is $623,000 per year, and fixed selling and administrative cost is $45,000 per year. The following data pertain to the company’s first three years of operation. (A unit refers to one case of cans.)

	Year 1		Year 2		Year 3
Planned production (in units)	89,000		89,000		89,000
Finished-goods inventory (in units), January 1	0		0		27,500
Actual production (in units)	89,000		89,000		89,000
Sales (in units)	89,000		61,500		102,750
Finished-goods inventory (in units), December 31	0		27,500		13,750

Actual costs were the same as the budgeted costs.

Required:

1.	Prepare operating income statements for Chenango Can Company for its first three years of operations using:

a.	Absorption costing:

             

b.	Variable costing:

             

2.	Reconcile Chenango Can Company’s operating income reported under absorption and variable costing for each of its first three years of operation. Use the shortcut method.

      

3.	Suppose that during Chenango's fourth year of operation actual production equals planned production, actual costs are equal to budgeted costs, and the company ends the year with no inventory on hand.

a.	What will be the difference between absorption-costing operating income and variable-costing operating income in year 4?

             

b.	What will be the relationship between total operating income for the four-year period as reported under absorption and variable costing?
	Total operating income will be higher under variable costing. Total operating income will be higher under absorption costing. Total operating income will be same under absorption and variable costing.

Answer 1

Solution 1:

Computation of Unit Product Cost - Variable Costing
Particulars	Year 1	Year 2	Year 3
Unit Product Cost:
Direct material	$6.00	$6.00	$6.00
Direct Labor	$2.00	$2.00	$2.00
Variable manufacturing overhead	$7.00	$7.00	$7.00
Unit Product Cost	$15.00	$15.00	$15.00

Computation of Unit Product Cost & Ending Inventory- Absorption Costing
Particulars	Year 1	Year 2	Year 3
Unit Product Cost:
Variable manufacturing cost	$15.00	$15.00	$15.00
Fixed manufacturing overhead ($623,000 / Nos of unit produced)	$7.00	$7.00	$7.00
Unit Product Cost	$22.00	$22.00	$22.00
Ending Inventory (In Units)	0	27500	13750
Value of ending inventory (FIFO) (Unit Product Cost * Ending Inventory)	$0.00	$605,000.00	$302,500.00

Income Statement - Absorption Cosing
Particulars	Per unit	Year 1		Year 2		Year 3
		Details	Amount	Details	Amount	Details	Amount
Sales	$30.00		$2,670,000.00		$1,845,000.00		$3,082,500.00
Cost of Goods Sold:
Cost of goods produced	$22.00	$1,958,000.00		$1,958,000.00		$1,958,000.00
Add: Opening Inventory	$22.00	$0.00		0		$605,000.00
Less: Ending Inventory	$22.00	$0.00	$1,958,000.00	$605,000.00	$1,353,000.00	$302,500.00	$2,260,500.00
Gross Profit			$712,000.00		$492,000.00		$822,000.00
Variable Selling & Administrative Expenses			$71,200.00		$49,200.00		$82,200.00
Fixed Selling & Administrative Expenses			$45,000.00		$45,000.00		$45,000.00
Net Operating Income			$595,800.00		$397,800.00		$694,800.00

Variable costing contribution format income statement - Chenango Can Company
Particulars	Per unit	Year 1		Year 2		Year 3
		Details	Amount	Details	Amount	Details	Amount
Sales	$30.00	89000*30	$2,670,000.00	61500*30	$1,845,000.00	102750*30	$3,082,500.00
Variable Cost:
Variable manufacturing cost	$15.00	89000*15	$1,335,000.00	61500*15	$922,500.00	102750*15	$1,541,250.00
Variable Selling and Administrative Expenses	$0.80	89000*0.80	$71,200.00	61500*0.80	$49,200.00	102750*0.80	$82,200.00
Contribution	$14.20		$1,263,800.00		$873,300.00		$1,459,050.00
Fixed Manufacturing Overhead			$623,000.00		$623,000.00		$623,000.00
Fixed Selling & Administrative Expenses			$45,000.00		$45,000.00		$45,000.00
Net Income			$595,800.00		$205,300.00		$791,050.00

Solution 2:

Reconciliation of Net Operating income under absorption costing & Variable Costing
Particulars	Year 1	Year 2	Year 3
Net Operating Income - Variable Costing	$595,800.00	$205,300.00	$791,050.00
Add : Fixed manufacturing overhead deferred in inventory Year 1 - $0 Year 2 - ($623,000/89,000*27500) Year 3 - ($623,000/89000*13750)	$0.00	$192,500.00	$96,250.00
Less: Fixed manufacturing overhead released in inventory	$0.00	$0.00	$192,500.00
Net Operating Income - Absorption Costing	$595,800.00	$397,800.00	$694,800.00

Solution 3a:

Income Statement - Absorption Costing
Particulars	Year 4
	Details	Amount
Sales		$3,082,500.00
Cost of Goods Sold:
Cost of goods produced	$1,958,000.00
Add: Opening Inventory	$302,500.00
Less: Ending Inventory	$0.00	$2,260,500.00
Gross Profit		$822,000.00
Variable Selling & Administrative Expenses		$82,200.00
Fixed Selling & Administrative Expenses		$45,000.00
Net Operating Income		$694,800.00

Income Statement - Variable Costing
Particulars	Year 4
	Details	Amount
Sales	102750*$30	$3,082,500.00
Variable Cost:
Variable manufacturing cost	102750*$15	$1,541,250.00
Variable Selling and Administrative Expenses	102750*$0.80	$82,200.00
Contribution		$1,459,050.00
Fixed Manufacturing Overhead		$623,000.00
Fixed Selling & Administrative Expenses		$45,000.00
Net Operating Income		$791,050.00

Difference between absorption-costing operating income and variable-costing operating income in year 4 = $791,050 - $694,800 = $96,250

Solution 3b:

Total operating income for four year period under absorption costing = $595,800 + $397,800 + $694,800 +$694,800 = $2,383,200

Total operating income for four year period under variable costing = $595,800 + $205,300 + $791,050 +$791,050 = $2,383,200

Therefore total operating income will be same under absorption and variable costing.