Question

Absorption and Variable Costing with Over- and Underapplied Overhead

Flaherty, Inc., has just completed its first year of operations. The unit costs on a normal costing basis are as follows:

Manufacturing costs (per unit):
Direct materials (3 lbs. @ 1.35)	$4.05
Direct labor (0.4 hr. @ 15.00)	6.00
Variable overhead (0.4 hr. @ 5.00)	2.00
Fixed overhead (0.4 hr. @ 7.00)	2.80
Total	$14.85
Selling and administrative costs:
Variable	$1.80	per unit
Fixed	$215,500

During the year, the company had the following activity:

Units produced	27,000
Units sold	24,300
Unit selling price	$36
Direct labor hours worked	10,800

Actual fixed overhead was $11,200 less than budgeted fixed overhead. Budgeted variable overhead was $4,800 less than the actual variable overhead. The company used an expected actual activity level of 10,800 direct labor hours to compute the predetermined overhead rates. Any overhead variances are closed to Cost of Goods Sold.

Required:

1. Compute the unit cost using (a) absorption costing and (b) variable costing.

	Unit Cost
Absorption costing	$
Variable costing	$

Feedback

The unit cost under absorption costing includes one more cost than under variable costing.

The unit cost under variable costing includes one less cost than under absorption costing.

2. Prepare an absorption-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Absorption-Costing Income Statement
For the First Year of Operations
Sales		$
Cost of goods sold	$
Less:
Overapplied overhead
Gross profit		$
Less: Selling and administrative expenses
Operating income		$

Feedback

Absorption costing assigns all manufacturing costs to each unit produced.

3. Prepare a variable-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Variable-Costing Income Statement
For the First Year of Operations
Sales		$
Variable cost of goods sold	$
Add:
Underapplied variable overhead
Variable selling expense
Contribution margin		$
Less:
Fixed factory overhead	$
Selling and administrative expenses		$
Operating income		$

Feedback

4. Reconcile the difference between the two income statements.
The absorption costing generates an income $more than variable costing.

Answer 1

1		Unit Cost
	Absorption costing	14.85
	Variable costing	12.05
2	Flaherty, Inc.
	Absorption-Costing Income Statement
	For the First Year of Operations
	Sales		874800
	Cost of goods sold	360855
	Less:
	Overapplied overhead	6400	354455
	Gross profit		520345
	Less: Selling and administrative expenses		259240
	Operating income		261105
3	Flaherty, Inc.
	Variable-Costing Income Statement
	For the First Year of Operations
	Sales		874800
	Variable cost of goods sold	292815
	Add:
	Underapplied variable overhead	4800
	Variable selling expense	43740	341355
	Contribution margin		533445
	Less:
	Fixed factory overhead	$	64400
	Selling and administrative expenses		215500
	Operating income		253545
4	Reconcilliation
	Operating Income as per absorpion costing	261105
	Less: Deferred in ending Inventory	7560
	Operating Income as per Variable costing	253545
	The absorption costing generates an income $more than variable costing
	by $7,560.