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 (2 lbs. @ 1.45)	$2.90
Direct labor (0.4 hr. @ 16.50)	6.60
Variable overhead (0.4 hr. @ 5.00)	2.00
Fixed overhead (0.4 hr. @ 7.00)	2.80
Total	$14.30
Selling and administrative costs:
Variable	$1.60	per unit
Fixed	$221,000

During the year, the company had the following activity:

Units produced	26,000
Units sold	23,400
Unit selling price	$37
Direct labor hours worked	10,400

Actual fixed overhead was $11,000 less than budgeted fixed overhead. Budgeted variable overhead was $5,200 less than the actual variable overhead. The company used an expected actual activity level of 10,400 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
		$
	$
Less:
Gross profit		$
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
		$
	$
Add:
Contribution margin		$
Less:
	$
		$
Operating income		$

Answer 1

Answer 1:

	Absorption	Variable
Direct Material	$        2.90	$   2.90
Direct Labor	$        6.60	$   6.60
Variable manufacturing overhead	$        2.00	$   2.00
Fixed manufacturing overhead	$        2.80	$       -
Total	$      14.30	$ 11.50

Answer 2:

Sales		$ 865,800
Less:
Cost of Goods sold	$ 334,620
Less: Over-applied overheads (Note 1)	$   (5,800)	$ 328,820
Gross profit		$ 536,980
Less: Selling and administration expenses		$ 258,440
Operating Income		$ 278,540

Note 1:

Budgeted fixed overheads = 7 * 10,400 = $ 72,800

Actual fixed overheads = 72,800 (-) 11,000 = $ 61,800

Budgeted Variable overheads = 5 * 10,400 = $52,000

Actual variable overheads = 52,000 + 5,200 = $ 57,200

Total budgeted overheads = 72,800 + 52000 = $ 124,800

Total actual overheads = 61,800 + 57,200 = $ 119,000

Over-absorbed overheads = $ 5,800

Answer 3:

Sales		$ 865,800
Less:
Cost of Goods sold	$ 269,100
Add: Under-applied overheads	$     5,200	$ 274,300
Variable selling expenses		$   37,440
Contribution		$ 554,060
Less: Fixed overheads		$   61,800
Less: Fixed selling expenses		$ 221,000
Net Income		$ 271,260

In case of any doubt or clarification, feel free to come back via comments.