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. @ 1.30)	$3.90
Direct labor (0.4 hr. @ 15.50)	6.20
Variable overhead (0.4 hr. @ 4.00)	1.60
Fixed overhead (0.4 hr. @ 7.00)	2.80
Total	$14.50
Selling and administrative costs:
Variable	$1.60	per unit
Fixed	$220,500

During the year, the company had the following activity:

Units produced	27,500
Units sold	24,750
Unit selling price	$36
Direct labor hours worked	11,000

Actual fixed overhead was $12,200 less than budgeted fixed overhead. Budgeted variable overhead was $5,000 less than the actual variable overhead. The company used an expected actual activity level of 11,000 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	$

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		$

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		$

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

Answer 1

Answer
1	Unit Cost
	Absorption costing (3.9+6.2+1.6+2.8)	14.5
	Variable costing (3.9+6.2+1.6)	11.7

2	Flaherty, Inc.
	Absorption-Costing Income Statement
	For the First Year of Operations
	Sales (24750*36)		$      8,91,000
	Cost of goods sold (24750*14.5)	$      3,58,875
	Less:
	Over applied overhead (12200-5000)	$          -7,200	$      3,51,675
	Gross profit		$      5,39,325
	Less: Selling and administrative expenses (1.6*24750)+220500		$      2,60,100
	Operating income		$      2,79,225

3	Flaherty, Inc.
	Variable-Costing Income Statement
	For the First Year of Operations
	Sales		$      8,91,000
	Variable cost of goods sold (11.7*24750)	$      2,89,575
	Add:
	Under applied variable overhead	$           5,000
	Variable selling expense (1.6*24750)	$         39,600	$      3,34,175
	Contribution margin		$      5,56,825
	Less:
	Fixed factory overhead (27500*2.8)-11000	$	$         66,000
	Selling and administrative expenses		$      2,20,500
	Operating income		$      2,70,325

4	Reconciliation
	Operating Income as per absorption costing	$      2,79,225
	Less: Deferred in ending Inventory	$           8,900
	Operating Income as per Variable costing	$      2,70,325
	The absorption costing generates an income $more than variable costing by $ 8,900