Question

O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$	25
Direct labor	$	17
Variable manufacturing overhead	$	4
Variable selling and administrative	$	2
Fixed costs per year:
Fixed manufacturing overhead	$	500,000
Fixed selling and administrative expenses	$	130,000

During its first year of operations, O’Brien produced 100,000 units and sold 77,000 units. During its second year of operations, it produced 83,000 units and sold 101,000 units. In its third year, O’Brien produced 82,000 units and sold 77,000 units. The selling price of the company’s product is $75 per unit.

3. Assume the company uses absorption costing and a FIFO inventory flow assumption (FIFO means first-in first-out. In other words, it assumes that the oldest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

4. Assume the company uses absorption costing and a LIFO inventory flow assumption (LIFO means last-in first-out. In other words, it assumes that the newest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

Answer 1

Solution 3:

Computation of Unit Product Cost - Absorption Costing
Particulars	Year 1	Year 2	Year 3
Unit Product Cost:
Direct material	$25.00	$25.00	$25.00
Direct Labor	$17.00	$17.00	$17.00
Variable manufacturing overhead	$4.00	$4.00	$4.00
Fixed manufacturing overhead ($500,000 / Nos of unit produced)	$5.00	$6.02	$6.10
Unit Product Cost	$51.00	$52.02	$52.10

Income Statement - Absorption Costing - O'Brien Company
	Year 1	Year 2	Year 3
Sales	$57,75,000	$75,75,000	$57,75,000
Cost of goods sold	$39,27,000	$52,30,560	$40,11,300
Gross Profit	$18,48,000	$23,44,440	$17,63,700
Variable Selling & Administrative Expenses	$1,54,000	$2,02,000	$1,54,000
Fixed Selling & Administrative Expenses	$1,30,000	$1,30,000	$1,30,000
Net Operating Income	$15,64,000	$20,12,440	$14,79,700

Solution 4:

Computation of Unit Product Cost - Absorption Costing
Particulars	Year 1	Year 2	Year 3
Unit Product Cost:
Direct material	$25.00	$25.00	$25.00
Direct Labor	$17.00	$17.00	$17.00
Variable manufacturing overhead	$4.00	$4.00	$4.00
Fixed manufacturing overhead ($500,000 / Nos of unit produced)	$5.00	$6.02	$6.10
Unit Product Cost	$51.00	$52.02	$52.10

Income Statement - Absorption Costing - O'Brien Company
	Year 1	Year 2	Year 3
Sales	$57,75,000	$75,75,000	$57,75,000
Cost of goods sold	$39,27,000	$52,35,660	$40,11,700
Gross Profit	$18,48,000	$23,39,340	$17,63,300
Variable Selling & Administrative Expenses	$1,54,000	$2,02,000	$1,54,000
Fixed Selling & Administrative Expenses	$1,30,000	$1,30,000	$1,30,000
Net Operating Income	$15,64,000	$20,07,340	$14,79,300