Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows:

	Year 1			Year 2
Sales (@ $61 per unit)	$	915,000		$	1,525,000
Cost of goods sold (@ $31 per unit)		465,000			775,000
Gross margin		450,000			750,000
Selling and administrative expenses*		294,000			324,000
Net operating income	$	156,000		$	426,000

* $3 per unit variable; $249,000 fixed each year.

The company’s $31 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		8
Variable manufacturing overhead		3
Fixed manufacturing overhead ($280,000 ÷ 20,000 units)		14
Absorption costing unit product cost	$	31

Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consists of depreciation charges on production equipment and buildings.

Production and cost data for the first two years of operations are:

	Year 1	Year 2
Units produced	20,000	20,000
Units sold	15,000	25,000

Required:

1. Using variable costing, what is the unit product cost for both years?

2. What is the variable costing net operating income in Year 1 and in Year 2?

3. Reconcile the absorption costing and the variable costing net operating income figures for each year.

Answer 1

Ans. 1	In variable costing method, the unit product cost is the sum of only variable
	manufacturing costs per unit
	Unit product cost under Variable Costing:
	Direct materials	$6.00
	Direct labor	$8.00
	Variable manufacturing overhead	$3.00
	Total unit product cost	$17.00
Ans. 2	HEATON COMPANY
	Variable Costing
	Income Statement
	PARTICULARS	Year 1		Year 2
	Sales		$915,000		$1,525,000
	Less: Variable cost of goods sold:
	Opening inventory	$0		$85,000
	Add: Cost of goods produced	$340,000		$340,000
	Variable cost of goods available for sale	$340,000		$425,000
	Less: Ending inventory	-$85,000		$0
	Variable cost of goods sold		$255,000		$425,000
	Gross Contribution Margin		$660,000		$1,100,000
	Less: Variable Selling and Administrative expenses		$45,000		$75,000
	Contribution Margin		$615,000		$1,025,000
	Less: Fixed expenses:
	Fixed manufacturing overhead	$280,000		$280,000
	Fixed selling and adm. expenses	$249,000	$529,000	$249,000	$529,000
	Net operating income		$86,000		$496,000
	*Sales   =   Units sold * Selling price
	Year 1 (15,000 * $61)	$915,000
	Year 2 (25,000 * $61)	$1,525,000
	*Cost of goods produced = Units produced * Unit product cost
	Year 1 (20,000 * $17)	$340,000
	Year 2 (20,000 * $17)	$340,000
	Ending inventory units = Beginning inventory + Units produced - Units sold
	Year 1 =   0 + 20,000 - 15,000   =   5,000 units
	Year 2 = 5,000 + 20,000 - 25,000   =   0 units
	(Ending inventory of Year 1 = Beginning inventory for Year 2)
	Cost of ending inventory = Ending inventory units * Unit product cost
	Year 1 (5,000 * $17)	$85,000
	Year 2 (0 * $17)	$0
	*Variable selling and administrative cost = Variable marketing cost per unit * Units sold
	Year 1 (15,000 * $3)	$45,000
	Year 2 (25,000 * $3)	$75,000
Ans. 3	HEATON COMPANY
	Reconciling Difference in Operating Income
	Between Absorption and Variable Costing
		Year 1	Year 2
	Change in inventory in units	5000	-5000
	(*) Fixed overhead rate	$14.00	$14.00
	Difference in operating income	$70,000.00	($70,000.00)
	Change in inventory in units   =   Units produced - Units sold
	Year 1 (20,000 - 15,000)	5000
	Year 2 (20,000 - 25,000)	-5000