Question

Herro Corporation began operations in July and manufactured 40,000 units during the month with the following unit costs:

Direct materials                       $7.00

Direct labor                             4.00

Variable overhead                   3.00

Variable marketing cost           3.00

Total fixed factory overhead is $400,000 per month. During July, 35,000 units were sold at a price of $40, and fixed marketing and administrative expenses were $150,000.

Required:

1. Calculate the unit product cost of each unit using absorption costing and variable costing.
2. Prepare a variable costing income statement for Herro Corporation for the month of July.
3. Explain how variable costing differs from absorption costing.

Answer 1

Answer-a)- Unit product cost under Absorption costing= $24 per unit.

Explanation- Unit product cost under Absorption costing:-Direct materials + Direct Labor+ Variable manufacturing overhead + fixed manufacturing overhead

=$7+$4+$3+$10

= $24 per unit

Unit fixed manufacturing overhead= fixed manufacturing overhead/No. of units produced

=$400000/40000 units

=$10 per unit

Unit product cost under Variable costing= $14 per unit.

Explanation-Unit product cost under Variable costing:-Direct materials + Direct Labor+ Variable manufacturing overhead

=$7+$4+$3

= $14 per unit

b)-

HERRO Corporation
Income statement (Using variable costing approach)
Particulars			Amount
			$
Sales (a)	35000 units*$40 per unit		1400000
Less:- Variable cost of goods sold (b)
Opening inventory		NIL
Add:- Variable cost of goods manufactured		560000
Direct materials	40000 units*$7 per unit	280000
Direct labor	40000 units*$4 per unit	160000
Variable overhead	40000 units*$3 per unit	120000
Variable cost of goods available for sale		560000
Less:- Closing inventory	5000 units*$14 per unit	70000	490000
Gross contribution margin C= a-b			910000
Less:-Variable marketing cost	35000 units*$3 per unit		105000
Contribution margin			805000
Less:- Fixed costs
Factory overhead			400000
Marketing & administrative exp.			150000
Net Income			255000

c)- Variable costing income based on contribution margin and valuation of ending inventory does not include fixed manufacturing cost but in absorption costing its vice versa hence income in absorption costing always higher compare to the Variable costing.