Question

Lehighton Chalk Company manufactures sidewalk chalk, which it sells online by the box at $22 per unit. Lehighton uses an actual costing system, which means that the actual costs of direct material, direct labor, and manufacturing overhead are entered into work-in-process inventory. The actual application rate for manufacturing overhead is computed each year; actual manufacturing overhead is divided by actual production (in units) to compute the application rate. Information for Lehighton’s first two years of operation is as follows:

	Year 1			Year 2
Sales (in units)		3,100			3,100
Production (in units)		3,600			2,600
Production costs:
Variable manufacturing costs	$	15,840		$	11,440
Fixed manufacturing overhead		19,440			19,440
Selling and administrative costs:
Variable		12,400			12,400
Fixed		11,400			11,400

Selected information from Lehighton’s year-end balance sheets for its first two years of operation is as follows:

LEHIGHTON CHALK COMPANY
Selected Balance Sheet Information
Based on absorption costing	End of Year 1			End of Year 2
Finished-goods inventory	$	4,900		$	0
Retained earnings		8,520			14,440
Based on variable costing	End of Year 1			End of Year 2
Finished-goods inventory	$	2,200		$	0
Retained earnings		5,820			14,440

1. Prepare operating income statements for both years based on absorption costing.

2. Prepare operating income statements for both years based on variable costing.

3. Prepare a numerical reconciliation of the difference in income reported under the two costing methods used in requirements (1) and (2).

Answer 1

ncome Statement - Absorption Cosing
Particulars	Year 1		Year 2
	Details	Amount	Details	Amount
Unit	3100		3100
Sales		$68,200.00		$68,200.00
Cost of Goods Sold:
Cost of goods produced	$35,280.00		$30,880.00
Add: Opening Inventory	$0.00		$4,900.00
Less: Ending Inventory	$4,900.00	$30,380.00	$0.00	$35,780.00
Gross Profit		$37,820.00		$32,420.00
Variable Selling & Administrative Expenses		$12,400.00		$12,400.00
Fixed Selling & Administrative Expenses		$11,400.00		$11,400.00
Net Operating Income		$14,020.00		$8,620.00

Variable costing contribution format income statement
Particulars	Year 1		Year 2
	Details	Amount	Details	Amount
Sales	3100*$22	$68,200.00	3100*$22	$68,200.00
Variable Cost:
Variable manufacturing cost	(15840/3600*3100)	$13,640.00	(11440/2600*3100)	$13,640.00
Variable Selling and Administrative Expenses		$12,400.00		$12,400.00
Contribution		$42,160.00		$42,160.00
Fixed Manufacturing Overhead		$19,440.00		$19,440.00
Fixed Selling & Administrative Expenses		$11,400.00		$11,400.00
Net Income		$11,320.00		$11,320.00

Reconciliation of operating income under variable costing and absorption costing
Particulars	Year 1	Year 2
Cost of goods sold under absorption costing	$30,380.00	$35,780.00
Less: Variable manufacturing cost under variable costing	$13,640.00	$13,640.00
	$16,740.00	$22,140.00
Fixed manufacturing overhead as period expense under variable costing	$19,440.00	$19,440.00
Difference in income under variable costing and absorption costing (a)	-$2,700.00	$2,700.00
Add: Operating income under absorption costing (b)	$14,020.00	$8,620.00
Operating income under variable costing (a+b)	$11,320.00	$11,320.00