Question

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

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,116,000		$	1,736,000
Cost of goods sold (@ $36 per unit)		648,000			1,008,000
Gross margin		468,000			728,000
Selling and administrative expenses*		303,000			333,000
Net operating income	$	165,000		$	395,000

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

The company’s $36 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		13
Variable manufacturing overhead		2
Fixed manufacturing overhead ($322,000 ÷ 23,000 units)		14
Absorption costing unit product cost	$	36

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	23,000	23,000
Units sold	18,000	28,000

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

Answer to Requirement 1:

Year 1:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $7 + $13 + $2
Unit Product Cost = $22

Year 2:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $7 + $13 + $2
Unit Product Cost = $22

Answer to Requirement 2:

Year 1:

Variable Cost of Goods Sold = Unit Product Cost * Units Sold
Variable Cost of Goods Sold = $22 * 18,000
Variable Cost of Goods Sold = $396,000

Variable Selling and Administrative Expense = Variable Selling and Administrative Expense per unit * Units Sold
Variable Selling and Administrative Expense = $3 * 18,000
Variable Selling and Administrative Expense = $54,000

Year 2:

Variable Cost of Goods Sold = Unit Product Cost * Units Sold
Variable Cost of Goods Sold = $22 * 28,000
Variable Cost of Goods Sold = $616,000

Variable Selling and Administrative Expense = Variable Selling and Administrative Expense per unit * Units Sold
Variable Selling and Administrative Expense = $3 * 28,000
Variable Selling and Administrative Expense = $84,000

Answer to Requirement 3: