Question

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

  

Variable costs per unit:
Manufacturing:
Direct materials		$ 25
Direct labor		$ 15
Variable manufacturing overhead		$ 5
Variable selling and administrative		$ 2
Fixed costs per year:
Fixed manufacturing overhead	$	250,000
Fixed selling and administrative expenses	$	80,000

During its first year of operations, Walsh produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $60 per unit.

Required:
1.	Assume the company uses variable costing:

a.	Compute the unit product cost for year 1 and year 2.

           

b.	Prepare an income statement for year 1 and year 2.

        

2.	Assume the company uses absorption costing:

a.	Compute the unit product cost for year 1 and year 2. (Round your answer to 2 decimal places.)

         

b.	Prepare an income statement for year 1 and year 2. (Round your intermediate calculations to 2 decimal places.)

   

3.	Reconcile the difference between variable costing and absorption costing net operating income in year 1 and year 2.

Answer 1

Concepts and reason

Costing: It is referred to an estimation of cost of a product or service. It is a comprehensive term which includes controlling of costs other than only calculating the costs.

Costing Methods: Costing is done using one of the two methods viz. variable and absorption costing.

Variable Costs: Variable costs are the total costs that changes with the change in level of activity. Variable costs are directly proportional to the level of activity. It means that the variable cost per unit does not change but the total variable costs changes with the level of activity. These are deducted from the sales to calculate the contribution margin.

Fixed Costs: Fixed costs remain constant in total amount over a specific range of activity, these do not increase or decrease when the volume of manufacture changes. Fixed cost per unit is inversely proportional to the level of activity. These fixed costs are deducted from the contribution margin to calculate the net operating income.

Fundamentals

Income Statement: An income statement is one of the financial statements prepared at the end of a particular period. It is a summary of income and expenses. It shows net income or loss for a particular period.

Absorption Costing: It is a system of accounting that accounts for all expenses relating to manufacturing of a product whether fixed or variable. Thus, whether a cost is variable or fixed, it will be assigned to the total cost of production. It is also known by the name of full costing.

Variable Costing: It is a system of accounting which assigns only variable costs to inventory and the cost of production. Costs may be fixed or variable depending upon their nature of change due to change in production level. The costs that change with the level of production or activity are variable costs and are thus assigned to cost of production under variable costing method.

Under variable costing method, only the cost that changes with the level of production is assigned to inventory and thus is used in calculating unit cost of product. In simple words, variable costs are added to obtain the total cost of production. The value of inventory under variable costing is generally less than that in the absorption costing since fixed costs do not form part of the cost of production here.

While preparing statement of cost under variable costing method, the variable costs are clubbed to obtain the unit cost of production and a separate section of fixed costs is prepared to obtain the correct income.

1.

a.

Prepare the statement as shown below to calculate the year wise unit cost of a product:

Thus, the unit product cost under variable costing for year 1 and year 2 is $45.

b.

Under variable costing technique, the section for fixed and variable cost is separate. Thus, fixed expenses incurred are shown separately without assigning them to cost of production. Prepare the Income Statement under variable costing as shown below:

Thus, Net Operating Income earned for year 1 and year 2 is $190,000 and $320,000 respectively.

2.

a.

Prepare the statement as shown below to calculate the year wise unit cost of a product:

Thus, the unit product cost under absorption costing is $50.00 for year 1 and $51.25 for year 2.

b.

Under absorption costing technique, no separate section for fixed and variable cost is made. Prepare the Income Statement under variable costing as shown below:

Thus, net operating income for year 1 and 2 is $240,000 and $270,000 respectively.

3.

Prepare the following statement to reconcile the differences between the two costing approaches:

Ans: Part 1.a

The unit product cost under variable costing for year 1 and year 2 is $45.

Part 1.b

The Net Operating Income earned for year 1 and year 2 is $190,000 and $320,000 respectively.

Part 2.a

Thus, the unit product cost under absorption costing is $50.00 for year 1 and $51.25 for year 2.

Part 2.b

The Net Operating Income earned for year 1 and year 2 is $240,000 and $270,000 respectively.

Part 3