Question

Required information [The following information applies to the questions displayed below.] Dowell Company produces a single product. Its Income statements under absorption costing for its first two years of operation follow Sales ($46 per unit) Cost of goods sold ($31 per unit) Gross margin Selling and administrative expenses Net income 2016 2017 $966,000 $1,886,000 651,000 1,271,000 315,000 615,000 292,250 337,250 $ 22,759 $ 277,750 Additional Information a. Sales and production data for these first two years follow. Units produced Units sold 2016 31,000 21,000 2017 31,000 41,000 b. Variable cost per unit and total fixed costs are unchanged during 2016 and 2017. The company's $31 per unit product cost consists of the following Direct materials Direct labor Variable overhead Fixed overhead (6310,000/31,000 units) Total product cont per unit

Answer 1

Difference between variable costing and absorption costing income statements: The only reason for the difference in net operating income (loss) between absorption costing and variable costing is the deferred fixed manufacturing overhead cost to next period through ending inventory under absorption costing. That is, under variable costing, entire fixed manufacturing overhead cost is considered as period cost and so charged to income statement. However, under the absorption costing, fixed mfg. overhead cost is considered as product cost and so a portion of it will be deferred to next reporting period through ending inventory. If number of units produced and sold are same, net operating income reported under both methods will be same. Under variable costing, unit product cost shall consider only variable mfg. costs incurred to produce the number goods. Therefore, Year-1 Year-2 Direct material cost per unit $4 Direct labor cost per unit $9 $9 Variable mfg. overhead per unit $8 Unit product cost $21 $4 $21

Variable Costing Income Statement Year-1 Year-2 Sales Revenue $966,000 $1,886,000 [21000 units x $46; 41000 units x $46] Variable Expenses: Variable Manufacturing costs $441,000 $861,000 [21000 units x $21; 41000 units x $21] Variable Selling and Admin. Expenses $47,250 $92,250 [21000 units x $2.25; 41000 units x $2.25] Total Variable Expenses $488,250 $953,250 Contribution Margin $477,750 $932,750 (Sales Revenue - Total Variable Expenses] Fixed Expenses: Fixed Manufacturing costs $310,000 $310,000 (Fully charged as expense] Fixed Selling and Admin. Expenses $245,000 $245,000 (Fully charged as expense] Total Fixed Expenses $555,000 $555,000 Net Operating Income $77,250 $377,750 [Contribution margin - Total Fixed Expenses] Under absorption costing, unit cost of goods manufactured shall consider both variable and fixed manufacturing costs incurred to produce the number goods. Therefore, Direct material cost per unit Direct labor cost per unit Variable mfg. overhead per unit Fixed mfg. overhead per unit Product cost per unit Year-1 $4.00 $9.00 $8.00 $10.00 $31.00 Year-2 $4.00 $9.00 $8.00 $10.00 $31.00 [Ref: NOTE]

NOTE: For Year-1, $310000 / 31000 units produced = $10; For Year-2, $310000 / 31000 units produced = $10. Absorption Costing Income Statement Year-1 Year-2 Sales Revenue $966,000 $1,886,000 (21000 units x $46; 41000 units x $46] Cost of Goods Sold $651,000 $1,271,000 [21000 units x $31; (10000 units x $31) + (31000 units x $31)] Gross Profit $315,000 $615,000 (Sales Revenue - Cost of Goods Sold] Marketing & Admin. Expenses $292,250 $337,250 [(21000 x $2.25) + $245000; (41000 x $2.25) + $245000] Net Operating Income $22,750 $277,750 Reconciliation between net incomes reported under absorption versus variable costing: Variable costing income (loss) Add: Fixed mfg. costs in ending inventory Less: Fixed mfg. costs in beginning inventory Absorption costing income (loss) Year-1 $77,250 $100,000 $0 $22,750 Year-2 $377,750 [As calculated above] $0 (10000 units x $10; 0 units x $10] $100,000 [Year-1's fixed mfg. costs in end. Inventory] $277,750