Question

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

	Year 1			Year 2
Sales (@ $61 per unit)	$	1,037,000		$	1,647,000
Cost of goods sold (@ $35 per unit)		595,000			945,000
Gross margin		442,000			702,000
Selling and administrative expenses*		305,000			335,000
Net operating income	$	137,000		$	367,000

* $3 per unit variable; $254,000 fixed each year.

The company’s $35 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		11
Variable manufacturing overhead		4
Fixed manufacturing overhead ($308,000 ÷ 22,000 units)		14
Absorption costing unit product cost	$	35

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	22,000	22,000
Units sold	17,000	27,000

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 = $6 + $11 + $4
Unit Product Cost = $21

Year 2:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $6 + $11 + $4
Unit Product Cost = $21

Answer to Requirement 2:

Heaton Company Variable Costing Income Statement Year 1 Year 2 $ 1,037,000 $ 1,647,000 Sales Variable Expenses: Variable Cost of Goods Sold Variable Selling and Administrative Expenses Total Variable Expenses Contribution Margin Fixed Expenses: Fixed Manufacturing Overhead Fixed Selling and Administrative Expenses Total Fixed Expenses Net Operating Income $ $ $ $ 357,000 $ 51,000$ 408,000 $ 629,000 $ 567,000 81,000 648,000 999,000 $ $ $ $ 308,000 $ 254,000 $ 562,000 $ 67,000 $ 308,000 254,000 562,000 437,000

Year 1:

Variable Cost of Goods Sold = Unit Product Cost * Units Sold
Variable Cost of Goods Sold = $21 * 17,000
Variable Cost of Goods Sold = $357,000

Variable Selling and Administrative Expense = Variable Selling and Administrative Expense per unit * Units Sold
Variable Selling and Administrative Expense = $3 * 17,000
Variable Selling and Administrative Expense = $51,000

Year 2:

Variable Cost of Goods Sold = Unit Product Cost * Units Sold
Variable Cost of Goods Sold = $21 * 27,000
Variable Cost of Goods Sold = $567,000

Variable Selling and Administrative Expense = Variable Selling and Administrative Expense per unit * Units Sold
Variable Selling and Administrative Expense = $3 * 27,000
Variable Selling and Administrative Expense = $81,000

Answer to Requirement 3:

Reconciliation of Variable Costing and Absorption Costing Net Operating Income Year 1 Year 2 Variable Costing Net Operating Income (Loss) $ 67,000 $ 437,000 Add: Fixed Manufacturing overhead deferred in inventory $ 70,000 Deduct: Fixed Manufacturing overhead released form inventory $ 70,000 Absorption Costing Net Operating Income $ 137,000 $ 367,000