Question

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

	Year 1			Year 2
Sales (@ $64 per unit)	$	1,088,000		$	1,728,000
Cost of goods sold (@ $38 per unit)		646,000			1,026,000
Gross margin		442,000			702,000
Selling and administrative expenses*		303,000			333,000
Net operating income	$	139,000		$	369,000

* $3 per unit variable; $252,000 fixed each year.

The company’s $38 unit product cost is computed as follows:

Direct materials	$	8
Direct labor		12
Variable manufacturing overhead		3
Fixed manufacturing overhead ($330,000 ÷ 22,000 units)		15
Absorption costing unit product cost	$	38

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.

	Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes Year 1 Year 2 Variable costing net operating income (loss) Absorption costing net operating income

Answer 1

Answer to Requirement 1:

Year 1:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $8 + $12 + $3
Unit Product Cost = $23

Year 2:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $8 + $12 + $3
Unit Product Cost = $23

Answer to Requirement 2:

Heaton Company Variable Costing Income Statement Year 1 1,088,000 Year 2 1,728,000 $ $ 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 $ $ $ $ 391,000 $ 51,000 $ 442,000 $ 646,000 $ 621,000 81,000 702,000 1,026,000 $ $ $ $ 330,000 $ 252,000 $ 582,000 $ 64,000 $ 330,000 252,000 582,000 444,000

Year 1:

Variable Cost of Goods Sold = Unit Product Cost * Units Sold
Variable Cost of Goods Sold = $23 * 17,000
Variable Cost of Goods Sold = $391,000

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 = $23 * 27,000
Variable Cost of Goods Sold = $621,000

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) $ 64,000 $ 444,000 Add: Fixed Manufacturing overhead deferred in inventory $ 75,000 Deduct: Fixed Manufacturing overhead released form inventory $ 75,000 Absorption Costing Net Operating Income $ 139,000$ 369,000