Question

High Country, Inc., produces and sells many recreational products. The company has just opened a new plant to produce a folding camp cot that will be marketed throughout the United States. The following cost and revenue data relate to May, the first month of the plant’s operation:

Beginning inventory 0

Units produced 10,000

Units sold 8,000

Selling price per unit $75

Selling and administrative expenses:

Variable per unit $6

Fixed (per month) $200,000

Manufacturing costs:

Direct materials cost per unit $20

Direct labor cost per unit $8

Variable manufacturing overhead cost per unit $2

Fixed manufacturing overhead cost (per month) $100,000

Management is anxious to assess the profitability of the new camp cot during the month of May.

Required: 1. Assume that the company uses absorption costing. a. Determine the unit product cost. b. Prepare an income statement for May. 2. Assume that the company uses variable costing. Page 211 a. Determine the unit product cost. b. Prepare a contribution format income statement for May. 3. Explain the reason for any difference in the ending inventory balances under the two costing methods and the impact of this difference on reported net operating income.

Answer 1

1	ABSORBTION COSTING
a	Production Cost	Per unit Cost
	Direct material cost	$20
	Direct labor cost	$8
	Variable manufacturing cost	$2
	Fixed manufactacturing cost(100,000/10000)	$10
		$40
	ABSORBTION COSTING INCOME Statement
b	Sales revenue		$600,000
	Cost of sales		$320,000
	Opening inventory	$0
	Add: Production cost (10,000 @ 40)	$400,000
	Less: Closing inventory ( 2,000 @40)	$80,000
	Gross profit		$280,000
	Less: Distribution and admin costs(fixed+variable)		$248,000
	Net Profit		$32,000
2	VARIABLE COSTING
a	Unit product cost	Per unit
	Direct Material	$20
	Direct labor	$8
	Variable manufacturing cost	$2
		$30
	VARIABLE COSTING INCOME Statement
	Sales revenue		$600,000
	Marginal Costs of Sales		$240,000
	Opening inventory	$0
	Add: cost of production (10,000@30)	$300,000
	Less: Closing inventory (2,000 @30)	$60,000
	Less: Variable distribution and admin costs		$48,000
	Contribution		$312,000
	less: fixed costs(Production, distribution, admin)		$300,000
	Profit for the year		$12,000
3	Reconciliation of profits
	Variable Costing Profit		$12,000
	Add: Fixed cost element in closing inventory		$20,000
	Absorption costing profit		$32,000
	Ending inventory balance under absorption costing is more of $20,000 because of fixed cost component in the closing inventory.
	Hence, Net operating income under absorption costing will be more by 20,000 because of such difference.

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