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	$	27
Direct labor	$	13
Variable manufacturing overhead	$	5
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	320,000
Fixed selling and administrative expenses	$	100,000

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 $57 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.

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

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

Answer 1

Answer 1-a.

Year 1:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $27 + $13 + $5
Unit Product Cost = $45

Year 2:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead
Unit Product Cost = $27 + $13 + $5
Unit Product Cost = $45

Answer 1-b.

Year 2 2,850,000 Walsh Company Variable Costing Income Statement Year 1 Sales $ 2,280,000 $ Variable Expenses Variable Cost of Goods Sold $ 1,800,000 $ Variable Selling and Administrative Expenses $ 160,000 $ Total Variable Expenses $ 1,960,000 $ Contribution Margin $ 320,000 $ Fixed Expenses: Fixed Manufacturing Overhead $ 320,000 $ Fixed Selling and Administrative Expenses $ 100,000 $ Total Fixed Expenses 420,000 $ Net Operating Income -100,000 $ 2,250,000 200,000 2,450,000 400,000 320,000 100,000 420,000 -20,000

Year 1:

Sales = 40,000 * $57
Sales = $2,280,000

Variable cost of goods sold = 40,000 * $45
Variable cost of goods sold = $1,800,000

Variable selling and administrative expenses = 40,000 * $4.00
Variable selling and administrative expenses = $160,000

Year 2:

Sales = 50,000 * $57
Sales = $2,850,000

Variable cost of goods sold = 50,000 * $45
Variable cost of goods sold = $2,250,000

Variable selling and administrative expenses = 50,000 * $4.00
Variable selling and administrative expenses = $200,000

Answer 2-a.

Year 1:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead + Fixed Manufacturing Overhead
Unit Product Cost = $27 + $13 + $5 + $320,000/50,000
Unit Product Cost = $51.40

Year 2:

Unit Product Cost = Direct Materials + Direct Labor + Variable Manufacturing Overhead + Fixed Manufacturing Overhead
Unit Product Cost = $27 + $13 + $5 + $320,000/40,000
Unit Product Cost = $53.00

Answer 2-b.

Walsh Company Absorption Costing Income Statement Year 1 Sales $ 2,280,000 $ Cost of Goods Sold $ 2,056,000 $ Gross Profit 224,000 $ Selling and Administrative Expenses 260,000 $ Net Operating Income -36,000 $ Year 2 2,850,000 2,634,000 216,000 300,000 -84,000

Year 1:

Sales = 40,000 * $57
Sales = $2,280,000

Cost of goods sold = 40,000 * $51.40
Cost of goods sold = $2,056,000

Selling and administrative expenses = 40,000 * $4.00 + $100,000
Selling and administrative expenses = $260,000

Year 2:

Sales = 50,000 * $57.00
Sales = $2,850,000

Cost of goods sold = 10,000 * $51.40 + 40,000 * $53.00
Cost of goods sold = $2,634,000

Selling and administrative expenses = 50,000 * $4.00 + $100,000
Selling and administrative expenses = $300,000

Answer 3.

Reconciliation of Variable Costing and Absorption Costing Net Operating Income Year 1 Year 2 Variable Costing Net Operating Income $ -100,000 $ -20,000 Add: Fixed Manufacturing overhead deferred $ 64,000 Deduct: Fixed Manufacturing overhead released $ 64,000 Absorption Costing Net Operating Income -36,000 $ -84,000