Question

2. Sleepwalking Inc., manufactures and sells bunny slippers. The fabric cost per pair is $ 11.5, and each pair requires 12 minutes of direct labor to produce with the hourly direct labor cost being $ 12. The variable manufacturing overhead cost to produce each pair is $ 0.50. The total fixed manufacturing overhead cost is made up of factory rent $ 240,000. each year and equipment depreciation of $ 60,000. The budgeted production is 10,000 pairs a year. Sleepwalking sells the slippers at $ 72.00 a pair, and pays a commission to its sales staff of $ 3.60 a pair on sales. The administration salaries are $12,000 a month and office rent is $5,000 a month. This year's sales in pairs were 9,000 and production was 10,500 pairs, with no beginning inventory this year. What is the variable manufacturing cost per pair, the total variable cost per pair, the total absorption manufacturing cost per pair, and the contribution margin per pair? Prepare both a traditional (absorption costing) and a contribution margin income statement for the year, and reconcile the operating income for the two methods.

Answer 1

Calculation of variable cost per pair (Amounts in $)

Fabric cost per pair	11.50
Direct labor cost per pair ($12*12 min/60 min)	2.40
Variable manufacturing overhead cost per pair	0.50
Total variable manufacturing cost per pair (a)	14.40
Variable commission on sales (b)	3.60
Total variable cost per pair (c = a+b)	18.00

Under absorption costing, fixed manufacturing overhead is considered as product cost and included in unit product cost whereas under variable costing, fixed manufacturing overhead is considered as period cost and not included in unit product cost.

Fixed manufacturing Overhead per pair = Total Fixed Manufacturing Overheads/Units produced

= ($240,000+$60,000)/10,500 pairs = $28.57143 per pair

Calculation of Absorption manufacturing cost per pair (Amounts in $)

Fabric cost per pair	11.50
Direct labor cost per pair ($12*12 min/60 min)	2.40
Variable manufacturing overhead cost per pair	0.50
Fixed manufacturing overhead cost per pair	28.57143
Total absorption manufacturing cost per pair	42.97143

Contribution Margin per pair = Selling price per pair - Total Variable cost per pair

= $72.00 - $18.00 = $54.00 per pair

Absorption (or Traditional) Costing Income Statement is shown as follows:- (Amounts in $)

Sales Revenue (9,000 pairs*$72)	648,000
Cost of Goods Sold (9,000 pairs*$42.97143)	(386,743)
Gross Profit	261,257
Selling and Administrative Expenses:
Variable selling and administrative expenses (9,000 pairs*$3.60)	(32,400)
Fixed selling and administrative expenses [(12,000+5,000)*12 months]	(204,000)
Net Income	24,857

Variable Costing Income Statement is shown as follows:- (Amounts in $)

Sales Revenue (9,000 pairs*$72)	648,000
Variable Cost (9,000 pairs*$18)	(162,000)
Contribution Margin	486,000
Fixed Expenses:
Fixed manufacturing overhead	(300,000)
Fixed selling and administrative expenses [(12,000+5,000)*12 months]	(204,000)
Net Income/Loss	(18,000)

Reconciliation of income under absorption costing and variable costing (Amounts in $)

Absorption costing net income	24,857
Less: Fixed manufacturing overhead deferred in ending inventory [(10,500-9,000) pairs*$28.57143]	42,857
Add: Fixed manufacturing overhead released from beginning inventory
Variable costing net income	(18,000)