Question

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

Sales (@ $63 per unit) Cost of goods sold (@ $43 per unit) Gross margin Selling and administrative expenses* Net operating income Year 1 $ 1,071,000 731,000 340,000 301,000 $ 139,000 Year 2 $ 1,701,000 1,161,000 540,000 331,000 $ 209,000

* $3 per unit variable; $250,000 fixed each year.

The company’s $43 unit product cost is computed as follows:

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 operatons are:

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

1. Computation of unit product cost for both years.as per variable cost :

particulars	Year 1	Year 2
Direct material	7	7
Direct labor	13	13
Variable overhead	4	4
Total product cost as per variable costing	$24	$24

2. Calculation of Net operating income as per variable costing method :

Heaton Company

Income Statement (variable)

particular		year 1		year 2
sales		1071000		1701000
Variable costs
costs of goods sold ($24*Sales)		408000		648000
selling expenses($3* Sales)		51000		81000
Total variable costs		459000		729000
Contribution Margin		612000		972000
Fixed Costs:
Fixed overhead ($19* sales)Fixed portion only		418000		418000
selling expenses (fixed portion only)		250000		250000
administrative expenses		0		0
Total fixed Expenses		668000		668000
Net operating income		($56000)		$304000

3. Reconciliation of net operating income:

Particular	Year 1	Year 2
Net operating income (Loss) under variable costing	($56000)	$304000
Fixed manufacturing overhead deferred in inventory(5000*19)	95000
Fixed manufacturing overhead released from inventory(5000*19)		(95000)
Net operating income under absorption costing	$39000	$209000