Question

During Heaton Company's first two years of operations, it reported absorption costing net operating income as follows: Sales (@ $60 per unit) Cost of goods sold (@ $40 per unit) Gross margin Selling and administrative expenses* Net operating income Year 1 $ 1,080,000 720,000 360,000 302,000 $ 58,000 Year 2 $1,680,000 1,120,000 560,000 332,000 $ 228,000 *$3 per unit variable; $248,000 fixed each year. The company's $40 unit product cost is computed as follows: $ 8 13 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($414,000 + 23,000 units) Absorption costing unit product cost ,00 units) 30 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: Units produced Units sold Year 1 23,000 18,000 Year 2 23,000 28,000

Answer 1

Solution:

The unit product cost under variable costing is computed as follows:

Variable costing unit product cost =Direct materials + Direct labor + Variable manufacturing overhead

=$8 + $13+ $1 =$22

Unit product cost =$22

2.Net operating income in year 1 and in year 2.

	Year 1	Year 2
Sales	$1,080,000	$1,680,000
Variable expenses:
Variable cost of goods sold	$396,000($22 × 18,000 units)	$616,000($22 × 28,000 units
Variable selling and administrative expenses	$54,000($3 × 18,000 units)	$84,000($3 × 28,000)
Total variable expenses	$450,000	$700,000
Contribution margin	$630,000	$980,000
Fixed expenses:
Fixed manufacturing overhead	$414,000	414,000
Fixed selling and administrative expenses	$248,000	$248,000
Total fixed expenses	$662,000	$662,000
Net operating income	$(32,000)	$318,000

3.Reconcile the absorption costing and the variable costing net operating income:

	Year 1	Year 2
Variable costing net operating income (loss)	$(30,000)	$318,000
Add: fixed manufacturing overhead cost deferred in inventory under absorption costing	$90,000
Less: Fixed manufacturing overhead cost released from inventory under absorption costing		$(90,000)
Absorption costing net operating income	$60,000	$228,000

Explanation:

	Year 1	Year2
Units in beginning inventory	0	5000
Add: units produced	23,000	23,000
Less: units sold	18,000	28,000
= Units in ending inventory	5,000	0

Add ( deduct) fixed manufacturing overhead deferred in (released from) inventory under absorption costing (5000 units × $18 per unit in year 1 ; 5000 units × $18 per unit year 2) =$90,000