Question

Case 4-29 (Algo) Variable and Absorption Costing Unit Product Costs and Income Statements [LO4-1, LO4-2] [The following information applies to the questions displayed below.] O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations: Variable costs per unit: Manufacturing: Direct materials $ 29 Direct labor $ 18 Variable manufacturing overhead $ 4 Variable selling and administrative $ 3 Fixed costs per year: Fixed manufacturing overhead $ 560,000 Fixed selling and administrative expenses $ 180,000 During its first year of operations, O’Brien produced 94,000 units and sold 75,000 units. During its second year of operations, it produced 83,000 units and sold 97,000 units. In its third year, O’Brien produced 86,000 units and sold 81,000 units. The selling price of the company’s product is $76 per unit.

Required:

1. Assume the company uses variable costing and a FIFO inventory flow assumption (FIFO means first-in first-out. In other words, it assumes that the oldest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

Answer 1

In the given approach of variable costing with FIFO, both the sales and production shall be based on the units produced in year. The units sold shall not be given any due relevance. Further, in case of variable costing, labor, materials and variable overhead only play role in products and hence, their costs are only evaluated. The fixed costs are ignored in computation of product costs.

a.

Under variable costing, only the variable manufacturing costs are included in product costs.
	Year 1	Year 2	Year 3
Direct materials	$          29	$          29	$          29
Direct labor	$          18	$          18	$          18
Variable manufacturing overhead	$             4	$             4	$             4
Variable costing unit product cost	$          51	$          51	$          51

b.

Year 1:

Variable cost of goods sold (75,000 units × $51 per unit) = $3,825,000

Variable selling and administrative expenses (75,000 units × $3 per unit) = $225,000

Year 2:

Variable cost of goods sold (97,000 units × $51 per unit) = $4,947,000

Variable selling and administrative expenses (97,000 units × $3 per unit) = $ 291,000

Year 3:

Variable cost of goods sold (81,000 units × $51 per unit) = $4,131,000

Variable selling and administrative expenses (81,000 units × $3 per unit) = $243,000

Income Statement

	Year 1	Year 2	Year 3
Sales	$                         5,700,000	$                         7,372,000	$                         6,156,000
Variable expenses:
Variable cost of goods sold	$                         3,825,000	$                         4,947,000	$                         4,131,000
variable selling and administrative	$                            225,000	$                            291,000	$                            243,000
Total variable expense	$                         4,050,000	$                         5,238,000	$                         4,374,000
Contribution margin	$                         1,650,000	$                         2,134,000	$                         1,782,000
Fixed expenses:
Fixed manufacturing overhead	$                            560,000	$                            560,000	$                            560,000
Fixed selling and administrative	$                            180,000	$                            180,000	$                            180,000
Total fixed expenses	$                            740,000	$                            740,000	$                            740,000
Net operating income	$                            910,000	$                         1,394,000	$                         1,042,000

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