Question

12.

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	$	26
Direct labor	$	15
Variable manufacturing overhead	$	3
Variable selling and administrative	$	4
Fixed costs per year:
Fixed manufacturing overhead	$	560,000
Fixed selling and administrative expenses	$	190,000

During its first year of operations, O’Brien produced 91,000 units and sold 76,000 units. During its second year of operations, it produced 81,000 units and sold 91,000 units. In its third year, O’Brien produced 85,000 units and sold 80,000 units. The selling price of the company’s product is $75 per unit.

Case 6-29 Part-3

3. Assume the company uses absorption 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

a)

	Year 1	Year 2	Year 3
Direct Materials	$        26	$        26	$        26
Direct Labor	$        15	$        15	$        15
Variable Manufacturing Overhead	$          3	$          3	$          3
Fixed Manufacturing Overhead	$    6.15	$    6.91	$    6.59
Absorption costing unit product cost	$ 50.15	$ 50.91	$ 50.59
Fixed Manufacturing Overhead
Year 1	(560000/91000)		$    6.15
Year 2	(560000/81000)		$    6.91
Year 3	(560000/85000)		$    6.59

b)

O'Brien Company
Absorption Costing Income Statement
	Year 1	Year 2	Year 3
Sales	$ 5,700,000	$ 6,075,000	$ 6,000,000
Cost of Goods Sold	$ 3,811,400	$ 4,621,410	$ 4,048,800
Gross Margin	$ 1,888,600	$ 1,453,590	$ 1,951,200
Selling & Administrative Expenses	$     494,000	$     554,000	$     510,000
Net Operating Income	$ 1,394,600	$     899,590	$ 1,441,200
Cost of Goods Sold
Year 1	(76000*$50.15)			$        3,811,400
Year 2	(15000*$50.15)+(76000*$50.91)			$        4,621,410
Year 3	(5000*$50.91)+(75000*$50.59)			$        4,048,800