Question

Denton Company manufactures and sells a single product.
Cost data for the product are given below:
Variable costs per unit:
Direct materials $7
Direct labor 10
Variable manufacturing overhead 5
Variable selling and administrative 3
Total variable cost per unit $25

Fixed costs per month:
Fixed manufacturing overhead $ 315,000
Fixed selling and administrative 245,000
Total fixed cost per month $ 560,000
The product sells for $60 per unit.

Production and sales data for July and August, the first two months of operations, follow:
Units Produced Units Sold
July 17,500 15,000
August 17,500 20,000

The company’s Accounting Department has prepared absorption costing income statements for July and August as presented below:
July August
Sales $900,000 $1,200,000    
Cost of goods sold                                     600,000   800,000     
Gross margin                                             300,000   400,000    
Selling and administrative expenses 290,000   305,000     
Net operating income $10,000 $95,000   

1. Determine the unit product cost under absorption costing and variable costing.
Absorption costing:
Variable Costing:

Prepare contribution format variable costing income statements for July and August.

Reconcile the variable costing and absorption costing net operating income figures.
July August
Variable costing net operating income (loss)
Add/Deduct fixed manufacturing overhead cost deferred in/released from
inventory under absorption costing
Absorption costing net operating income/loss

Answer 1

Concepts and reason

Absorption costing: Absorption costing is an approach where both the fixed and variable manufacturing costs are accounted and apportioned to the product. It is a technique used to determine the cost of the inventory.

Variable costing statement: A statement which involves deduction of existing revenue by reducing it through the variable expenses resulting in contribution and further deducting it by fixed expenses is known as variable costing statement. The resultant is net income.

Net operating income: Net operating income is the income calculated after deducting the total operating income and settling all operating expenses. It is also termed to be as Earnings before Interest and Taxes.

Fundamentals

Direct Material cost: Direct material cost is the cost related to the purchase of the raw materials which are directly related with the production of the goods. It includes opening stock of materials, purchases, cost of purchases, and deducts the closing stock of materials.

Direct labor cost: It refers to the cost of providing wages to the workers who are directly associated with the production of goods or services rendered to the customers. The cost of direct labour includes the wages payroll taxes, and all the benefits sponsored by the manufacturer.

Variable manufacturing overhead: Variable manufacturing overhead is a type of manufacturing overhead, which are changed according to the level of production.

Fixed manufacturing overhead: It is a type of manufacturing overhead; it doesn't change according to the level of production.

Unit product cost: The cost ascertained and divided by number of units of the product is the unit product cost. It includes prime cost, factory cost and production cost.

Cost of goods sold: The costs which are incurred by a business to sell products in a particular period are called as cost of goods sold. It is also known as cost of sales. It is considered to be as expense of current period.

1)

Calculate unit product cost:

Therefore, unit product cost is $40 in absorption costing and $22 for variable costing.

Workings:

Calculation of fixed manufacturing overhead:

$\begin{array}{c}\\{\rm{Fixed manufacturing overhead = }}\frac{{{\rm{Fixed manufacturing overhead}}}}{{{\rm{Units produced}}}}\\\\ = \frac{{\$ 315,000}}{{\$ 17,500}}\\\\ = \$ 18\\\end{array}$

Therefore, fixed manufacturing overhead is $18.

2)

Prepare contribution format variable costing income statements for July and August.

3)

Reconcile the variable costing and absorption costing net operating income figures.

Ans: Part 1

Unit product cost is $40 in absorption costing and $22 for variable costing.

Part 2

Part 3