Question

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

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,054,000		$	1,674,000
Cost of goods sold (@ $40 per unit)		680,000			1,080,000
Gross margin		374,000			594,000
Selling and administrative expenses*		300,000			330,000
Net operating income	$	74,000		$	264,000

* $3 per unit variable; $249,000 fixed each year.

The company’s $40 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		11
Variable manufacturing overhead		2
Fixed manufacturing overhead ($440,000 ÷ 22,000 units)		20
Absorption costing unit product cost	$	40

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:

	Year 1	Year 2
Units produced	22,000	22,000
Units sold	17,000	27,000

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.

Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes Year 2 Variable costing net operating income (loss) Add: Fixed manufacturing overhead cost released from inventory under absorption costing Absorption costing net operating income Required 2 Required 3 >

Answer 1

Computation of Unit product cost under Variable Costing :- Particulars Year 1 Year 2 Direct material 7.00 7.00 Direct labour Variable manufacturing overhead Variable product cost 11.00 2.00 20.00 11.00 2.00 20.00 Year 2 16,74,000 1,00,000 4,40,000 5,40,000 Variable costing net operating income in Year 1 and in Year 2 :- Particulars Year 1 Sales 10,54,000 Less: Variable expenses Less : - Variable cost of goods sold Beginning inventory Add: Variable cost of goods produced 4,40,000 Cost of goods available for sale 4,40,000 Less: Ending inventory (5000+20) (1,00,000) Variable cost of goods sold 3,40,000 Manufacturing Margin 7,14,000 Less: Variable selling and administrative expenses (51,000) Contribution Margin 6,63,000 Less :- Fixed expenses Fixed manufacturing expenses 4,40,000 Fixed selling and administrative expenses 2,49,000 Total Fixed expenses 6,89,000 Income from Operations (26,000) 5,40,000 11,34,000 (81,000) 10,53,000 4,40,000 2,49,000 6,89,000 3,64,000 Reconciliation of Absprbtion and Variable costing Income Statements: Year 1 Year 1 3,64,000 (26,000) 1,00,000 Particulars Variable costing income/(Loss): Add: Fixed manufacturing overhead in ending inventory (5000*20) Less: Fixed manufacturing overhead in Opening inventory (5000*20) Income/(Loss) as per absorbtion costing system (1,00,000) 74,000 2,64,000