Question

Chataqua Can Company manufactures metal cans used in the food-processing industry. A case of cans sells for $30. The variable costs of production for one case of cans are as follows:

Direct material	$	6.50
Direct labor		4.00
Variable manufacturing overhead		5.00
Total variable manufacturing cost per case	$	15.50

Variable selling and administrative costs amount to $0.60 per case. Budgeted fixed manufacturing overhead is $567,000 per year, and fixed selling and administrative cost is $41,000 per year. The following data pertain to the company’s first three years of operation.

		Year 1			Year 2			Year 3
Planned production (in units)		81,000			81,000			81,000
Finished-goods inventory (in units), January 1		0			0			23,500
Actual production (in units)		81,000			81,000			81,000
Sales (in units)		81,000			57,500			92,750
Finished-goods inventory (in units), December 31		0			23,500			11,750

Actual costs were the same as the budgeted costs.

Required:

1. Prepare operating income statements for Chataqua Can Company for its first three years of operations using:

1. Absorption costing.

2. Variable costing.

2. Reconcile Chataqua Can Company’s operating income reported under absorption and variable costing for each of its first three years of operation. Use the shortcut method.

3. Suppose that during Chataqua’s fourth year of operation actual production equals planned production, actual costs are as expected, and the company ends the year with no inventory on hand.

1. What will be the difference between absorption-costing income and variable-costing income in year 4?

2. What will be the relationship between total operating income for the four-year period as reported under absorption and variable costing?

Answer 1

Answer

Given Data Variable costs per unit: Manufacturing: Variable manufacturing Cost Variable selling and administrative $ 15.50 0.60 16.10 Fixed costs per year: Fixed manufacturing overhead Fixed selling and administrative expenses 5,67,000 41,000 Year 1 Year 2 Year 3 Opening Balance Units produced Units sold Ending Inventory Year 4 11,750 81,000 92,750 81,000 81,000 23,500 81,000 92,750 11,750 81,000 57,500 23,500 Selling Price per unit $30.00 Variable Costing Income Statement Per Unit / per period Year 1 81,000 30.00 $ 24,30,000 Year 2 57,500 $ 17,25,000 Year 3 92,750 $ 27,82,500 Year 4 92,750 $ 27,82,500 Units sold Sales Variable expenses: Variable cost of goods sold Variable selling and administrative Total variable expenses Contribution margin (Sales-VC) $ 15.50 0.60 $ $ $ $ 12,55,500 48,600 13,04,100 11,25,900 $ $ $ $ 8,91,250 34,500 9,25,750 7,99,250 $ $ $ $ 14,37,625 $ 14,37,625 55,650 $ 55,650 14,93,275 $ 14,93,275 12,89,225 $ 12,89,225 Fixed expenses: Fixed manufacturing overhead Fixed selling and administrative Total fixed expenses: Net operating income (loss) (Cont-FC) 5,67,000 41,000 5,67,000 41,000 6,08,000 5,17,900 5,67,000 41,000 6,08,000 1,91,250 5,67,000 41,000 6,08,000 6,81,225 5,67,000 41,000 6,08,000 $ 6,81,225 $ $ $

Absorption costing: Per Unit $ 15.50 Units produced Variable manufacturing Cost Fixed manufacturing overhead Total Manufacturing Cost Units produced Unit product cost Fixed Overhead per unit Year 1 81,000 $ 12,55,500 $ 5,67,000 $ 18,22,500 81,000 $ 22.50 7.00 Year 2 81,000 $ 12,55,500 $ 5,67,000 $ 18,22,500 81,000 $ 22.50 7.00 Year 3 81,000 $ 12,55,500 $ 5,67,000 $ 18,22,500 81,000 $ 22.50 7.00 Year 4 81,000 $ 12,55,500 $ 5,67,000 $ 18,22,500 81,000 $ 22.50 7.00 Absorption Costing Income Statement Year 1 Year 2 Year 3 Year 4 Units sold 81,000 57,500 92,750 92,750 Sales $ 30.00 $ 24,30,000 $ 17,25,000 $ 27,82,500 $ 27,82,500 Cost of goods sold refer below)) $ 18,22,500 $ 12,93,750 $ 20,86,875 $ 20,86,875 Gross margin $ 6,07,500 $ 4,31,250 $ 6,95,625 $ 6,95,625 Selling and administrative expenses (Fixed + Variable) 89,600 $ 75,500 $ 96,650 $ 96,650 Net operating income (loss) $ 5,17,900 $ 3,55,750 $ 5,98,975 $ 5,98,975 L L Working Notes Cost of goods sold Opening Balance Units produced Units sold Ending Inventory 81,000 81,000 81,000 57,500 23,500 23,500 81,000 92,750 11,750 11,750 81,000 92,750 0 18,22,500 $ $ $ $ $ 2,64,375 $ 18,22,500 | $ Opening Balance Add: Cost of production Less: Ending Inventory Cost of goods sold 18,22,500 (5,28,750) 12,93,750 5,28,750 18,22,500 (2,64,375) 20,86,875 18,22,500 20,86,875

Prepare a numerical reconciliation and explanation of the difference in the income each month between variable costing and absorption costing. Reconciliation Year 1 Year 2 Year 3 Variable costing Net Operating Income (loss) $ 5,17,900 $ 1,91,250 $ 6,81,225 Add: Fixed manufacturing overhead deferred in inventory under absorption costing (closing inventory - opening inventory) x fixed manufacturing overhead per unit produced. Year 4 $ 6,81,225 1,64,500.00 (82,250.00) (23000 x $7) / (11750-23500)*$7 (11750-23500)*$7 (0-11750)*$7 Absorption costing net operating income (loss) (82,250.00) $ 5,98,975 $ 5,17,900 $ 3,55,750 $ 5,98,975