Question

During Heaton Company's first two years of operations, it reported absorption costing net operating income as follows: Sales @ $63 per unit) Cost of goods sold @ $39 per unit) Gross margin Selling and administrative expenses* Net operating income Year 1 $ 1,008,000 624,000 384,000 301,000 $ 83,000 Year 2 $ 1,638,000 1,014,000 624,000 331,000 $ 293,000 * $3 per unit variable: $253,000 fixed each year. The company's $39 unit product cost is computed as follows: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($399,000 = 21,000 units) Absorption costing unit product cost $ 39 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: Units produced Units sold Year 1 21,000 16,000 Year 2 21,000 26,000

Answer 1

Answer 1:

Unit Product Cost (variable costing Method
Cost	Year 1	Year 2
Direct Material	6	6
Direct Labor	11	11
Variable Manufacturing overhead	3	3
Unit Product Cost	20	20

- Remember that Fixed Manufacturing overheads (Depreciation and Wages & Salaries) will be treated as Period expense and will not be considered as part of product variable cost under Marginal Costing technique.

- Variable portion of Selling expense will not be considered as part of unitproduct cost since unit product cost takes care of the cost till production not the selling cost.

2. Income Statement-Variable Costing
Particulars	Per Unit	Year 1 $	Year 2 $
Sales Revenue	63	1008000	1638000
Less Variable Product Cost	20	320000	520000
Gross Contribution	43	688000	1118000
Less Variable Selling Overheads	3	48000	78000
Net Contribution	40	640000	1040000
Less Fixed Expenses
Manufacturing		399000	399000
Selling		253000	253000
Total Fixed Cost		652000	652000
Net Operating Income		-12000	388000

Answer-3:

We have already calculated Unit Product cost in Solution 1 above and net Operating Inceome under Solution 2, Let's make the stock register for 2 years as well:

Inventory Statement
	Year 1	Year 2
Opening Stock	0	5000
Add: Actual Production	21000	21000
Less: Sale	16000	26000
Closing Stock	5000	0

It should be noted that Closing stock for Year 1 will become opening Stock for Year 2.

Now we have all the Inputs to answer question 3. Reconcilation between income under both the approaches will look like below:

Reconciliation
Net Operating Income	Year 1	Year 2
Under Absorbtion Costing	83000	293000
Under Marginal Costing	-12000	388000
Difference	95000	-95000

- It should be noted that Under Absorbtion costing, Closing stock valuation will be having the part of fixed Manufacturing overheads in year 1. Due to this Absorbtion costing will show higher income. In our question, Year 1 closing stock is 5000 units and fixed manufacturing overhead per unit is $19 per unit. Total Manufacturing overheads sitting inclosing stock is 5000 * 19= $ 95,000 which is a gap between both the incomes

- Next year same difference is reversed since there is no closing stock left. Under Absorbtion costing, all the overheads will be charged in current year since there is no closing stock left