Question

During Heaton Company's first two years of operations, it reported absorption costing net operating income as follows: Year 1 Year 2 Sales (@$60 per unit) 900,000 $ 1,500,000 Cost of goods sold (@$42 per unit) 630,000 1,050,000 Gross margin 270,000 450,000 Selling and Admin expense 293,000 323,000 Net operating income (23,000) 127,000 *$3 per unit variable: $248,000 fixed each year. The company's $42 unit product is computer as follows: Direct materials $ 6 Direct labor 13 Variable manufacturing overhead 5 18 Fix manufacturing overhead ($360,000/20,000 units) Absorption costing unit product cost $42 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 20,000 20,000 Units Sold 15,000 25,000 What is the variable costing net operations income in year 1 and year 2? Reconcile the absorption costing and the variable costing net operating income figures for each year. w

Answer 1

Requirement 1

Heaton Company
Variable Costing Income Statement
	Year 1	Year 2
Sales	$      900,000.00	$ 1,500,000.00
Less: Variable Cost
Direct Material	$        90,000.00	$      150,000.00
Direct Labor	$      195,000.00	$      325,000.00
Variable Overheads	$        75,000.00	$      125,000.00
Variable selling and Administrative expenses	$        45,000.00	$        75,000.00
Total Variable cost	$      405,000.00	$      675,000.00
Contribution Margin	$      495,000.00	$      825,000.00
Less: Fixed Cost
Fixed manufacturing Overheads	$      360,000.00	$      360,000.00
Fixed Selling and Administrative Expenses	$      248,000.00	$      248,000.00
Total Fixed cost	$      608,000.00	$      608,000.00
Net Income	$   (113,000.00)	$      217,000.00

Requirement 2

Heaton Company
Reconciliation of Variable costing and Absorbtion Costing system
	Year 1	Year 2
variable Costing Income (loss)	$   (113,000.00)	$      217,000.00
Fixed manufacturing overhead applied to ending inventory in absorption costing (18*5000 Units)	$        90,000.00	$      (90,000.00)
Absorbtion Costing Income	$      (23,000.00)	$      127,000.00

$90000 of inventory in year 1 is the closing unsold inventory which increased profit as per absorption costing. Since in absorption costing the cost of unsold stock is not included in income statement but shown as an asset under Ending Finished inventory.In variable costing fixed cost is charged as period cost and no coat is assigned to unsold inventory.

$90000 deducted in Year 2 represents the cost of opening inventory in absorption but there was no opening inventory as per variable costing so that amount is deducted from variable costing profit to get profit as per absorption system.

Please note that Inventory indicated as a reconciling entry only includes fixed cost allocation portion. Actual Finished inventory is more than $90000. since 5000 units are fully complete.