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O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

 

Variable costs per unit:
Manufacturing:
Direct materials	$	28
Direct labor	$	15
Variable manufacturing overhead	$	4
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	550,000
Fixed selling and administrative expenses	$	180,000

 

During its first year of operations, O’Brien produced 94,000 units and sold 71,000 units. During its second year of operations, it produced 85,000 units and sold 103,000 units. In its third year, O’Brien produced 82,000 units and sold 77,000 units. The selling price of the company’s product is $80 per unit.

4. Assume the company uses absorption costing and a LIFO inventory flow assumption (LIFO means last-in first-out. In other words, it assumes that the newest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

 

Answer 1

Answer to Question (a):-

Under Variable Costing, only variable manufacturing overhead costs are included in Product cost.

Computation of Unit Product Cost
Particulars	Year 1	Year 2	Year 3
Direct Material(in $)	$ 28	$ 28	$ 28
Direct Labor(in $)	$ 15	$ 15	$ 15
Variable Manufacturing Overhead($)	$ 4	$ 4	$ 4
Total Variable Cost(Unit oroduct cost in $)	$ 47	$ 47	$ 47

Note: Variable Selling & Administrative cost are not treated as product costs. They do not form part of inventory cost and are considered period costs.

Answer to Question (b):-

Income Statement for 3 years
Particulars	Year 1	Year 2	Year 3
Sales(A)	56,80,000	82,40,000	61,60,000
	[71,000*$80]	[103,000*$80]	[77,000*$80]
Less: Cost of goods sold(B)	33,37,000	48,41,000	38,54,000
[71,000*$47]	[85,000*47]	[77,000*47]
	[18,000*47]	[5,000*47]
33,37,000	48,41,000	38,54,000
Contribution Margin(C)=[A-B]	23,43,000	33,99,000	23,06,000
Less: Fixed Cost
Manufacturing	$ 5,50,000	$ 5,50,000	$ 5,50,000
Administrative & Selling	$ 18,00,000	$ 18,00,000	$ 18,00,000
Total Fixed Expenses('D)	$ 23,50,000	$ 23,50,000	$ 23,50,000
Net Operating Income/(Loss)[C-D]	(7,000)	10,49,000	(44,000)

Note: LIFO Method is followed while computing the cost of goods sold.