Question

Problem 7-22 Variable Costing Income Statements; Income Reconciliation [LO7-1, LO7-2, LO7-3]

Denton Company manufactures and sells a single product. Cost data for the product are given:

Variable costs per unit:
Direct materials			$	7
Direct labor				10
Variable manufacturing overhead				5
Variable selling and administrative				3
Total variable cost per unit			$	25
Fixed costs per month:
Fixed manufacturing overhead	$	315,000
Fixed selling and administrative		245,000
Total fixed cost per month	$	560,000

The product sells for $60 per unit. Production and sales data for July and August, the first two months of operations, follow:

	Units Produced	Units Sold
July	17,500	15,000
August	17,500	20,000

The company’s Accounting Department has prepared the following absorption costing income statements for July and August:

	July			August
Sales	$	900,000		$	1,200,000
Cost of goods sold		600,000			800,000
Gross margin		300,000			400,000
Selling and administrative expenses		290,000			305,000
Net operating income	$	10,000		$	95,000

Required:

1. Determine the unit product cost under:

a. Absorption costing.

b. Variable costing.

2. Prepare contribution format variable costing income statements for July and August.

3. Reconcile the variable costing and absorption costing net operating incomes.

Answer 1

Ans. 1 a	In absorption costing method, the unit product cost is the sum of all manufacturing costs per unit
	whether it is fixed or variable.
	Unit product cost under Absorption Costing:
	Direct materials	$7
	Direct labor	$10
	Variable Overhead per unit	$5
	Fixed overhead per unit   ($315,000 / 17,500)	$18
	Product Cost per unit	$40
	*Fixed overhead per unit = Fixed overhead / Units produced
Ans. 1 b	Unit product cost under Variable Costing:
	Direct materials	$7
	Direct labor	$10
	Variable Overhead per unit	$5
	Total production cost per unit	$22
Ans. 2	DENTON COMPANY
	Variable Costing
	Income Statement
	PARTICULARS	July		August
	Sales		$900,000		$1,200,000
	Less: Variable cost of goods sold:
	Opening inventory	$0		$55,000
	Add: Cost of goods produced	$385,000		$385,000
	Variable cost of goods available for sale	$385,000		$440,000
	Less: Ending inventory	-$55,000		$0
	Variable cost of goods sold		$330,000		$440,000
	Gross Contribution Margin		$570,000		$760,000
	Less: Variable Selling and Adm. Exp.		$45,000		$60,000
	Contribution Margin		$525,000		$700,000
	Less: Fixed expenses:
	Fixed manufacturing overhead	$315,000		$315,000
	Fixed selling and adm. expenses	$245,000	$560,000	$245,000	$560,000
	Net operating income		($35,000)		$140,000
	*Working Notes:
	*Sales will be same as absorption costing income statement.
	Ending inventory units for July = Production - Sales
	17,500 - 15,000 = 2,500 units
	Ending inventory for July = Ending inventory units * Unit product cost = (2,500 * $22) = $55,000.
	Ending inventory for August = Beginning inventory units + Units produced - Units sold
	2,500 + 17,500 - 20,000   =   0 units
	Beginning inventory for August = Ending inventory for July = $33,000
	*Cost of goods produced = Units produced * Unit product cost
	July (17,500 * $22) = $385,000
	August   (17,500 * $22) = $385,000
	*Variable selling and administrative cost = Variable marketing cost per unit * Units sold
	July (15,000 * $3) = $45,000
	August   (20,000 * $3) = $60,000
Ans. 3	July:
	Variable costing net income		($35,000)
	Add: Ending inventory at fixed overhead per unit (2,500 * $18)		$45,000
	Absorption costing net income		$10,000
	August:
	Variable costing net income		$140,000
	Less: Beginning inventory		-$45,000
	Absorption costing net income		$95,000