Question

Chenango 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	$	8.00
Direct labor		2.50
Variable manufacturing overhead		7.50
Total variable manufacturing cost per case	$	18.00

Variable selling and administrative costs amount to $.40 per case. Budgeted fixed manufacturing overhead is $455,000 per year, and fixed selling and administrative cost is $46,000 per year. The following data pertain to the company’s first three years of operation. (A unit refers to one case of cans.)

	Year 1		Year 2		Year 3
Planned production (in units)	91,000		91,000		91,000
Finished-goods inventory (in units), January 1	0		0		28,500
Actual production (in units)	91,000		91,000		91,000
Sales (in units)	91,000		62,500		105,250
Finished-goods inventory (in units), December 31	0		28,500		14,250

Actual costs were the same as the budgeted costs.

Required:

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

a.	Absorption costing:

             

b.	Variable costing:

             

2.	Reconcile Chenango 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 Chenango's fourth year of operation actual production equals planned production, actual costs are equal to budgeted costs, and the company ends the year with no inventory on hand.

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

             

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

Answer 1

		Chenango Can Company
		Absorption Costing Income Statement
		For the Year Ended									Fixed Manufacturing OH	455000
			Year 1	Year 2	Year 3		Year 1	Year 2	Year 3		Actual Production	91000
		Sales	2730000	1875000	3157500		91000*30	62500*30	105250*30		Fixed Manufacturing OH PU	5.00
		Less: Cost of Goods Sold
		Direct Material	728000	500000	842000		91000*8	62500*8	105250*8
		Direct Labor	227500	156250	263125		91000*2.5	62500*2.5	105250*2.5
		Variable M.OH	682500	468750	789375		91000*7.5	62500*7.5	105250*7.5
		Fixed M.OH	455000	312500	526250		91000*5	62500*5	105250*5
		Contribution Margin	637000	437500	736750
		Less: Variable S&A Ex	36400	25000	42100		91000*0.4	62500*0.4	105250*0.4
		Less: Fixed S&A Ex	46000	46000	46000
		Net Operating Income	554600	366500	648650
		Chenango Can Company
		Variable Costing Income Statement
		For the Year Ended
			Year 1	Year 2	Year 3		Year 1	Year 2	Year 3
		Sales	2730000	1875000	3157500		91000*30	62500*30	105250*30
		Less: Cost of Goods Sold
		Direct Material	728000	500000	842000		91000*8	62500*8	105250*8
		Direct Labor	227500	156250	263125		91000*2.5	62500*2.5	105250*2.5
		Variable M.OH	682500	468750	789375		91000*7.5	62500*7.5	105250*7.5
		Variable S&A Ex	36400	25000	42100		91000*0.4	62500*0.4	105250*0.4
		Contribution Margin	1055600	725000	1220900
		Less: Fixed M.OH	455000	455000	455000
		Less: Fixed S&A Ex	46000	46000	46000
		Net Operating Income	554600	224000	719900
		Reconciliation of VC to AC:
			Year 1	Year 2	Year 3		Year 2	Year 3
		Net Operating Income-AC	554600	366500	648650
		Less: Fixed M.OH Deferred in Closing Units	0	142500	71250		28500*5	14250*5
		Add: Fixed M.OH Deferred in Opening Units	0	0	142500			28500*5
		Net Operating Income-VC	554600	224000	719900
	3	There will be no difference since there is no impact of Inventory(Opening or Closing)
		Total Operating Income will be same under Absorption and Variable Costing