Question

Absorption and Variable Costing with Over- and Underapplied Overhead

Flaherty, Inc., has just completed its first year of operations. The unit costs on a normal costing basis are as follows:

Manufacturing costs (per unit):
Direct materials (2 lbs. @ 1.25)	$2.50
Direct labor (0.4 hr. @ 15.00)	6.00
Variable overhead (0.4 hr. @ 5.00)	2.00
Fixed overhead (0.4 hr. @ 7.00)	2.80
Total	$13.30
Selling and administrative costs:
Variable	$1.80	per unit
Fixed	$221,500

During the year, the company had the following activity:

Units produced	27,500
Units sold	24,750
Unit selling price	$35
Direct labor hours worked	11,000

Actual fixed overhead was $12,600 less than budgeted fixed overhead. Budgeted variable overhead was $4,900 less than the actual variable overhead. The company used an expected actual activity level of 11,000 direct labor hours to compute the predetermined overhead rates. Any overhead variances are closed to Cost of Goods Sold.

Required:

1. Compute the unit cost using (a) absorption costing and (b) variable costing.

	Unit Cost
Absorption costing	$ ?????
Variable costing	$ ?????

2. Prepare an absorption-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Absorption-Costing Income Statement
For the First Year of Operations
Sales		$ ?????
Cost of goods sold	$ ?????
Less:
Overapplied overhead	?????	?????
Gross profit		$ ?????
Less: Selling and administrative expenses		?????
Operating income		$ ?????

3. Prepare a variable-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Variable-Costing Income Statement
For the First Year of Operations
Sales		$ ?????
Variable cost of goods sold	$ ?????
Add:
Underapplied variable overhead	?????	?????
Variable selling expense		?????
Contribution margin		$ ?????
Less:
Fixed factory overhead	$ ?????
Selling and administrative expenses	?????	$ ?????
Operating income		$ ?????

Feedback

4. Reconcile the difference between the two income statements.
The absorption costing generates an income $ ????? more  than variable costing.

Answer 1

Computation of Unit cost
Absorption costing	13.3
Variable costing (13.30-2.80)	10.5

Absorption-Costing Income Statement
For the First Year of Operations
Unit sold		24750
Sales @$35		$866,250.00
Cost of goods sold @13.30	$329,175.00
Less:
Overapplied overhead (12600-4900)	$7,700.00	$321,475.00
Gross profit		$544,775.00
Less: Selling and administrative expenses (24750*1.80)+221500		$266,050.00
Operating income		$278,725.00

Variable-Costing Income Statement
For the First Year of Operations
Sales		$866,250.00
Variable cost of goods sold (10.50*24750)	$259,875.00
Add:
Underapplied variable overhead	$4,900.00
Variable selling expense	$44,550.00	$309,325.00
Contribution margin		$556,925.00
Less:
Fixed factory overhead ($2.80X 27500)-12600		$64,400.00
Selling and administrative expenses		$221,500.00
Operating income		$271,025.00

Reconcilliation
Operating Income as per absorpion costing	$278,725.00
Less: Deferred in ending Inventory (27500 Unit - 24750 Unit )X 2.80	$7,700.00
Operating Income as per Variable costing	$271,025.00

The absorption costing generates an income $more than variable costing by $7700