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 (3 lbs. @ 1.30)	$3.90
Direct labor (0.4 hr. @ 14.50)	5.80
Variable overhead (0.4 hr. @ 4.00)	1.60
Fixed overhead (0.4 hr. @ 8.00)	3.20
Total	$14.50
Selling and administrative costs:
Variable	$1.70	per unit
Fixed	$221,000

During the year, the company had the following activity:

Units produced	26,000
Units sold	23,400
Unit selling price	$35
Direct labor hours worked	10,400

Actual fixed overhead was $13,400 less than budgeted fixed overhead. Budgeted variable overhead was $5,700 less than the actual variable overhead. The company used an expected actual activity level of 10,400 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
		$
	$
Less:
Gross profit		$
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
		$
	$
Add:
Contribution margin		$
Less:
	$
		$
Operating income		$

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

Answer 1

1) cost per unit

	absorption costing	variable costing
direct material	3.9	3.9
direct labor	5.8	5.8
variable overhead	1.60	1.60
fixed overhead	3.20	it is a period cost
cost per unit	14.50	11.30

2)

absorption costing income statement

sales (35 * 23400 )		819,000
plus production ( 26000 * 14.5 )	377000
less ending inventory (26000 - 23400 = 2600   , 2600 * 14.5 = 37700	37700
gross profit		479700
less period cost
variable selling price	39780
fixed cost	221,000
operating income		218920

3)

variable costing income statement

sales 35 * 23400		819000
less production cost (11.3 * 26000)	293800
add ending inventory ( 2600 * 11.30)	29380
manufacturing cost		554580
less variable selling expenses (1.9 * 23400 )	39780
contribution		514800
less fixed cost and fixed selling cost 83200 + 221000)	304200
operating income		210600

4) Variable costing and absorption costing usually produce different net operating income figures. The reason is that the fixed manufacturing overhead cost is not treated the same way under two costing methods. To understand how the difference in treatment of fixed manufacturing overhead cost changes the net operating income figures of two costing systems, we need to prepare two income statements, one under variable costing and one under absorption costing.

level	income
production > sales	absorption costing > variable costing
production < sales	absorption costing < variable costing
production = sales	absorption = variable

absorption costing operating income = 218920

variable costing operating income = 210600

difference is 8320