Question

During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows:

	Year 1			Year 2
Sales (@ $62 per unit)	$	1,178,000		$	1,798,000
Cost of goods sold (@ $35 per unit)		665,000			1,015,000
Gross margin		513,000			783,000
Selling and administrative expenses*		305,000			335,000
Net operating income	$	\208,000\		$	448,000

* $3 per unit variable; $248,000 fixed each year.

The company’s $35 unit product cost is computed as follows:

Direct materials	$	5
Direct labor		10
Variable manufacturing overhead		4
Fixed manufacturing overhead ($384,000 ÷ 24,000 units)		16
Absorption costing unit product cost	$	35

Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consists of depreciation charges on production equipment and buildings.

Production and cost data for the first two years of operations are:

	Year 1	Year 2
Units produced	24,000	24,000
Units sold	19,000	29,000

Required:

1. Using variable costing, what is the unit product cost for both years?

2. What is the variable costing net operating income in Year 1 and in Year 2?

3. Reconcile the absorption costing and the variable costing net operating income figures for each year.

Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes Year 1 Variable costing net operating income (loss) Year 2 Absorption costing net operating income

Answer 1

1
	Year 1	Year 2
Direct materials	5	5
Direct labor	10	10
Variable manufacturing overhead	4	4
Unit product cost	19	19
Unit product cost = 19
2
	Year 1	Year 2
Sales	1178000	1798000
Variable expenses:
Variable cost of goods sold	361000	551000
Variable selling and administrative expenses	57000	87000
Total Variable expenses	418000	638000
Contribution margin	760000	1160000
Fixed expenses:
Fixed manufacturing overhead	384000	384000
Fixed selling and administrative expenses	248000	248000
Total Fixed expenses	632000	632000
Net operating income	128000	528000
3
	Year 1	Year 2
Variable costing net operating income(loss)	128000	528000
Add: Fixed manufacturing overhead deferred in inventory under absorption costing	80000		=(24000-19000)*16
Deduct: Fixed manufacturing overhead released from inventory under absorption costing		(80000)	=(24000-29000)*16
Absorption costing net operating income	208000	448000