Question

Strved Help Sa During Heaton Company's first two years of operations, it reported absorption costing net operating income as follows Year 1 Year 2 $1,708, 000 1,036, 000 672, 000 338, 000 Sales (e $61 per unit) Cost of goods sold (@ $37 per unit) Gross margin Selling and administrative expenses Net operating income $1,098,000 666, 000 432, 000 308,000 $ 124,000 $ 334, 000 $3 per unit variable; $254,000 fixed each year The company's $37 unit product cost is computed as follows: $ 9 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($276, 000 23, 000 units) Absorption costing unit product cost 13 3 12 $ 37 Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consists of depreciation charges on production equipment and buildings Next> 3 of 5 < Prev

Answer 1

Solution of the above problem is as under:

1)

Computation of Unit Product Cost using Variable Costing
Particulars	Amount ($)
Direct Material	9
Direct Labour	13
Variable Manufacturing Overhead	3
Variable Costing Unit Product Cost	25

Note: Note: Variable Costing as the name defines only variable costs are used to calculate the cost per unit of a product. But though variable selling cost is also variable but it is a period cost and is expensed when incurred.

2) Statement showing Net Operating Income in Year-1 and Year-2 using Variable Costing

	Year-1	Year-2
Particulars	Amount ($)	Amount ($)
Sales	1098000	1708000
Less: Cost of Goods Sold	450000	700000
Gross Contribution Margin	648000	1008000
Less: Variable Selling and Administrative Expenses	54000	84000
Contribution Margin	594000	924000
Less: Period Cost
Fixed Manufacturing Overheads	276000	276000
Fixed Selling and Administrative Expenses	254000	254000
Net Operating Income	64000	394000

Production and Sales Data for the first two years of operation are:
Particulars	Year-1	Year-2
Units Produced	23000	23000
Units Sold	18000	28000
Closing Inventory (Produced-Sales)	5000	0*
* Opening Inventory in Year-2 is 5000 units carried from the Year-1

3) Reconciliation of Absorption Costing and Variable Costing Net Operating Incomes

Reconciliation of Absorption Costing and Variable Costing Net Operating Incomes
	Year-1	Year-2
Particulars	Amount ($)	Amount ($)
Variable Costing Net Operating Income	64000	394000
Add: Fixed Manufacturing Overhead deferred in Inventory (5000 Units * $12)	60000
Less: Fixed Manufacturing Overhead Expenses released from the Inventory (5000 units * $12)		60000
Absorption Costing Net Operating Income	124000	334000

Note: The difference in profit between the two methods in Year-1 of $60000 (= $124000 − $64000) is attributed to the $12 per unit fixed manufacturing overhead cost assigned to the 5000 units in ending inventory using absorption costing ($60000 = $12 × 5000 units).

The difference in profit between the two methods in Year-2 of $60000 (= $394000 − $334000) is attributed to the $12 per unit fixed manufacturing overhead cost assigned to the 5,000 units in inventory Year-1 and recorded as cost of goods sold during Year-2 using absorption costing ($60000 = $12 × 5,000 units).

Thus, The net operating income under Absorption Costing is more than the net operating income under Variable Costing because when production is more than sales, the fixed manufacturing overhead is deferred in Inventory that causes a higher Net Operating Income under Absorption Costing than under Variable Costing and vise-versa