Question

Lehighton Chalk Company manufactures sidewalk chalk, which it sells online by the box at $25 per unit. Lehighton uses an actual costing system, which means that the actual costs of direct material, direct labor, and manufacturing overhead are entered into work-in-process inventory. The actual application rate for manufacturing overhead is computed each year; actual manufacturing overhead is divided by actual production (in units) to compute the application rate. Information for Lehighton’s first two years of operation is as follows:

	Year 1			Year 2
Sales (in units)		2,600			2,600
Production (in units)		3,100			2,100
Production costs:
Variable manufacturing costs	$	15,500		$	10,500
Fixed manufacturing overhead		18,600			18,600
Selling and administrative costs:
Variable		10,400			10,400
Fixed		9,400			9,400

Selected information from Lehighton’s year-end balance sheets for its first two years of operation is as follows:

LEHIGHTON CHALK COMPANY
Selected Balance Sheet Information
Based on absorption costing	End of Year 1			End of Year 2
Finished-goods inventory	$	5,500		$	0
Retained earnings		11,100			19,000
Based on variable costing	End of Year 1			End of Year 2
Finished-goods inventory	$	2,500		$	0
Retained earnings		8,100			19,000

Required:

1. Reconcile Lehighton’s operating income reported under absorption and variable costing, during each year, by comparing the following two amounts on each income statement:

• Cost of goods sold
• Fixed cost (expensed as a period expense)

2. What was Lehighton’s total operating income across both years under absorption costing and under variable costing?

3. What was the total sales revenue across both years under absorption costing and under variable costing?

4. What was the total of all costs expensed on the operating income statements across both years under absorption costing and under variable costing?

5. Subtract the total costs expensed across both years [requirement (4)] from the total sales revenue across both years [requirement (3)]: (a) under absorption costing and (b) under variable costing.

6. Considering the results obtained in requirements 1-5 above, select which of the following statements (is) are true by selecting an "X".

Year 1 Year 2 Subtotal Total 0 $ 0 Difference in operating income Total Operating Income Absorption costing Variable costing Total Sales Revenue Absorption costing Variable costing Costs Expensed Absorption costing Variable costing Amount Absorption costing Variable costing Sales revenue is different depending on the costing method used. Timing is the key in distinguishing between absorption and variable costing. Since Lehighton's combined operating income, across the two-year period, is the same under both absorption and variable costing, then the operating income must be the same within each year under both methods. The difference between absorption and varible costing is caused by the timing with which expenses are recognized.

Answer 1

Solution

Lehighton Chalk Company                  

1. Reconcile

Reconciliation:

	Year 1	Year 2
Cost of goods sold under absorption costing	$28,600	$34,600
Less: Variable manufacturing costs under variable costing	$13,000	$13,000
sub total	$15,600	$21,600
Less: Fixed manufacturing overhead as period expense under variable costing	$18,600	$18,600
Total	($3,000)	$3,000
Operating income under variable costing	$13,600	$13,600
Less: operating income under absorption costing	$16,600	$10,600
Difference in operating income	($3,000)	$3,000

2. Computation of operating income across both years under absorption costing and under variable costing:

	Operating Income
	Year 1
Absorption Costing	27,200
Variable Costing	$23,380

Computations:

Absorption Costing Income Statement
		Year 1			Year 2
Sales (2,600 units)			65,000	Sales (2,600 units)			$65,000
Less: Cost of Goods Sold				Less: Cost of Goods Sold
Beginning inventory		$0		Beginning inventory	(500 x $11)	$5,500
Add: cost of goods manufactured	(3,100 x $8.50)	$34,100		Add: cost of goods manufactured	(1,900 x 13.86)	$29,100
Goods Available for Sale		$34,100		Goods Available for Sale		$34,600
Less: ending inventory	(500 x $11)	$5,500		Less: ending inventory	0	$0
Cost of goods sold			$28,600	Cost of goods sold			$34,600
Gross Margin			$36,400	Gross Margin			$30,400
Less: selling and administrative expenses				Less: selling and administrative expenses
Variable selling expenses		$10,400		Variable selling expenses		$10,400
Fixed Selling expenses		$9,400		Fixed Selling expenses		$9,400
Total selling and administrative expenses			$19,800	Total selling and administrative expenses			$19,800
Operating Income			$16,600	Operating Income			$10,600

Computations:

Cost of goods manufactured, Year 1 –

Variable + fixed overhead

Variable overhead = 15,500/3,100 = $5

Fixed overhead = 18,600/3,100 = $6

Total cost of goods manufactured per unit = $11

Cost of goods manufactured, Year 2 –

Variable = $5

Fixed = 18,600/2,100 units = $8.86

Total cost of goods manufactured per unit = $13.86

1. Operating income statements for both years using variable costing method:

Variable Costing Income Statement
	Year 1			Year 2
sales		$65,000	sales		$65,000
Variable expenses:			Variable expenses:
Variable cost of goods manufactured			Variable cost of goods manufactured
Beg. Inventory	0		Beg. Inventory	$2,500
Variable cost of goods manufactured	$15,500		Variable cost of goods manufactured	$10,500
Less: ending inventory	$2,500		Less: ending inventory	0
Variable cost of goods sold		$13,000	Variable cost of goods sold		$13,000
Manufacturing margin		$52,000	Manufacturing margin		$52,000
Less: Variable selling expenses		$10,400	Less: Variable selling expenses		$10,400
Contribution margin		$41,600	Contribution margin		$41,600
Fixed costs:			Fixed costs:
Manufacturing overhead	$18,600		Manufacturing overhead	$18,600
Selling expenses	$9,400		Selling expenses	$9,400
Total fixed expenses		$28,000	Total fixed expenses		$28,000
Net Income		$13,600	Net Income		$13,600

2. Total sales revenue across both years under absorption costing and under variable costing:

	Total Sales Revenue
Absorption Costing	$130,000
Variable Costing	$130,000

3. Total of all costs expensed on the operating income statements across both years under absorption costing and under variable costing:

	Costs Expensed
Absorption Costing	$102,800
Variable Costing	$102,800

Computations:

Total cost expensed = total cost of goods sold for two years + selling and administrative expenses for two years

Absorption Costing –

= (28,600 + 34,600) + (19,800 + 19,800) = $102,800

Variable costing –

= (13,000 + $13,000) + (10,400 + 10,400) + (28,000 + 28,000) = $102,800

4. Subtract total costs expensed under both years from the total sales revenue across both years under absorption costing and variable costing:

	Amount
Absorption Costing	$27,200
Variable Costing	$27,200

5. Considering the results -

Select which of the following statements is true by selecting an 'X':
Sales revenue is different depending on the costing method used	FALSE
Timing is the key in distinguishing between absorption and variable costing	X
Since Lehighton's combined operating income, across the two-year period is the same under both absorption and variable costing, then the operating income must be the same within each year under both the methods	FALSE
The difference between absorption and variable costing is caused by the timing with which expenses are recognized	X

Check the reconciliation:

Year	Change in inventory in units		Actual fixed overhead	Difference in fixed overhead	Absorption - variable costing operating income difference
1	500	+	$6	$3,000	$3,000
2	-500	-	$6	($3,000)	($3,000)