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)	$	1,240,000		$	1,860,000
Cost of goods sold (@ $34 per unit)		680,000			1,020,000
Gross margin		560,000			840,000
Selling and administrative expenses*		311,000			341,000
Net operating income	$	\249,000\		$	499,000

* $3 per unit variable; $251,000 fixed each year.

The company’s $34 unit product cost is computed as follows:

Direct materials	$	7
Direct labor		8
Variable manufacturing overhead		1
Fixed manufacturing overhead ($450,000 ÷ 25,000 units)		18
Absorption costing unit product cost	$	34

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	25,000	25,000
Units sold	20,000	30,000

Required:

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

Unit product cost

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

Net operating income (loss)

Year 1

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	Year 2
Variable costing net operating income (loss)
Absorption costing net operating income

Complete this question by entering your answers in the tabs below.

Answer 1

1. Unit product cost under variable costing:-

Direct material	$7
Direct labor	8
Variable manufacturing overhead	1
Unit product cost	$16

2.

	Year 1	Year 2
Sales (@$62 per unit)	$1,240,000	$1,860,000
Variable cost (@$16 per unit)	320,000	480,000
Variable selling and administrative expenses (@$3 per unit)	60,000	90,000
Contribution margin	860,000	1,290,000
Fixed manufacturing overhead	450,000	450,000
Fixed selling and administrative expenses	251,000	251,000
Net operating income	$159,000	$589,000

3.

Reconciliation of Variable Costing and Absorption Costing Net Operating Income

	Year 1	Year 2
Variable costing net operating income (loss)	$159,000	$589,000
Add (Less) : Fixed manufacturing overhead deferred in inventory :- Year 1 (5,000×18) Year 2 (5,000×18)	90,000	(90,000)
Absorption costing net operating income	$249,000	$499,000