Question

Problem 6-19 Variable Costing Income Statement; Reconciliation [LO6-2, LO6-3]

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

	Year 1			Year 2
Sales (@ $25 per unit)	$	1,000,000		$	1,250,000
Cost of goods sold (@ $18 per unit)		720,000			900,000
Gross margin		280,000			350,000
Selling and administrative expenses*		210,000			230,000
Net operating income	$	70,000		$	120,000

*$2 per unit variable; $130,000 fixed each year.

The company’s $18 unit product cost is computed as follows:

Direct materials	$	4
Direct labor		7
Variable manufacturing overhead		1
Fixed manufacturing overhead ($270,000 ÷ 45,000 units)		6
Absorption costing unit product cost	$	18

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	45,000	45,000
Units sold	40,000	50,000

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.

Answer 1

	Year 1	Year 2
Direct materials	$         4	$         4
Direct labor	$         7	$         7
Variable manufacturing overhead	$         1	$         1
Product cost under variable costing	$       12	$       12

Fixed overhead will not consider while calculating product cost under variable costing.

2.

Heaton Company
Variable costing income statement
	Year 1	Year 2
Sales (@ $25 per unit)	$                       1,000,000	$                       1,250,000
Variable expense
Direct material	40,000*$4 = $160,000	50,000*$4 = $200,000
Direct labour	40,000*$7 = $280,000	50,000*$7 = $350,000
Variable manufacturing overhead	40,000*$1 = $40,000	50,000*$1 = $50,000
Variable selling and administrative overhead	40,000*$2 = $80,000	50,000*$2 = $100,000
total variable cost	$                           560,000	$                           700,000
Contribution margin	$                           440,000	$                           550,000
Fixed costs
Manufacturing overhead	$                           270,000	$                           270,000
Selling and administrative expenses	$                           130,000	$                           130,000
Total fixed costs	$                           400,000	$                           400,000
Net operating income	$                             40,000	$                           150,000

3.

Reconciliation of Variable costing and Absorption costing net operating income
	Year 1	Year 2
Variable costing net operating income (loss)	$                        40,000	$                         150,000
Add fixed manufacturing overhead deferred in inventory under absorption costing	5,000*$6 = $30,000
Deduct fixed manufacturing overhead released from inventory under absorption costing		5,000*$6 = ($30,000)
Absorption costing net operating income (loss)	$                        70,000	$                         120,000

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