Question

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

	Year 1			Year 2
Sales (@ $61 per unit)	$	915,000		$	1,525,000
Cost of goods sold (@ $37 per unit)		555,000			925,000
Gross margin		360,000			600,000
Selling and administrative expenses*		297,000			327,000
Net operating income	$	\63,000\		$	273,000

* $3 per unit variable; $252,000 fixed each year.

The company’s $37 unit product cost is computed as follows:

Direct materials	$	6
Direct labor		10
Variable manufacturing overhead		3
Fixed manufacturing overhead ($360,000 ÷ 20,000 units)		18
Absorption costing unit product cost	$	37

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	20,000	20,000
Units sold	15,000	25,000

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

1	Year 1	Year 2
Direct materials	6	6
Direct labor	10	10
Variable manufacturing overhead	3	3
Unit product cost	19	19
2
	Year 1	Year 2
Sales	915000	$1,525,000
Variable expenses:
Variable cost of goods sold	285000	475000
Variable selling and administrative expenses	45000	75000
Total Variable expenses	330000	550000
Contribution margin	585000	975000
Fixed expenses:
Fixed manufacturing overhead	360000	360000
Fixed selling and administrative expenses	252000	252000
Total Fixed expenses	612000	612000
Net operatimg income(loss)	($27,000)	$363,000
3
	Year 1	Year 2
Variable costing net income	($27,000)	$363,000
Add(deduct) fixed manufacturing overhead deferred in(released)	90000	-90000
Absorption costing net operating income	$63,000	$273,000