Question

O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$26
Direct labor	$18
Variable manufacturing overhead	$5
Variable selling and administrative	$3
Fixed costs per year:
Fixed manufacturing overhead	$530,000
Fixed selling and administrative expenses	$170,000

During its first year of operations, O’Brien produced 93,000 units and sold 77,000 units. During its second year of operations, it produced 78,000 units and sold 89,000 units. In its third year, O’Brien produced 84,000 units and sold 79,000 units. The selling price of the company’s product is $78 per unit.

Assume the company uses variable costing and a LIFO inventory flow assumption (LIFO means last-in first-out. In other words, it assumes that the newest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

Answer 1

Solution:

(A) Under variable costing, only the variable manufacturing costs are included in product costs. So : Particulars Year1 ($) Year2 ($) Year3 ($) Direct Material (A) 26 26 26 Direct Labour(B) 18 18 18 Variable Manufacturing Overhead(C) 5 5 5 Unit product cost under Variable costing ($) {Total of A+B+C= D} 49 49 49 (B) Income Statement : Particulars Year 1 Year 2 Year 3 Sales($) {1} 6006000 6942000 6162000 Variable Expenses: Variable cost of goods sold 3773000 4361000 3871000 Variable selling and administrative expenses 231000 267000 237000 Total of Variable expenses{2} 4004000 4628000 4108000 Contribution Margin {1- 2 = 3} 2002000 2314000 2054000 Fixed Expenses: Fixed Manufacturing Overhead 530000 530000 530000 Fixed Selling & Administrative 170000 170000 170000 Total of Fixed Expenses{4} 700000 700000 700000 Net Operating Income($) {3 - 4 =5} 1302000 1614000 1354000 WORKING NOTES: Year 1: Sales (77,000 units × $78 per unit) = $6,006,000 Variable cost of goods sold (77,000 units × $49 per unit) = $3,773,000 Variable selling and administrative expenses (77,000 units × $3 per unit) = $2,31,000 Year 2: Sales (89,000 units × $78 per unit) = $6,942,000 Variable cost of goods sold (89,000 units × $49 per unit) = $4,361,000 Variable selling and administrative expenses (89,000 units × $3 per unit) = $2,67,000 Year 3: Sales (79,000 units × $78 per unit) = $6,162,000 Variable cost of goods sold (79,000 units × $49 per unit) = $3,871,000 Variable selling and administrative expenses (79,000 units × $3 per unit) = $2,37,000