Question

# During Heaton Company’s first two years of operations, the company reported absorption costing net operating income...

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

 Year 1 Year 2 Sales (@ \$63 per unit) \$ 1,134,000 \$ 1,764,000 Cost of goods sold (@ \$37 per unit) 666,000 1,036,000 Gross margin 468,000 728,000 Selling and administrative expenses* 304,000 334,000 Net operating income \$ \164,000\ \$ 394,000

 * \$3 per unit variable; \$250,000 fixed each year.

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

 Direct materials \$ 7 Direct labor 13 Variable manufacturing overhead 3 Fixed manufacturing overhead (\$322,000 ÷ 23,000 units) 14 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 two years are:

 Year 1 Year 2 Units produced 23,000 23,000 Units sold 18,000 28,000

 Required:
 1. Prepare a variable costing contribution format income statement for each year.

 2. Reconcile the absorption costing and the variable costing net operating income figures for each year. (Losses should be indicated by a minus sign.)

SOLUTION

1. Variable costing contribution format income statement

Units-

Year 1 = 1,134,000 / \$63 = 18,000 units

Year 2 = 1,764,000 /\$63 = 28,000 units

 Year 1 (\$) Year 2 (\$) Sales 1,134,000 1,764,000 Variable expenses: Cost of goods sold (7+13+3) 414,000 644,000 Selling and administrative expense (18,000*3), (28,000*3) 54,000 84,000 Contribution margin 666,000 1,036,000 Fixed expenses: Fixed manufacturing overhead 322,000 322,000 Selling and administrative expense 250,000 250,000 Total fixed expenses 572,000 572,000 Net operating income 94,000 464,000

2. Reconciliation of variable and absorption costing net operating income

 Year 1 (\$) Year 2 (\$) Variable costing net income 94,000 464,000 Fixed overhead deferred (5,000*14) 70,000 (70,000) Absorption costing net operating income 164,000 394,000