Question

Yale Company manufactures hair brushes that sell at wholesale for $3 per unit. The company had no beginning inventory in the prior year. These data summarize the current and prior year operations: Prior Year 3,200 units 4,800 units Current Year 6,400 units 4,800 units Sales Production Production cost Factory-variable (per unit) -fixed Marketing-variable Administrative-fixed $ 0.60 $2,400 $ 0.40 $ 500 $ 0.60 $2,400 $ 0.40 $ 500 Required: 1. Prepare an income statement for each year based on full costing. 2. Prepare an income statement for each year based on variable costing. 3. Prepare a reconciliation of the difference each year in the operating income resulting from using the full costing method and variable costing method.

Answer 1

1) Under absorption costing (=full costing), unit cost of goods manufactured shall consider both variable and fixed manufacturing costs incurred to produce the number goods. Therefore, Variable product cost per unit Fixed product cost per unit Product cost per unit Prior Year $0.60 $0.50 $1.10 This Year $0.60 $0.50 $1.10 [For Year-1, $2400 / 4800 units = $0.5; For Year-2, $2400 / 4800 units = $0.5]

This Year $19,200 [3200 units x $3; 6400 units x $3] $0 YALE COMPANY Income Statement Full Costing Prior Year Sales Revenue $9,600 Less: Cost of Goods Sold Beginning inventory Add: Cost of goods produced $5,280 Available for sale $5,280 Less: Cost of ending inventory $1,760 Cost of Goods Sold $3,520 Gross Margin $6,080 Less: Selling and Administrative costs Marketing costs $1,280 Administrative costs $500 Selling and Administrative costs $1,780 Operating Income $4,300 $1,760 $5,280 $7,040 [This year = (4800 - 3200) < $1.10 = 1600 x $1.10 = $1760) [4800 x $1.10 for both years] __ $0 [Prior year = (4800 - 3200) < $1.10 = 1600 x $1.10 = $1760] $7,040 $12,160 (Sales Revenue - Cost of Goods Sold] $2,560 $500 [Prior year = 3200 x $0.4 = $1280; Current year = 6400 x $0.4 = $2560] [Fixed and so do not change) $3,060 $9,100 2) Under variable costing, unit product cost shall consider only variable mfg. costs incurred to produce the number of goods. Therefore, Year-1 Year-2 Unit product cost $0.40 $0.40 Variable product cost per unit

This Year $19,200 [3200 units x $3; 6400 units x $3] $O $960 $2,880 $3,840 [This year = (4800 - 3200) < $0.60 = 1600 x $0.60 = $960] [4800 x $0.60 for both years] YALE COMPANY Income Statement Variable Costing Prior Year Sales Revenue $9,600 Less: Cost of goods sold Beginning inventory Add: Cost of goods produced $2,880 Available for sale $2,880 Less: Cost of ending inventory $960 Cost of Goods Sold $1,920 Variable marketing costs $1,280 Total variable costs $3,200 Contribution Margin $6,400 Fixed Expenses: Fixed product costs $2,400 Fixed administrative costs $500 Total fixed costs $2,900 Net Operating Income $3,500 $0 [Prior year = (4800 - 3200) < $0.60 = 1600 x $0.60 = $960] $3,840 $2,560 [Prior year = 3200 units x $0.4; Current year = 6400 units x $0.4] $6,400 $12,800 $2,400 $500 [Fully charged as expense] [Fully charged as expense] $2,900 $9,900

3) The only reason for the difference in net operating income (loss) between absorption costing and variable costing is the deferred fixed manufacturing overhead cost to next period through ending inventory under absorption costing. That is, under variable costing, entire fixed manufacturing overhead cost is considered as period cost and so charged to income statement. However, under the absorption costing, fixed mfg. overhead cost is considered as product cost and so a portion of it will be deferred to next reporting period through ending inventory. If number of units produced and sold are same, net operating income reported under both methods will be same. Units in beginning inventory Number of units produced Total units accounted for Less: Number of units sold Ending inventory Prior Year 0 4,800 4,800 3,200 1,600 This Year 1,600 4,800 6,400 6,400 0 YALE COMPANY Reconciling Difference in Operating Income Between Full and Variable Costing Prior Year Change in inventory 1,600 x fixed overhead rate $0.5 Difference in operating income $800 This Year -1,600 [Prior Year=0-1600=-1600; This Year=1600-0=1600] $0.5 [As calculated in Part-1] $800 (Prior year = 1600 x $0.5 = $800; Current year = -1600 x $0.5 = $800]