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)	$	976,000		$	1,586,000
Cost of goods sold (@ $38 per unit)		608,000			988,000
Gross margin		368,000			598,000
Selling and administrative expenses*		294,000			324,000
Net operating income	$	\74,000\		$	274,000

* $3 per unit variable; $246,000 fixed each year.

The company’s $38 unit product cost is computed as follows:

Direct materials	$	8
Direct labor		13
Variable manufacturing overhead		4
Fixed manufacturing overhead ($273,000 ÷ 21,000 units)		13
Absorption costing unit product cost	$	38

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	21,000	21,000
Units sold	16,000	26,000

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	8	8
Direct labor	13	13
Variable manufacturing overhead	4	4
Unit product cost	25	25
2
	Year 1	Year 2
Sales	$976,000	$1,586,000
Variable expenses:
Variable cost of goods sold @ $25 per unit	$400,000	$650,000
Variable selling and administrative expenses @ $3 per unit	$48,000	$78,000
Total Variable expenses	$448,000	$728,000
Contribution margin	$528,000	$858,000
Fixed expenses:
Fixed manufacturing overhead	$273,000	$273,000
Fixed selling and administrative expenses	$246,000	$246,000
Total Fixed expenses	$519,000	$519,000
Net Operating income	$9,000	$339,000
3
	Year 1	Year 2
Variable costing Net Operating income	$9,000	$339,000
Add/(deduct): Fixed manufacturing overhead deferred in(released) from inventory under absorption costing	65000	-65000
Absorption costing Net Operating income	$74,000	$274,000