Question

Chataqua Can Company manufactures metal cans used in the food-processing industry. A case of cans sells for $35. The variable costs of production for one case of cans are as follows:

Direct material	$	9.50
Direct labor		3.50
Variable manufacturing overhead		9.00
Total variable manufacturing cost per case	$	22.00

Variable selling and administrative costs amount to $0.90 per case. Budgeted fixed manufacturing overhead is $546,000 per year, and fixed selling and administrative cost is $39,500 per year. The following data pertain to the company’s first three years of operation.

		Year 1			Year 2			Year 3
Planned production (in units)		78,000			78,000			78,000
Finished-goods inventory (in units), January 1		0			0			22,000
Actual production (in units)		78,000			78,000			78,000
Sales (in units)		78,000			56,000			89,000
Finished-goods inventory (in units), December 31		0			22,000			11,000

Actual costs were the same as the budgeted costs.

Required:

1. Prepare operating income statements for Chataqua Can Company for its first three years of operations using:

a. Absorption costing.

b. Variable costing.

2. Reconcile Chataqua Can Company’s operating income reported under absorption and variable costing for each of its first three years of operation. Use the shortcut method.

3. Suppose that during Chataqua’s fourth year of operation actual production equals planned production, actual costs are as expected, and the company ends the year with no inventory on hand.

4. What will be the difference between absorption-costing income and variable-costing income in year

5. What will be the relationship between total operating income for the four-year period as reported under absorption and variable costing?

Answer 1

1.

Statement Of Operating Income

(absorption costing)

Particulars	Year 1 ($)	Year 2 ($)	Year 3 ​​​​​​​($)
Sales revenue	2,730,000 [78000 units * $ 35]	1,960,000 [56000 units * $ 35]	3,115,000 [89000 units * $ 35]
Less: cost of goods sold	2,262,000	1,624,000	2,581,000
Gross profit	468,000	336,000	534,000
Less: Variable selling and admin expense	70,200 [78000 units * $ 0.90]	50,400 [56000 units * $ 0.90]	80,100 [89000 units * $ 0.90]
Less: Fixed selling and admin expense	39,500	39,500	39,500
Net operating Income	358,300	246,100	414,400

Working Note:-

Statement showing cost of goods sold

Particulars	year 1 ​​​​​​​($)	year 2 ​​​​​​​($)	year 3 ​​​​​​​($)
variable Manufacturing costs	1,716,000 [78000 units * $ 22]	1,232,000 [56000 units * $ 22]	1,958,000 [89000 units * $ 22]
Add: Fixed Manufacturing costs	546,000 [78000 units * $ 7]	392,000 [56000 units * $ 7]	623,000 [89000 units * $ 7]
Cost of goods sold	2,262,000	1,624,000	2,581,000

Note: In absorption costing the the fixed manufacturing overheads are calculated per unit basis and allocated on the number of units sold , the per unit rate is calculated by dividing the fixed manufacturing overheads by the total production of units in the period

$ 546,000 / 78,000 units = $ 7

Statement Of Operating Income

(variable costing)

Particulars	year 1 ​​​​​​​($)	year 2 ​​​​​​​($)	year 3 ​​​​​​​($)
Sales Revenue	2,730,000 [78000 units * $ 35]	1,960,000 [56000 units * $ 35]	3,115,000 [89000 units * $ 35]
Less: Variable Manufacturing costs	1,716,000 [78000 units * $ 22]	1,232,000 [56000 units * $ 22]	1,958,000 [89000 units * $ 22]
Less: Variable Selling and Admin costs	70,200 [78000 units * $ 0.90]	50,400 [56000 units * $ 0.90]	80,100 [89000 units * $ 0.90]
Contribution Margin	943,800	677,600	1,076,900
Less: Fixed Manufacturing Overheads	546,000	546,000	546,000
Less; Fixed Selling and Admin costs	39,500	39,500	39,500
Net operating Income	358,300	92,100	491,400

3.

Actual production equals planned production 78,000 units , it already has an opening inventory of 11,000 units so total units available for sale 89,000 units . It is mentioned that at year 4 no closing inventory is maintained therefore total units sold in year 4 is 89,000 units.

Statement Of Operating Income

(absorption costing)

Particulars	Year 4 ​​​​​​​($)
Sales revenue	3,115,000 [89000 units * $ 35]
Less: cost of goods sold	2,581,000
Gross profit	534,000
Less: Variable selling and admin expense	80,100 [89000 units * $ 0.90]
Less: Fixed selling and admin expense	39,500
Net operating Income	414,400

Working Note:-

Statement showing cost of goods sold

Particulars	year 4 ​​​​​​​($)
variable Manufacturing costs	1,958,000 [89000 units * $ 22]
Add: Fixed Manufacturing costs	623,000 [89000 units * $ 7]
Cost of goods sold	2,581,000

Statement Of Operating Income

(variable costing)

Particulars	year 4 ($)
Sales Revenue	3,115,000 [89000 units * $ 35]
Less: Variable Manufacturing costs	1,958,000 [89000 units * $ 22]
Less: Variable Selling and Admin costs	80,100 [89000 units * $ 0.90]
Contribution Margin	1,076,900
Less: Fixed Manufacturing Overheads	546,000
Less; Fixed Selling and Admin costs	39,500
Net operating Income	491,400

4.

The net operating income for the year for as per absorption costing is $ 414,400 and the net operating income for the year for as per variable costing is $ 491,400 . the net operating income as per variable costing is $ 77,000 more than the net operating income as per absorption costing.

This is because in year 4 the sales units is more than that was produced in that year due to the presence of opening inventory of 11000 units

5.

	Year 1	Year 2	Year 3	Year 4
Net operating Income as per absorption costing	358,300	246,100	414,400	414,400

Net operating Income as per Variable costing

358,300

92,100

491,400

491,400

Analysis:

• In the year 1 the planned production , actual production and the sale is same i.e 78,000 units therefore the net operating income is same in both the methods.
• In the year 2 the sales units are 56,000 and the production is 78,000 , as per absorption costing the fixed overheads are allocated proportionate to units sold where as according to variable costing fixed costs are always on the planned production therefore the net operating income in variable costing is less than absorption
• In the year 3 and 4 the sales units are 89,000 and the production is 78,000 , as per absorption costing the fixed overheads are allocated proportionate to units sold where as according to variable costing fixed costs are always on the planned production therefore the net operating income in variable costing is more than absorption