Diego Company manufactures one product that is sold for $71 per unit in two geog

Question

Diego Company manufactures one product that is sold for $71 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 54,000 units and sold 49,000 units. Variable costs per unit: Manufacturing: Direct materials $ 22 Direct labor $ 12 Variable manufacturing overhead $ 3 Variable selling and administrative $ 5 Fixed costs per year: Fixed manufacturing overhead $ 864,000 Fixed selling and administrative expenses $ 586,000 The company sold 36,000 units in the East region and 13,000 units in the West region. It determined that $280,000 of its fixed selling and administrative expenses is traceable to the West region, $230,000 is traceable to the East region, and the remaining $76,000 is a common fixed cost. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product. 12. If the company produces 5,000 fewer units than it sells in its second year of operations, will absorption costing net operating income be higher or lower than variable costing net operating income in Year 2? Higher Lower

Explanation / Answer

For this we have first calculate the Closing Stock of the Year 1 under both the methods:

Absorption Costing = (Total Variable Manufacturing Cost + Total Fixed cost) * Closing stock in units / total production in units

= (37 * 54000 + 864000) * 5000 / 54000 = $265000

Variable costing = Total Variable Manufacturing Cost * Closing stock in units / total production in units

=( 37 * 54000 ) * 5000 / 54000 = $185000

Difference = $80000

As the Year 1 more cost than variable costing is transferred to year 2 under Absorption Costing, so the Operating income would be lower by $80000 in Year 2 under Absorption costing than the Variable Costing method.

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