Huron Chalk Company manufactures sidewalk chalk which it sells online by the box

Question

Huron Chalk Company manufactures sidewalk chalk which it sells online by the box at $25 per unit. Huron uses an actual costing system, which means that the actual costs of direct material, direct labor, and manufacturing overhead are entered into work-in-process inventory. The actual application rate for manufacturing overhead is computed each year; actual manufacturing overhead is divided by actual production (in units) to compute the application rate. Information for Huron’s first two years of operations is as follows:

Selected information from Huron’s year-end balance sheets for its first two years of operation is as follows:

                                             HULK CHALK COMPANY

                                             Selected Balance Sheet Information

* For convenience, assume that dividends for Year 1 is $5,500 and Year 2 is $2,700. No taxes or other expenses were incurred for both the years.

1. Prepare operating income statements for both years based on absorption costing.

2. Prepare operating income statements for both years based on variable costing.

3. Prepare a numerical reconciliation of the difference in income reported under the two costing methods used in requirements (1) and (2).

Year 1 Year 2 Sales (in units) 2,500 2,500 Production (in units) 3,100 1,900 Production Costs:                  Variable manufacturing costs $15,190 $9,310                  Fixed manufacturing costs 18,290 18,290 Selling & Administrative Expenses:                  Variable 10,000 10,000                   Fixed 9,000 9,000

Explanation / Answer

Operating Income under Absorbtin Costing Method Year 1 Year 2 Units Amount ($) Amount ($) Units   Amount ($) Amount ($) a Sales      2,500            62,500            62,500       2,500 62500 b Production Costs: c Opening Inventory 600 6480 d Variable Manafacturing cost            15,190              9,310 e Fixed Manufacturing Cost            18,290           18,290 f Total cost (c+d+e) 3100            33,480       1,900 g Closing Inventory          600            (6,480)                     -   h Cost of Goods sold (f-g)          (27,000)           34,080 -34080 i Gross margin (a-h)            35,500 28420 j Selling & Admin Expenses :                      -   k a) Variable            10,000           10,000 b) Fixed               9,000              9,000 -19000 -19,000 l Operating Income            16,500 9,420 Operating income under Variable Costing Method Units Amount($) Amount ($)   Units Amount($) Amount ($)   a Sales      2,500            62,500       2,500             62,500 b Variable Manufacturing cost : opening inventory           600              2,940 c Variable Manufacturing cost      2,500                  15,190       1,900              9,310 d Less Closing Inventory       (600)                  (2,940) e Cost of Goods Sold (b+c - d)                  12,250           12,250 f Selling & Admin expeses : Variable                  10,000           10,000 g Total Variable cost (e+f)          (22,250)          (22,250) h Contributin Margin            40,250             40,250 i Less: j Fixed Manufacturing Overhead                  18,290           18,290 k Fixed Selling and Adminstrative Costs                    9,000              9,000 l Total Fixed Costs          (27,290)          (27,290) m Operating Income            12,960             12,960 3. Reconciliation of reported operating income under absorption and variable costing. Year Change in inventory in units Increse, or decrease Actual Fixed Difference In Fixed Absorption minus variable costing operating income   a b c d e f a b c d e f 1                  600 Increase $   5.90 * $       3,540 * $             3,540 2                 (600) Decrease $   5.90 * $      (3,540) * $            (3,540)

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