During Heaton Company\'s first two years of operations, the company reported abs

Question

During Heaton Company's first two years of operations, the company reported absorption costing net operating income as follows ear $ 1,178,000 ear Sales (@ $62 per unit) Cost of goods sold ( $ 1,798,000 $37 per unit) 703,0001,073,000 Gross margin Selling and administrative expenses 475,000 368,600 725,000 398,600 Net operating income S 106,400 326,400 $3 per unit variable: $311,600 fixed each year. The company's $37 unit product cost is computed as follows: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($456,000 9 24,000 units)19 $ 37 Absorption costing unit product cost 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 two years are Units produced Units sold Year 1 Year 2 24 000 24.000 19000 29.000

Explanation / Answer

In the given problem, production is 24000 units. But, Sales are 19000 and 29000 respectively.

Absorption costing absorbs fixed cost as per the production units as it considers the fixed manufacturing expenses as product cost. Whereas variable costing considers fixed cost as period cost.

The operating income from absorption costing will be differ from operating income as per variable costing as only 19000 units sold in the year one out of 24000 produced. So, as per absorption costing the fixed manufacturing cost proportionate to 19000 only absorbed whereas in case of variable costing total fixed costs are considered.

Fixed manufacturing cost is 456000

For Year 1:

Absorption costing considers 456000*19000/24000= 361000.

Whereas variable costing considers total 456000. Therefore, the difference 456000-361000=95000.

95000 fixed manufacturing overhead is deffered.

For Year 2:

As the sales units 29000 is more than the produced units 24000, fixed cost will be absorbed more than $456000. i.e. 29000*19= $551000. The difference is $95000.

Year 1

Sales 19000 units

Amount in $

Year 2

Sales 29000 units

Amount in $

Revenue    

19000*62

1178000

29000*62

1798000

Variable expenses:

Direct material @ $6

19000*6

114000

29000*6

174000

Direct Labour @ $9

19000*9

171000

29000*9

261000

Variable manufacturing overhead @ $3

19000*3

57000

29000*3

87000

Variable selling and administrative expenses @ $3

19000*3

57000

29000*3

87000

Total variable expenses

399000

609000

Contribution= Revenue-Total variable expenses

779000

1189000

Fixed expenses:

Fixed manufacturing overhead

456000

456000

Fixed Selling and administrative expenses

311600

311600

Total fixed expenses

767600

767600

Net operating income(loss): Contribution-Total fixed expenses

11400

421400

Calculation of deferred fixed manufacturing overhead:

Amount in $

Amount in $

Fixed costs as per variable costing

456000

456000

Fixed costs absorbed as per absorption costing

361000

551000

Fixed manufacturing overhead deferred

95000

-95000

Reconciliation of variable costing and absorption costing net operating incomes:

Net operating income(loss): Contribution-Total fixed expenses

11400

421400

Add (deduct) Fixed manufacturing overhead deferred in (released from) inventory under absorption cositng

95000

-95000

Absorption costing net operating income(loss)

106400

326400

Year 1

Sales 19000 units

Amount in $

Year 2

Sales 29000 units

Amount in $

Revenue    

19000*62

1178000

29000*62

1798000

Variable expenses:

Direct material @ $6

19000*6

114000

29000*6

174000

Direct Labour @ $9

19000*9

171000

29000*9

261000

Variable manufacturing overhead @ $3

19000*3

57000

29000*3

87000

Variable selling and administrative expenses @ $3

19000*3

57000

29000*3

87000

Total variable expenses

399000

609000

Contribution= Revenue-Total variable expenses

779000

1189000

Fixed expenses:

Fixed manufacturing overhead

456000

456000

Fixed Selling and administrative expenses

311600

311600

Total fixed expenses

767600

767600

Net operating income(loss): Contribution-Total fixed expenses

11400

421400

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