During Heaton Company\'s first two years of operations, it reported absorption c
ID: 2576819 • Letter: D
Question
During Heaton Company's first two years of operations, it reported absorption costing net operating income as follows: Sales (@ $60 per unit) Cost of goods sold (@ $32 per unit) Gross margin Selling and administrative expenses* Net operating income Year 1 $ 1,200,000 640, eee 560,000 305,000 $ ,000 Year 2 $ 1,800,000 960,000 840,000 335,000 585,000 * $3 per unit variable; $245,000 fixed each year. The company's $32 unit product cost is computed as follows: $ 5 11 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($325,000 + 25,000 units) Absorption costing unit product cost 13 $ 32 Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consists of depreciation charges on E production equipment and buildings. E Production and cost data for the first two years of operations are: Units produced Units sold Year 1 Year 2 25,000 25,000 20,000 30,000 E Required: E 1. Using variable costing, what is the unit product cost for both years? E 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.Explanation / Answer
Solution:
Variable Costing System
1) Product Cost refers to the costs used to fabricate/make/produce a product.
2) Under Variable Costing System, product cost includes only following variable manufacturing costs:
- Cost of direct material used
- Direct labor cost
- Variable manufacturing overheads.
3) Under this system, fixed costs are not considered in product cost and for valuation of closing stock of finished goods. Fixed costs are treated as period cost in this system.
4) The value of finished goods and work in process is also comprised only of Manufacturing Variable Costs.
5) Selling and administrative expenses are not included because these are not the expenses incurred in production department. These expenses relate to selling and admin department.
Part 1 --- Unit Product Cost for both years under variable costing
Product Cost per unit
Year 1
Year1
Direct materials
$5.00
$5.00
Direct labor
$11.00
$11.00
Variable manufacturing overhead
$3.00
$3.00
Unit Product Cost
$19.00
$19.00
Part 2 – Variable Costing Net Operating Income
Variable Costing Income Statement
Year 1
Year 2
Sales
$1,200,000
$1,800,000
Variable Cost of Cost of Goods Sold:
Production Cost (Refer note 1)
$475,000
$475,000
Add: Beginning Inventory
$0
$95,000
Cost of Goods Available for sale
$475,000
$570,000
Less: Ending Inventory (Refer note 1)
-$95,000
$0
Variable Cost of Goods Sold
$380,000
$570,000
Add: Variable Selling and administrative expenses (Unit Sold x $3 per unit)
$60,000
$90,000
Total Variable Cost
$440,000
$660,000
Contribution Margin (sales - total variable cost)
$760,000
$1,140,000
Fixed Costs:
Fixed Manufacturing Costs
$325,000
$325,000
Fixed Selling and Admin Costs
$245,000
$245,000
Total Fixed Costs
$570,000
$570,000
Income from Operations
$190,000
$570,000
Note 1 –
Year 1
Year 2
Beginning Inventory
5,000
Units Produced
25000
25,000
Units Sold
20000
30,000
Ending Inventory
5000
Cost of Production (Produced Units 25,000 x Unit Product Cost @ $19)
$475,000
$475,000
Value of Ending Inventory (Units 5,000 x Product Cost $19 per unit)
$95,000
Part 3 --- Reconciliation absorption costing and variable costing net operating income
Absorption Costing System
- Product Cost refers to the costs used to fabricate/make/produce a product.
- Under Absorption Costing, product cost includes both fixed and variable manufacturing expenses incurred in fabrication of the product or service.
- It includes cost of direct material used, cost of direct labor, consumable supplies used and manufacturing/factory overheads (both variable as well as fixed factory overhead).
- Ending Inventory is valued on Production Cost.
- Product Cost does not include Selling, General and Administrative Expenses.
Reconciliation Statement
Year 1
Year 2
Net Operating Income as per Variable Costing
$190,000
$570,000
Add or (Deduct) the Fixed Manufacturing Overhead cost deferred or released from the Inventory (Since variable cost does not include fixed manufacturing cost in product cost but the absorption costing includes)
Ending Inventory of Year 1 and Beginning Inventory of Year 2 (5,000 Units x $13 Fixed Overhead Per Unit
$65,000
-$65,000
Net Operating Income as per Absorption Costing
$255,000
$505,000
Hence, the reason for different in operating income under both method is the treatment of fixed manufacturing overhead. Absorption Costing includes fixed manufacturing overhead in product cost whereas variable costing does not.
Product Cost per unit
Year 1
Year1
Direct materials
$5.00
$5.00
Direct labor
$11.00
$11.00
Variable manufacturing overhead
$3.00
$3.00
Unit Product Cost
$19.00
$19.00
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