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Exercise 1 Unit Product Cost Under Varia
Exercise 1 Unit Product Cost Under Varia
Super Bike Manufacturing Company presents the following data for 2011:
Solution:
Notice that the fixed manufacturing overhead cost has not been included while computing
the cost of one bike under variable costing system.
Note: Selling and administrative expenses (both variable and fixed) are not relevant for
the computation of unit product cost.
Required:
1. Prepare a contribution margin income statement using variable costing system.
2. Reconcile any difference between net operating income figure under variable
costing income statement and net operating income figure under absorption
costing income statement.
Solution
(1) Income Statement:
A company manufactures and sells large size tables to be used in the offices of the
executives. One table is sold for $400. The data for 2010 is as follows:
Manufacturing costs:
Direct materials per unit $120
Direct labor per unit $60
Variable manufacturing overhead per unit $20
Fixed manufacturing overhead per year $600,000
Non-manufacturing costs:
Variable selling administrative per unit $40
Fixed selling administrative $900,000
Inventory:
Opening 0
Production during 2010 10,000
———
Units available for sale 10,000
Sales 9,000
———
Closing inventory 1,000
———
Required:
Solution
= $1,500,000 / $160*
= 9,375 Units
The production and sales data of Albari company for the year 2011 is as follows:
During 2011, Albari company manufactured 30,000 units out of which 25,000 units were
sold. At the end of 2011, the finished goods inventory account showed a balance of
$170,000.
Required:
Solution:
For external reporting purposes, company must use finished goods inventory figure
computed on the basis of absorption costing system. It is computed as follows:
AGA company manufactures and sells a product for $20/Kg. The data for the last year is
given below:
Sales 75,000 Kg
Finished goods inventory at the beginning of the
12,000 Kg
period
Finished goods inventory at the closing of the period 17,000 Kg
Manufacturing costs:
Variable cost $8 per Kg
$320,000 per
Fixed manufacturing overhead cost
year
Marketing and administrative expenses:
Variable expenses $2 per Kg of sale
$300,000 per
Fixed expenses
year
Required:
Solution
(1) Income statements:
Sales 1,500,000
Less cost of goods sold:
Beginning inventory (12000Kg × $12) 144,000
Cost of goods manufactured (80,000* Kg × $12**) 960,000
———
Cost of goods available for sale 1,104,000
Closing inventory (17,000Kg × 12 ) 204,000 900,000
——— ———
Gross profit 600,000
Less marketing and administrative expenses:
Variable expenses (75,000Kg × $2) 150,000
Fixed expenses 300,000 450,000
——— ———
Net operating income 150,000
———
*Production for last year: **Manufacturing cost per
unit
Sales 75,000Kg Variable $8
Closing inventory 17,000Kg Fixed (320,000 / 80,000) $4
———- ——
Total inventory available for
92,000Kg $12
sale
Opening inventory 12,000Kg ——
———-
Production for the period 80,000Kg
———-
(b)Variable costing:
Sales 1,500,000
Less variable cost of goods sold:
Beginning inventory (12000Kg × $8) 96,000
Variable cost of goods manufactured (80,000 Kg × $8) 640,000
———
Variable cost of goods available for sale 736,000
Closing inventory (17,000Kg × 8 ) 136,000 600,000
——— ———
Gross contribution margin 900,000
Variable marketing and admin. expenses (75,000Kg ×
150,000
$2)
———
750,000
Less period costs:
Marketing and administrative 300,000
Manufacturing 320,000 620,000
——— ———
Net operating income 130,000
———
The net operating income under absorption costing is $20,000 more than the net
operating income under variable costing. When production is more than sales (as in this
exercise), the fixed manufacturing overhead is deferred in inventory that causes a higher
net operating income under absorption costing than under variable costing. The
reconciliation of net operating income is as follows:
Operating income under absorption costing 150,000
Operating income under variable costing 130,000
———
Difference in net operating income 20,000
———
Change in inventory (17,000Kg – 12,000Kg) 5,000Kg
———
Fixed cost deferred in inventory (5,000Kg ×
20,000
$4.00)
———
or
Absorption costing income statement of a company for the first two years is as follows:
Year-1 Year-2
Sales 2,000,000 3,000,000
Less cost of goods sold:
Beginning inventory 0 340,000
Add cost of goods manufactured 1,700,000 1,700,000
————- ————-
Goods available for sale 1,700,000 2,040,000
Less ending inventory 340,000 0
————- ————-
Cost of goods sold 1,360,000 2,040,000
————- ————-
Gross margin 640,000 480,000
Less selling and administrative expenses* 620,000 680,000
————- ————-
Net operating income 20,000 280,000
————- ————-
*6 per unit variable; $500,000 fixed each year.
Year-1 Year-2
Units produced 25,000 25,000
Units sold 20,000 30,000
Required:
Solution
(1) Variable costing (contribution margin) income statement:
Year-1 Year-2
Sales 2,000,000 3,000,000
Less variable cost of goods sold:
Beginning inventory 0 200,000
Add variable cost of goods manufactured (25,000 ×
1,000,000 1,000,000
$40)
————
————-
-
Goods available for sale 1,000,000 1,200,000
Less ending inventory (5,000 × $40) 200,000 0
————
————-
-
Variable cost of goods sold 800,000 1,200,000
————
————-
-
Gross contribution margin 1,200,000 1,800,000
Less variable selling and administrative expenses 120,000 180,000
————
————-
-
Contribution margin 1,080,000 1,620,000
———— ————
- -
Less period costs:
Fixed manufacturing costs 700,000 700,000
Fixed selling and administrative expenses 500,000 500,000
————
————-
-
Total period costs 1,200,000 1,200,000
————
————-
-
Net operating income/(loss) (120,000) 420,000
————
————-
-
(2) Reconciliation:
Year-1 Year-2
Net operating income (loss) under variable costing (120,000) 420,000
Fixed manufacturing cost deferred in inventory ($28 ×
140,000
5000)
Fixed manufacturing cost released from inventory ($28 ×
(140,000)
5000)
———- ———-
Net income under absorption costing 20,000 280,000
———- ———-
For reconciliation of net operating income figures:
A company manufactures a unique device that is used to boost Wi-Fi signals. The
following data relates to the first month of operation:
Beginning inventory 0
Units produced 40,000
Units sold 35,000
Selling price per unit $120
Selling and administrative expenses:
Variable per unit $4
Fixed (total for the month) $1,120,000
Manufacturing costs:
Direct materials cost per unit $30
Direct labor cost per unit $14
Variable manufacturing overhead cost per unit $4
Fixed manufacturing overhead cost $1,280,000
Required:
1. Calculate unit product cost and prepare income statement under variable costing
system and absorption costing system.
2. Prepare income statement under two costing system.
3. Prepare a schedule to reconcile the net operating income under variable and
absorption costing system.
Solution:
(1) Calculation of unit product cost:
*1,280,000/40,000
Absorption costing:
AJX company manufactures and sells a single product. Company sold the same number
of units this year as it did last year but generated different profit for two years. The
president asks for the explanation of difference in net operating income for two years.
Year 1 Year 2
Sales (40,000 units) $2,500,000 $2,500,000
Less cost of goods sold $1,680,000 $1,440,000
————- ————-
Gross margin 820,000 1,060,000
Less selling and administrative expenses 700,000 700,000
————- ————-
Net operating income 120,000 360,000
————- ————-
Year 1 Year 2
Production in units 40,000 50,000
Sales in units 40,000 40,000
Variable production cost per unit $12 $12
Fixed manufacturing overhead cost $1,200,000 $1,200,000
Variable selling and administrative expenses of AJX are $4.00 per unit sold. A new
manufacturing overhead rate is computed each year.
Required:
1. Calculate unit product cost for both the years under absorption costing and direct
costing (variable costing).
2. Prepare a contribution margin format income statement for two years.
3. Reconcile the net operating income figures for each year under two costing
methods.
4. Explain how operations would have different in year 2 if the company had been
using just in time (JIT) manufacturing and inventory control methods.
Solution:
(1) Computation of unit product cost:
Year 1 Year 2
Unit product cost under variable costing $12 $12
Unit product cost under absorption costing $12+$30*=$42 $12+$24**=$36
*1,200,000 / 40,000
**1,200,000 / 50,000
Year 1 Year 2
Sales 2,500,000 2,500,000
——— ———-
Less variable cost of goods sold:
Beginning inventory 0 0
Variable cost of goods manufactured 480,000 600,000
———- ———-
Cost of goods available for sale 480,000 600,000
Less ending inventory 0 120,000
———- ———-
Cost of goods sold 480,000 480,000
———- ———-
Gross contribution margin 2,020,000 2,020,000
Less variable selling and administrative expenses 160,000 160,000
———- ———-
Contribution margin 1,860,000 1,860,000
———- ———-
Less fixed costs:
Fixed manufacturing overhead expenses 1,200,000 1,200,000
Fixed selling and administrative expenses 540,000 540,000
———- ———-
Total fixed expenses 1,740,000 1,740,000
———- ———-
120,000 120,000
———- ———-
Year 1 Year 2
Variable costing income statement 120,000 120,000
Fixed manufacturing overhead deferred in inventory 0 240,000
———- ———-
120,000 360,000
———- ———-
If the company had been using just in time manufacturing and inventory control methods
in year 2 the difference in net operating income under variable costing and absorption
costing would have been very little to zero. The central idea of just in time manufacturing
is to eliminate inventories. For better understanding of the impact of JIT read our article
variable and absorption costing with just in time (JIT) manufacturing system.
Fine Producers Inc. suffered a loss for the first month of operations. Following is the
income statement prepared by the accounting service providers of Fine Producers.
Sales $400,000
Less variable cost of goods sold $160,000
————
Gross contribution margin $240,000
Less variable selling and administrative expenses $60,000
————
Contribution margin $180,000
Less fixed expenses:
Fixed manufacturing overhead $150,000
Fixed selling and administrative expenses $40,000 $190,000
———— ————
Net operating loss $(10,000)
————
The loss created a serious problem because company was planning to use the statement to
encourage investors to purchase the stock of the company. Other relevant data is given
below:
Required:
1. What costing method was used by the accounting service providers to prepare
income statement of Fine Producers Inc? Can an absorption costing income
statement show a profit rather than loss? Support your answer with computations.
2. Prepare company’s income statement using variable costing and absorption
costing for the second month if 60,000 units were sold in the second month and
there were no closing inventories.
3. Reconcile the second month’s net operating income under both the costing
approaches.
Solution:
(1) Costing method:
Accounting service providers used variable costing method to prepare income statement
of Fine Producers.
Yes, an income statement prepared on the basis of absorption costing can show a profit
rather than loss because a portion of fixed manufacturing overhead cost would be
absorbed by ending finished goods inventory. Under absorption costing, this absorbed
fixed cost would be deferred to the next period and would reduce the burden of current
period.
The net operating loss for the first month of operation under variable costing is $10,000
and the cost to be absorbed under absorption costing system is $30,000*. It results in a
net operating profit of $20,000 (30,000 – $10,000). The computations are shown below:
Absorption costing:
Variable costing:
(3) Reconciliation:
If the company sells 60,000 units in second month, the sales of the second month will be
more than production. In that case, the fixed manufacturing overhead cost deferred in
inventory in first month will be released from inventory in the second month and the net
operating income under absorption costing will be less than the net operating income
under variable costing.