During Heaton Company’s first two years of operations, the company reported absorption costing net operating income as follows: Year 1 Year 2 Sales (@ $61 per unit) $ 976,000 $ 1,586,000 Cost of goods sold (@ $34 per unit) 544,000 884,000 Gross margin 432,000 702,000 Selling and administrative expenses* 295,000 325,000 Net operating income $ 137,000 $ 377,000 * $3 per unit variable; $247,000 fixed each year. The company’s $34 unit product cost is computed as follows: Direct materials $ 6 Direct labor 8 Variable manufacturing overhead 2 Fixed manufacturing overhead ($378,000 ÷ 21,000 units) 18 Absorption costing unit product cost $ 34 Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consistsof depreciation charges on production equipment and buildings. Production and cost data for the two years are: Year 1 Year 2 Units produced 21,000 21,000 Units sold 16,000 26,000 Required: 1. Prepare a variable costing contribution format income statement for each year. Heaton Company Variable Costing Income Statement Year 1 Year 2 Variable expenses: Total variable expenses Fixed expenses: Total fixed expenses Net operating income (loss) 2. Reconcile the absorption costing and the variable costing net operating income figures for each year. Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes (Losses) Year 1 Year 2 Variable costing net operating income (loss) Add (deduct) fixed manufacturing overhead deferred in (released from) inventory under absorption costing Absorption costing net operating income (loss)
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
During Heaton Company’s first two years of operations, the company reported absorption costing net operating income as follows:
| Year 1 | Year 2 | ||||||
| Sales (@ $61 per unit) | $ | 976,000 | $ | 1,586,000 | |||
| Cost of goods sold (@ $34 per unit) | 544,000 | 884,000 | |||||
| Gross margin | 432,000 | 702,000 | |||||
| Selling and administrative expenses* | 295,000 | 325,000 | |||||
| Net operating income | $ | 137,000 | $ | 377,000 | |||
* $3 per unit variable; $247,000 fixed each year.
The company’s $34 unit product cost is computed as follows:
| Direct materials | $ | 6 | |
| Direct labor | 8 | ||
| Variable manufacturing |
2 | ||
| Fixed manufacturing overhead ($378,000 ÷ 21,000 units) | 18 | ||
| Absorption costing unit product cost | $ | 34 | |
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:
| Year 1 | Year 2 | ||||||
| Units produced | 21,000 | 21,000 | |||||
| Units sold | 16,000 | 26,000 | |||||
Required:
1. Prepare a variable costing contribution format income statement for each year.
|
2. Reconcile the absorption costing and the variable costing net operating income figures for each year.
|
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