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Exercise 7-9 Variable and Absorption Costing Unit Product Costs and Income Statements [LO7-1, LO7-2, LO7-3]
Walsh Company manufactures and sells one product. The following information pertains to each of the company’s first two years of operations:
Variable costs per unit:
Manufacturing:
Direct materials $ 25
Direct labor $ 15
Variable manufacturing overhead $5
Variable selling and administrative $2
Fixed costs per year:
Fixed manufacturing overhead $250,000
Fixed selling and administrative expenses $80,000
During its first year of operations, Walsh produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $60 per unit.
Required:
1. Assume the company uses variable costing:
a. Compute the unit product cost for Year 1 and Year 2.
b. Prepare an income statement for Year 1 and Year 2.
2. Assume the company uses absorption costing:
a. Compute the unit product cost for Year 1 and Year 2.
b. Prepare an income statement for Year 1 and Year 2.
3. Reconcile the difference between variable costing and absorption costing net operating income in Year 1.

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Answer:

1 a. Year 1 unit product cost = 45

     Year 2 unit product cost = 45

Notes: Unit product cost = Direct materials + direct labor + Variable manufacturing overhead = 25 + 15 + 5 = 45 units

1 b.                        Income statement

                                                     Year 1           Year 2

Sales                                         2,400,000    3,000,000

(40000*60); (50000*60)

Less:

Variable cost of goods sold     1,800,000     2,250,000    

Variable selling and adm.          80,000         100,000

Contribution margin                520,000        650,000

Less:

Fixed manufacturing overhead  250,000      250,000    

Fixed selling & adm expense      80,000         80,000

Net income                                  $190,000     $320,000

2 a.  Notes

                                                             Year 1   Year 2

Direct materials                                      25     25  

Direct labor                                              15     15  

Variable manufacturing overhead         5         5  

Fixed manufacturing overhead             5      6.25

(250,000/50,000); (250,000/40000)

Unit product cost                                    50    51.25

b.                                 Income statement

                                              Year 1         Year 2

Sales                                   2400000    3000000

Less: cost of goods sold   2000000    2550000

Gross margin                      400,000     450,000

Less: Selling and                160,000 180,000

administrative expense  

Net income                         240,000     270,000

Workings

Cost of goods sold for year 2 = (10,000* 50) + (40000 * 51.25)

= 500,000 + 2,050,000

= 25,500,000

3. Reconciliation                                Year 1          Year 2

Variable costing net operating        190,000      320,000

income (loss)    

Add: Deferred fixed overhead          50,000

in ending inventory (10000*5)  

Less: Fixed overhead realized                             -50,000

in beginning inventory(10000*5)

Absorption costing net operating   $240,000    270,000

income (loss)  

Answer 1:

Part a

  • Unit product cost = Direct materials + direct labor + Variable manufacturing overhead
  • Unit product cost = 25 + 15 + 5
  • Unit product cost = 45 units

Year 1 -unit product cost = 45

Year 2 -unit product cost = 45

Part  b :

                                                   Income statement

                                                    Year 1           Year 2

Sales                                         2,400,000    3,000,000  

                                                 (40000*60)  (50000*60)  

Less:  

Variable cost of goods sold     1,800,000     2,250,000    

Variable selling and adm.          80,000         100,000

Contribution margin                  520,000        650,000

Less:

Fixed manufacturing overhead  250,000      250,000    

Fixed selling & adm expense      80,000         80,000

Net income                                  $190,000     $320,000

Answer 2 :

Part a  

                                                            Year 1   Year 2

Direct materials                                       25     25    

Direct labor                                               15     15    

Variable manufacturing overhead           5       5    

Fixed manufacturing overhead               5      6.25  

(250,000/50,000); (250,000/40000)  

Unit product cost                                    50    51.25

Part b.                                

                                          Income statement

                                              Year 1         Year 2  

Sales                                   2400000    3000000

Less: cost of goods sold   2000000    2550000

Gross margin                      400,000     450,000

Less: Selling and                160,000 180,000

 Net income                         240,000     270,000

  • An income statement for Year 1 - 240,000and Year 2-270,000.

(Working Notes):

Cost of goods sold for year 2 = (10,000* 50) + (40000 * 51.25)

Cost of goods sold for year 2 = 500,000 + 2,050,000

Cost of goods sold for year 2 = 25,500,000

Answer 3:

The difference between variable costing and absorption costing net operating income in Year 1.

        Reconciliation                                    Year 1          Year 2

  • Variable costing net operating         190,000      320,000

          income (loss)    

  • Add: Deferred fixed overhead          50,000

          in ending inventory (10000*5)  

  • Less: Fixed overhead realized                               -50,000

       in beginning inventory(10000*5)

      Absorption costing net operating    $240,000    270,000

 

  • The difference between variable costing and absorption costing net operating income in Year 1 is $2,40,000.

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