Chapter 5, Problem 5.25P

1.

To determine

Introduction: Absorption costing is a technique for calculating cost of product by taking indirect expense and direct cost into consideration.

To prepare: absorption costing income statement.

Answer to Problem 5.25P

Income statement is given below.

Explanation of Solution

Year 1 Variable cost of goods sold

  $\begin{array}{l}COGS=(UnitsSold\times Unitproduct\cos t)\\ =50000units\times \$2\\ =\$100,000\end{array}$

Variable selling and administrative expense:

  $\begin{array}{l}Variabelsellingad\min istrative\cos ts=Unitssold\times Variable\cos tperunit\\ =50,000unitssold\times \$1\\ =50,000\end{array}$

Data	Amount $	`Amount $
Sales		800,000
Variable Expense
Cost of goods sold	100,000
Variable administrative	50,000
Total variable expense		150,000
Contribution margin		650,000
Fixed expense :
Fixed manufacturing expense	480,000
Fixed administrative expense	140,000
Total fixed expense		620,000
Net operating income		30,000

Year 2 Variable cost of goods sold

  $\begin{array}{l}COGS=(UnitsSold\times Unitproduct\cos t)\\ =40000units\times \$2\\ =\$100,000\end{array}$

Variable selling and administrative expense:

  $\begin{array}{l}Variabelsellingad\min istrative\cos ts=Unitssold\times Variable\cos tperunit\\ =40,000unitssold\times \$1\\ =40,000\end{array}$

Data	Amount $	`Amount $
Sales		640,000
Variable Expense
Cost of goods sold	80,000
Variable administrative	40,000
Total variable expense		120,000
Contribution margin		520,000
Fixed expense :
Fixed manufacturing expense	480,000
Fixed administrative expense	140,000
Total fixed expense		620,000
Net operating income		(10,000)

Year 3 Variable cost of goods sold

  $\begin{array}{l}COGS=(UnitsSold\times Unitproduct\cos t)\\ =50000units\times \$2\\ =\$100,000\end{array}$

Variable selling and administrative expense:

  $\begin{array}{l}Variabelsellingad\min istrative\cos ts=Unitssold\times Variable\cos tperunit\\ =50,000unitssold\times \$1\\ =50,000\end{array}$

Data	Amount $	`Amount $
Sales		800,000
Variable Expense
Cost of goods sold	100,000
Variable administrative	50,000
Total variable expense		150,000
Contribution margin		650,000
Fixed expense :
Fixed manufacturing expense	480,000
Fixed administrative expense	140,000
Total fixed expense		620,000
Net operating income		30,000

2.

To determine

Introduction: Absorption costing is a technique for calculating cost of product by taking indirect expense and direct cost into consideration.

To calculate: Unit product cost by using absorption costing for each year.

Answer to Problem 5.25P

Unit product cost by using absorption costing for year 1 is $11.60, year 2 is $10 and year 3 is $14

Explanation of Solution

1. Fixed manufacturing overhead
Year 1

  $\begin{array}{l}Fixedmanufacturingoverhead=\frac{Totalfixedmanufacturingoverhead}{Numberofunitsproduced}\\ =\frac{\$480,000}{50,000units}\\ =\$9.60\end{array}$

Unit product cost as follows:

Particular	Per unit costs $
Variable manufacturing overhead	2
Add: fixed manufacturing overhead	9.60
Unit product cost by using absorption costing	11.60

Year 2

  $\begin{array}{l}Fixedmanufacturingoverhead=\frac{Totalfixedmanufacturingoverhead}{Numberofunitsproduced}\\ =\frac{\$480,000}{60,000units}\\ =\$8\end{array}$

Unit product cost as follows:

Particular	Per unit costs $
Variable manufacturing overhead	2
Add: fixed manufacturing overhead	8
Unit product cost by using absorption costing	110

Year 3

  $\begin{array}{l}Fixedmanufacturingoverhead=\frac{Totalfixedmanufacturingoverhead}{Numberofunitsproduced}\\ =\frac{\$480,000}{40,000units}\\ =\$12\end{array}$

Unit product cost as follows:

Particular	Per unit costs $
Variable manufacturing overhead	2
Add: fixed manufacturing overhead	12
Unit product cost by using absorption costing	14

2. Units in ending inventory:

Year 1

  $\begin{array}{l}Unitsinendinginventory=Unitbeginninginventory+Unitsproduced-unitsold\\ =0+50000units-50000\text{}units\\ =0\end{array}$

  $\begin{array}{l}Fixedmanufacturingoverheadinendinginventory-fixedmanufacturingoverheadinbeginninginventory\\ =0\times \$5-\$0\\ =\$0\end{array}$

Absorption net operating income as:

Particular	Amount $
Variable net operating income	30000
Add: fixed manufacturing overhead deferred in inventory	0
Absorption costing net operating income	30000

Absorption costing net operating income for year 1 is $30,000

Year 2

  $\begin{array}{l}Unitsinendinginventory=Unitbeginninginventory+Unitsproduced-unitsold\\ =0+60000units-40000\text{}units\\ =20,000units\end{array}$

  $\begin{array}{l}Fixedmanufacturingoverheadinendinginventory-fixedmanufacturingoverheadinbeginninginventory\\ =20,000\times \$8-\$0\\ =\$160,000\end{array}$

Absorption net operating income as:

Particular	Amount $
Variable net operating income	(10,000)
Add: fixed manufacturing overhead deferred in inventory	160,000
Absorption costing net operating income	60,000

Absorption costing net operating income for year 1 is $60,000 Year 3

  $\begin{array}{l}Unitsinendinginventory=Unitbeginninginventory+Unitsproduced-unitsold\\ =20000+40000units-50000\text{}units\\ =10000units\end{array}$

  $\begin{array}{l}Fixedmanufacturingoverheadinendinginventory-fixedmanufacturingoverheadinbeginninginventory\\ =(10000\times \$12)-(\$20000\times 12)\\ =(\$40,000)\end{array}$

Absorption net operating income as:

Particular	Amount $
Variable net operating income	30,000
Add: fixed manufacturing overhead deferred in inventory	(40,000)
Absorption costing net operating income	(10,000)

Absorption costing net operating income for year 1 is ($10,000) Unit product cost by using absorption costing for year 1 is $11.60, year 2 is $10 and year 3 is $14

3.

To determine

Introduction: Absorption costing is a technique for calculating cost of product by taking indirect expense and direct cost into consideration.

the absorption costing income statement, net operating income was higher in year 2 than it was in Year 1

Answer to Problem 5.25P

The two main reason of increasing net operating income for the year are given below.

Explanation of Solution

The two main reason of increasing net operating income for the year are as follows:

• Reduction in the unit product cost sue to high production in year 2
• Huge amount of fixed manufacturing overhead for the year was deferred in inventory.

4.

To determine

Introduction: Absorption costing is a technique for calculating cost of product by taking indirect expense and direct cost into consideration.

To determine: the reason for loss in year 3

Answer to Problem 5.25P

Reason for loss in year 2 is that the fixed manufacturing overhead deferred in inventory was charged against the operation in year 3

Explanation of Solution

Reason for loss in year 2 is that in year 2 the fixed manufacturing overhead deferred in inventory was charged against the operation in year 3. The included costs charged are higher than the cost deferred to the upcoming years. As a result the company reported loss for the year even though the units sold is same in year.

5.

To determine

Introduction: Absorption costing is a technique for calculating cost of product by taking indirect expense and direct cost into consideration.

To prepare: Net operating income for year 1,2 and 3

Answer to Problem 5.25P

Net operating income for year 1 is $30000, year 2 ($10000) and year 3 is $30000

Explanation of Solution

1. By using lean production company’s production will be attached to sales in each year. Hence no finished goods inventory would have developed in the second year or third
2. Income statement using absorption costing

Particular	Year 1	Year 2	Year 3
Sales	800,000	640,000	800,000
Cost of goods sold	580,000		580,000
Cost of goods manufactured	464,000
Add: under applied overhead	96,000
Cost of goods sold	580,000	560,000	580,000
Gross margin	220,000	80,000	220,000
Less: selling and administrative expense	190,000	180,000	190,000
Net operating income	30000	(100000)	30,000

Under applied overhead:

  $\begin{array}{l}undreappliedoverhead=(unitssales\times costofgoodsmanufacturedperunit)\\ =40,000units\times 11.60\\ =\$464,000\end{array}$

Net operating income for year 1 is $30000, year 2 ($10000) and year 3 is $30000