EXERCISE 6-6 Variable and Absorption Costing Unit Product Costs and Income Statements L06-1, LO6-2 |
Lynch Company manufactures and sells a single product. The following costs were incurred during the company's first year of operations: |
Variable costs per unit | ||||
Manufacturing: | ||||
Direct materials | $24 | |||
Direct labor | $14 | |||
Variable manufacturing |
$2 | |||
Variable selling and administrative | $4 | |||
Fixed costs per year | ||||
Fixed manufacturing overhead | $800,00 | |||
Fixed selling and administrative expense | $496,000 |
During the year, the company produced 25,000 units and sold 20,000 units. The selling price of the company's product is $50 per unit. |
|
Required: | |
Assume that the company uses absorption costing: | |
Compute the unit product cost. | |
Prepare an income statement for the year. | |
Assume that the company uses variable costing: | |
Compute the unit product cost. | |
Prepare an income statement for the year. | |
The absorption costing is a technique where the all the cost relating to manufacturing (whether fixed or variable) shall be taken in to consideration, whereas in variable costing, only variable cost of manufacturing is taken into consideration while valuing inventory.
Requirement1a:
The cost per unit produced under absorption costing method.
Answer to Problem 6E
Solution: The cost per unit produced under absorption costing method is $30.
Explanation of Solution
Under Absorption costing, the total cost of manufacturing the goods includes the direct material cost, direct labour cost and manufacturing overheads (whether fixed and variable). On the basis of total cost of manufacturing, the cost per unit produced shall be computed.
Under Absorption costing, the product unit cost shall be computed as under:
STATEMENT SHOWING UNIT PRODUCT COST UNDER ABSORPTION COSTING | |
AMOUNT $ | |
Total cost of manufacturing: | |
Direct Material (25000 units @$6 per unit) | 150,000 |
Direct Labour (25000 units@ $9 per unit) | 225000 |
Variable manufacturing Overheads (25000 units@ $3) | 75000 |
Fixed manufacturing Overheads | 300,000 |
TOTAL MANUFACTURING COST | 750,000 |
Divide by: Number of units produced | 25,000 |
PRODUCT UNIT COST | 30 |
To conclude, it must be said that the total cost under Absorption costing includes all the direct material, direct labour and total manufacturing overheads (whether fixed or variable).
Requirement1b:
To show: The Income Statement as per Absorption costing.
Answer to Problem 6E
Solution: The Income Statement as per Absorption costing shall be made as under:
INCOME STATEMENT UNDER ABSORPTION COSTING | |
AMOUNT $ | |
Sales Revenue (20000 units@ $ 50 per unit) | 1000000 |
Less: Cost of Goods sold (20,000 units @30) | 600000 |
Gross Margin | 400,000 |
Less: Selling overheads | |
Variable selling overheads (20,000 units@ $ 4) | 80,000 |
Fixed Selling overheads | 190,000 |
NET OPERATING INCOME | 130,000 |
Explanation of Solution
Under Absorption costing, the cost of goods sold shall be prepared on the basis of product unit cost as computed above. The Gross margin shall be the net of revenue over cost of goods sold. Then the total selling overheads shall be deducted from Gross margin to arrive at the Net operating income under Absorption costing.
To conclude, it must be said that the net operating income shall be generated by deducting the cost of goods sold and total selling overheads from the sales revenue under Absorption costing.
Requirement2:
The unit product cost under variable costing.
Answer to Problem 6E
Solution: The unit product cost under variable costing is $18.
Explanation of Solution
Under variable costing, the total cost of manufacturing shall be considered on the basis of direct material cost, direct labour cost and variable manufacturing overheads and per unit cost of goods produced shall be determined accordingly.
The direct material and direct labour cost is a cost related to manufacturing which is variable in nature and is included in the total cost of manufacturing in both absorption and variable costing techniques. The difference between both the techniques is the inclusion of manufacturing overheads in the total cost of manufacturing. Under absorption costing, all manufacturing overheads are taken into consideration while computing total cost of manufacturing. In variable costing, only variable manufacturing overheads are taken into consideration for computing the total cost of manufacturing.
The product unit cost under variable costing shall be computed as under:
STATEMENT SHOWING UNIT PRODUCT COST UNDER VARIABLE COSTING | |
AMOUNT $ | |
Total cost of manufacturing: | |
Direct Material (25000 units @$6 per unit) | 150,000 |
Direct Labour (25000 units@ $ 9 per unit) | 225000 |
Variable manufacturing Overheads (25000 units@ $3) | 75000 |
TOTAL MANUFACTURING COST | 450,000 |
Divide by: Number of units produced | 25,000 |
PRODUCT UNIT COST | 18 |
To conclude, it must be said that the manufacturing cost includes the cost of manufacturing of variable nature only and does not include fixed manufacturing overheads.
Requirement2b:
To prepare: The income statement under Variable costing.
Answer to Problem 6E
Solution: The Income statement under Variable costing shall be made as under:
INCOME STATEMENT UNDER VARIABLE COSTING | |
AMOUNT $ | |
Sales Revenue (20,000 units@ $ 50 per unit) | 1,000,000 |
Less: Variable cost | |
Cost of goods sold (20,000 units @$18 per unit) | 360,000 |
Selling Overheads (20,000 units@$4 per unit) | 80,000 |
Contribution margin | 560,000 |
Less: Fixed cost | |
Fixed Manufacturing overheads | 300,000 |
Fixed Selling overheads | 190,000 |
NET OPERATING INCOME | 70,000 |
Explanation of Solution
Under Variable costing, the cost of goods sold is valued at unit product cost computed. The contribution margin earned shall be computed by deducting the cost of goods sold and variable selling overheads from Sales revenue. The Total fixed cost including the manufacturing overheads shall be deducted from the contribution margin to compute the net operating income.
To conclude, it must be said that the difference between absorption and variable costing technique is the inclusion of fixed manufacturing overheads in absorption costing in valuation of Ending inventory which is not so in case of Variable costing technique.
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EBK MANAGERIAL ACCOUNTING
- Appendix Absorption costing income statement On June 30, the end of the first month of operations, Tudor Manufacturing Co. prepared the following income statement, based on the variable existing concept: Sales (420,000 units) 7,450,000 Variable cost of goods sold: Variable cost of goods manufactured (500,000 units x 14 per unit) 7,000,000 Less ending inventory (80,000 units x 14 per unit) 1,120,000 Variable cost of goods sold 5,880,000 Manufacturing margin 1,570,000 Variable selling and administrative expenses 80,000 Contribution margin 1,490,000 Fixed costs: Fixed manufacturing costs 160,000 Fixed selling and administrative expenses 75,000 235,000 Income from operations 1,255,000 a. Prepare an absorption costing income statement. b. Reconcile the variable costing income from operations of 1,255,000 with the absorption costing income from operations determined in (a).arrow_forward(Appendix 11A) Manufacturing Cycle Efficiency Kurena Company provided the following information on one of its factories: Maximum units produced in a quarter: 180,000 units Actual units produced in a quarter: 112,500 units Hours of cell production labor in a quarter: 30,000 hours Theoretical cycle time: 10 minutes per unit Actual cycle time: 16 minutes per unit Required: 1. Calculate the amount of processing time per unit and the amount of nonprocessing time per unit. 2. Calculate the MCE (rounded to three significant digits).arrow_forward
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