During Heaton Company’s first two years of operations, it reported absorption costing net operating income as follows: Year 1 Year 2 Sales (@ $64 per unit) $ 1,024,000 $ 1,664,000 Cost of goods sold (@ $31 per unit) 496,000 806,000 Gross margin 528,000 858,000 Selling and administrative expenses* 299,000 329,000 Net operating income $ 229,000 $ 529,000 * $3 per unit variable; $251,000 fixed each year. The company’s $31 unit product cost is computed as follows: Direct materials $ 7 Direct labor 8 Variable manufacturing overhead 5 Fixed manufacturing overhead ($231,000 ÷ 21,000 units) 11 Absorption costing unit product cost $ 31 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 first two years of operations are: Year 1 Year 2 Units produced 21,000 21,000 Units sold 16,000 26,000 1. Using variable costing, what is the unit product cost for both years? 2. What is the variable costing net operating income in Year 1 and in Year 2? 3. Reconcile the absorption costing and the variable costing net operating income figures for each year.
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, it reported absorption costing net operating income as follows:
| Year 1 | Year 2 | ||||
| Sales (@ $64 per unit) | $ | 1,024,000 | $ | 1,664,000 | |
| Cost of goods sold (@ $31 per unit) | 496,000 | 806,000 | |||
| Gross margin | 528,000 | 858,000 | |||
| Selling and administrative expenses* | 299,000 | 329,000 | |||
| Net operating income | $ | 229,000 | $ | 529,000 | |
* $3 per unit variable; $251,000 fixed each year.
The company’s $31 unit product cost is computed as follows:
| Direct materials | $ | 7 |
| Direct labor | 8 | |
| Variable manufacturing |
5 | |
| Fixed manufacturing overhead ($231,000 ÷ 21,000 units) | 11 | |
| Absorption costing unit product cost | $ | 31 |
Forty percent of fixed manufacturing overhead consists of wages and salaries; the remainder consists of
Production and cost data for the first two years of operations are:
| Year 1 | Year 2 | |
| Units produced | 21,000 | 21,000 |
| Units sold | 16,000 | 26,000 |
1. Using variable costing, what is the unit product cost for both years?
2. What is the variable costing net operating income in Year 1 and in Year 2?
3. Reconcile the absorption costing and the variable costing net operating income figures for each year.
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