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1) Consider the following information for Narnia Co. Selling price per unit $12.00 Variable...

Question:

1) Consider the following information for Narnia Co.

  1. Selling price per unit $12.00
  2. Variable manufacturing cost per unit $6.50
  3. Variable selling and administrative cost per unit $1.25
  4. Fixed selling and administrative expense $150,000
  5. Beginning inventory last year 0 units
  6. Production last year 240,000 units
  7. Sales last year 233,500 units
  8. Production this year 200,000 units
  9. Sales this year 203,000 units
  10. Fixed manufacturing cost per unit last year $2.00

1. Given that fixed manufacturing overhead in total has not changed from last year, what is this year's net operating income using absorption costing?

  1. a) $225,550
  2. b) $228,150
  3. c) $276,350
  4. d) $306,750

2) Given that total fixed manufacturing overhead has not changed from last year, what is this year's net operating income using variable costing?

  1. a) $226,050
  2. b) $232,750
  3. c) $252,250
  4. d) $306,750

Variable costing and absorption costing:

Variable costing is used by the management for internal reporting purposes only while absorption costing is used for external reporting purposes. The difference between variable costing and absorption costing is the treatment of fixed overhead cost. Under absorption costing, fixed overhead is recognized as part of product cost while under variable costing, fixed overhead is recognized as part of period cost.

Answer and Explanation:

Question 1

First, let us determine the total value of fixed manufacturing overhead:

  • Fixed manufacturing overhead = total production last year x fixed manufacturing cost per unit
  • Fixed manufacturing overhead = 240,000 units x $2 per unit
  • Fixed manufacturing overhead = $480,000

Next, let us determine the value of beginning inventory this year (last year's ending inventory):

  • Beginning inventory = (Production last year - Sales last year) x (variable manufacturing cost per unit + fixed manufacturing cost per unit)
  • Beginning inventory = (240,000 units - 233,500 units) x ($6.5 + $2)
  • Beginning inventory = 6,500 units x $8.5
  • Beginning inventory = $55,250

To proceed, let us compute for the fixed manufacturing overhead per unit for the current year:

  • Fixed manufacturing overhead per unit = Fixed manufacturing overhead / Production this year
  • Fixed manufacturing overhead per unit = $480,000 / 200,000 units
  • Fixed manufacturing overhead per unit = $2.4 per unit

Now that we have the fixed manufacturing overhead per unit for this year, let us now compute for the ending inventory this year and its corresponding cost:

  • Ending inventory = Beginning inventory + Production this year -Sales this year
  • Ending inventory = 6,500 units + 200,000 units - 203,000 units
  • Ending inventory = 3, 500 units


  • Cost of ending inventory = Ending inventory x Cost per unit
  • Cost of ending inventory = 3,500 units x (variable overhead + fixed overhead per unit)
  • Cost of ending inventory = 3,500 units x ($6.5 + $2.4)
  • Cost of ending inventory = 3,500 units x $8.9
  • Cost of ending inventory = $31,150

Afterwards, let us determine the value of the units produced this year:

  • Value of units produced = total units produced x (variable overhead + fixed overhead per unit)
  • Value of units produced = 200,000 units x ($6.5 + $2.4)
  • Value of units produced = 200,000 units x $8.9
  • Value of units produced = $1,780,000

Now we are ready to compute for the absorption costing net income:

  • Net income = Sales - Cost of goods sold - Selling and administrative cost
  • Net income = ($12 x 203,000 units) - (value of beginning inventory + value of total units produced - value of ending inventory) - selling and administrative cost
  • Net income = $2,436,000 - ($55,250 + $1,780,000 - $31,150) - $150,000 - ($1.25 x 203,000 units)
  • Net income = $2,436,000 - $1,804,100 - $150,000 - $253,750
  • Net income = $228,150

Therefore, based on our computation, the absorption costing net income is b. $228,150.

Question 2

Under variable costing, the total fixed overhead is expensed outright, thus to compute:

  • Variable costing net income - Sales - Variable cost - Fixed cost
  • Variable costing net income = ($12 x 203,000 units) - (($6.5 + $1.25) x 203,000 units) - Fixed manufacturing overhead - Fixed selling and administrative cost
  • Variable costing net income = ($12 x 203,000 units) - (($6.5 + $1.25) x 203,000 units) - $480,000 - $150,000
  • Variable costing net income = $2,436,000 - ($7.75 x 203,000) - $480,000 - $150,000
  • Variable costing net income = $2,436,000 - $1,573,250 - $480,000 - $150,000
  • Variable costing net income = $232,750

Therefore, our answer is b. $232,750


Learn more about this topic:

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Variable Costing: Method, Formula & Advantages

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