# Flaherty, Inc., has just completed its first year of operations. The unit costs on a normal...

## Question:

Flaherty, Inc., has just completed its first year of operations. The unit costs on a normal costing basis are as follows: Manufacturing costs (per unit):

Direct materials (3 lbs. @ 1.40) $4.20 Direct labor (0.4 hr. @ 15.00) 6.00 Variable overhead (0.4 hr. @ 4.00) 1.60 Fixed overhead (0.4 hr. @ 7.00) 2.80 Total$14.60

Variable $1.60 per unit Fixed$217,000

During the year, the company had the following activity: Units produced 26,500 Units sold 23,850 Unit selling price $35 Direct labor hours worked 10,600 Actual fixed overhead was$12,800 less than budgeted fixed overhead. Budgeted variable overhead was $4,500 less than the actual variable overhead. The company used an expected actual activity level of 10,600 direct labor hours to compute the predetermined overhead rates. Any overhead variances are closed to Cost of Goods Sold. Required: 1. Compute the unit cost using (a) absorption costing and (b) variable costing. 2. Prepare an absorption-costing income statement. Round your answers to the nearest cent. 3. Prepare a variable-costing income statement. Round your answers to the nearest cent. 4. Reconcile the difference between the two income statements. The absorption costing generates an income$ _ _ _ than variable costing.

## Absorption Vs. Variable Costing:

There are two primary methods available to assign costs to units of inventory: absorption costing and variable costing. Under absorption costing, all manufacturing costs are absorbed into inventory including direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. Under variable costing, in contrast, only variable manufacturing costs are included; thus, fixed manufacturing overhead is excluded.

Question 1.

Compute the unit cost using (a) absorption costing and (b) variable costing.

Absorption Variable
Direct materials (3 lbs. @ 1.40) $4.20$4.20
Direct labor (0.4 hr. @ 15.00) 6.00 6.00
Variable overhead (0.4 hr. @ 4.00) 1.60 1.60
Fixed overhead (0.4 hr. @ 7.00) 2.80
$14.60$11.80

Question 2.

Prepare an absorption-costing income statement. Round your answers to the nearest cent.

First, note the way in which the overhead variances will be closed to cost of goods sold.

Account Debit Credit Explanation
Factory Overhead - Fixed $12,800 Close out variance in fixed factory overhead account Cost of Goods Sold$8,300 Transfer variances to cost of goods sold, balancing the entry ($12,800 -$4,500)
Factory Overhead - Variable $4,500 Close out variance in variable factory overhead account We're now ready to construct our statement. Note that any further calculations are located in parentheses in the first column. Flaherty, Inc., Income Statement For the year ended December 31, 201X Sales ($35 x 23,850) $834,750 Less: Cost of goods sold ($14.60 x 23,850 - $8,300) 339,910 Gross profit 494,840 Less: Selling and administrative expenses Variable selling and administrative expense ($1.60 x 23,850 units) 38,160
Fixed selling and administrative expense 217,000
Total selling and administrative expense 255,160
Operating income $239,680 Question 3. Prepare a variable-costing income statement. Round your answers to the nearest cent. Flaherty, Inc., Income Statement For the year ended December 31, 201X Sales ($35 x 23,850) $834,750 Less: Cost of goods sold ($11.80 x 23,850 - $8,300) 273,130 Less: Selling and administrative expenses ($1.60 x 23,850 units) 38,160
Contribution Margin 523,460
Less: Fixed overhead ($2.80 x 26,500 units) 74,200 Fixed selling and administrative expense 217,000 Operating income$232,260

Question 4.

Reconcile the difference between the two income statements. The absorption costing generates an income $_ _ _ than variable costing.  Net operating income under absorption costing$239,680 Net operating income under variable costing $232,260 Difference in net operating income$7,420 Difference in units manufactured and sold (26,500 - 23,850) 2,650 Fixed manufacturing overhead per unit x $2.80 Fixed manufacturing overhead deferred in inventory$7,420

The absorption costing generates an income \$7,420 higher than variable costing.