Far North Telecom, Ltd., of Ontario, has organized a new division to manufacture

ID: 2351286 • Letter: F

Question

Far North Telecom, Ltd., of Ontario, has organized a new division to manufacture and sell specialty cellular telephones. The division's monthly costs are shown below:

Manufacturing costs:
Variable costs per unit:
Direct materials $82
Variable manufacturing overhead $4
Fixed manufacturing overhead costs (total) $246,000
Selling and administrative costs:
Variable 15% of sales
Fixed (total) $159,000

Far North Telecom regards all of its workers as full-time employees and the company has a long-standing no layoff policy. Furthermore, production is highly automated. Accordingly, the company includes its labor costs in its fixed manufacturing overhead. The cellular phones sell for $330 each. During September, the first month of operations, the following activity was recorded:

Units produced 4,100
Units sold 3,300

Requirement 1:
(a) Compute the unit product cost under Absorption costing. (Omit the "$" sign in your response.)

Unit product cost $

(b) Compute the unit product cost under Variable costing. (Omit the "$" sign in your response.)

Unit product cost $

Requirement 2:
Prepare an absorption costing income statement for September. (Input all amounts as positive values. Omit the "$" sign in your response.)

Sales$
Cost of goods sold$
Gross profit$
Selling and administrative expenses$
Net operating income$

Requirement 3:

Prepare a contribution format income statement for September using variable costing. (Input all amounts as positive values except net operating loss which should be indicated by a minus sign. Omit the "$" sign in your response.)

Sales$

(Variable expenses:)

Variable selling and administrative expenses$
Variable cost of goods sold$
Contribution margin$

(Fixed Expenses)

Fixed selling and administrative expenses$
Fixed manufacturing overhead$
Net operating income$

Requirement 4

Reconcile the absorption costing and variable costing net operating incomes in requirement 2 and 3 above. (Negative amounts should be indicated by a minus sign. Omit the "$" sign in your response.)

Variable costing net operating income$

Add Fixed manufacturing overhead cost deferred

Absorption costing net operating income$

Explanation / Answer

a. and b.

Absorption Costing

Variable Costing

Direct materials...................................................................

$48

Variable manufacturing overhead.......................................

Fixed manufacturing overhead
($360,000 ÷ 12,000 units)...............................................

—

Unit product cost................................................................

$80

$50

2. Absorption costing income statement:

Sales (10,000 units × $150 per unit).............................

$1,500,000

Less cost of goods sold:

Beginning inventory.................................................

$ 0

Add cost of goods manufactured
(12,000 units × $80 per unit).................................

960,000

Good available for sale.............................................

960,000

Less ending inventory
(2,000 units × $80 per unit)...................................

160,000

800,000

Gross margin................................................................

700,000

Less selling and administrative expenses
[(12% × $1,500,000) + $470,000]............................

650,000

Net operating income...................................................

$ 50,000

3. Variable costing income statement:

Sales (10,000 units × $150 per unit)..................................

$1,500,000

Less variable expenses:

Variable cost of goods sold:

Beginning inventory.................................................

$ 0

Add variable manufacturing costs
(12,000 units × $50 per unit).................................

600,000

Goods available for sale............................................

600,000

Less ending inventory
(2,000 units × $50 per unit)...................................

100,000

Variable cost of goods sold*.........................................

500,000

Variable selling and administrative expenses.................

180,000

680,000

Contribution margin..........................................................

820,000

Less fixed expenses:

Fixed manufacturing overhead......................................

360,000

Fixed selling and administrative expenses....................

470,000

830,000

Net operating loss..............................................................

$ (10,000)

* This could be computed more simply as 10,000 units × $50 per unit = $500,000

4. A manager may prefer to take the statement prepared under the absorption approach in part (2), since it shows a profit for the month. As long as inventory levels are rising, absorption costing will report higher profits than variable costing. Notice in the situation above that the company is operating below its theoretical break-even point, but yet reports a profit under the absorption approach. The ethics of this approach are debatable.

Variable costing net operating loss.................................................

$ (10,000)

Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing
(2,000 units × $30 per unit).........................................................

60,000

Absorption costing net operating income.......................................