Walsh Company manufactures and sells one product. The following information pertains to each of the company’s first two years of operations:

Variable costs per unit:
Manufacturing:
Direct materials $ 25
Direct labor $ 15
Variable manufacturing overhead $ 5
Variable selling and administrative $ 2
Fixed costs per year:
Fixed manufacturing overhead $ 250,000
Fixed selling and administrative expenses $ 80,000

During its first year of operations, Walsh produced 50,000 units and sold 40,000 units. During its second year of operations, it produced 40,000 units and sold 50,000 units. The selling price of the company’s product is $60 per unit.

Required:1. Assume the company uses variable costing:a. Compute the unit product cost for year 1 and year 2. b. Prepare an income statement for year 1 and year 2. 2. Assume the company uses absorption costing:a. Compute the unit product cost for year 1 and year 2. (Round your answer to 2 decimal places.) b. Prepare an income statement for year 1 and year 2. (Round your intermediate calculations to 2 decimal places.) 3. Reconcile the difference between variable costing and absorption costing net operating income in year 1 and year 2.

Walsh company

A.

Assume Variable Costing

a. Unit Product Costing

Direct materials $ 25

Add: Direct labor $ 15

Add: Variable manufacturing overhead $ 5

Total Variable costs per unit = $45

Year 1 product costs = $45 x 50,000 = $2,250,000

Year 2 product costs = $45 x 40,000 = $1,800,000

b.i. Income statement for Year 1.

Sales = $60 x 40,000 = $2,400,000

Less Cost of Sales = $45 x 40,000 = -$1,800,000

Gross Margin = $600,000

Less Fixed Costs:

Fixed Manufacturing Overhead = -$250,000

Fixed Selling & Admin expense = -$80,000

Less Variable selling & Admin Expenses ($2 x 40,000) = -$80,000

Net income (Year 1) = $190,000

b.ii. Income statement for Year 2.

Sales = $60 x 50,000 = $3,000,000

Less Cost of Sales = $45 x 50,000 = -$2,250,000

Gross Margin = $750,000

Less Fixed Costs:

Fixed Manufacturing Overhead = -$250,000

Fixed Selling & Admin expense = -$80,000

Less Variable selling & Admin Expenses ($2 x 50,000) = -$100,000

Net income (Year 2) = $320,000

B.

Assume Absorption Costing

Unit Product Cost

Year 1.

Fixed Manufacturing Costs + Variable Manufacturing Costs = $250,000 + ($45 x 50,000) = $2,500,000

Cost Per Unit = $2,500,000 divided by 50,000 = $50

Year 2.

Fixed Manufacturing Costs + Variable Manufacturing Costs = $250,000 + ($45 x 40,000) = $2,050,000

Cost Per Unit = $2,050,000 divided by 40,000 = $51.25

b.i. Income statement for Year 1.

Sales = $60 x 40,000 = $2,400,000

Less Cost of Sales = $50 x 40,000 = -$2,000,000

Gross Margin = $400,000

Less: Fixed Selling & Admin expense = -$80,000

Less Variable selling & Admin Expenses ($2 x 40,000) = -$80,000

Net income (Year 1) = $240,000

b.ii. Income statement for Year 2.

Sales = $60 x 50,000 = $3,000,000

Less Cost of Sales = $51.25 x 50,000 = -$2,562,500

Gross Margin = $437,500

Less: Fixed Selling & Admin expense = -$80,000

Less Variable selling & Admin Expenses ($2 x 50,000) = -$100,000

Net income (Year 2) = $257,500

C.

Year 1 (Net Income)

Variable costing = $190,000

absorption Costing = $240,000

Difference = $50,000

Comment: difference is driven by production volumes exceeding sales Volume. This makes absorbed costs per unit drop under the absorption costing technique

Year 2 (Net Income)

Variable costing = $320,000

absorption Costing = $257,500

Difference = $62,500

Comment: difference is driven by lower production volume compared to sales, resulting in higher product cost per unit under the Absorption Costing technique

Explanation:

Walsh Company

The Absorption Costing and Variable Costing are 2 methods of costs allocation to Products sold by businesses.

The Absorption costing identifies all costs identifiable to production (both Variable and Fixed) and apportions these based on drivers.

The eventual costs in a case of a single product business is the addition of the Fixed and Variable costs

Variable Costing on the other hand recognises only the Variable elements of Costs in its product Costing. It completely eliminated Fixed Costs in assigning Product costs.

In this wise, Gross Margin under the Variable costing approach will be higher. However both will deliver same Net Profit, as the Fixed Costs under Variable Costing will be recognized as an overhead costs against Gross Margin if production and sales Volume are the same.

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