Problem-3 (Impact of change in production on variable and absorption costing)

AJX company manufactures and sells a single product. Company sold the same number of units this year as it did last year but generated different profit for two years.  The president asks for the explanation of difference in net operating income for two years.

The income statements of two years are as follows:

problem-3-vaac-img1

Sales, production and production for two years are as follows:

problem-3-vaac-img2

Variable selling and administrative expenses of AJX are $4.00 per unit sold. A new manufacturing overhead rate is computed each year.

Required:

  1. Calculate unit product cost for both the years under absorption costing and direct costing (variable costing).
  2. Prepare a contribution margin format income statement for two years.
  3. Reconcile the net operating income figures for each year under two costing methods.
  4. Explain how operations would have different in year 2 if the company had been using just in time (JIT) manufacturing and inventory control methods.

Solution:

(1) Computation of unit product cost:

Year 1:

Unit product cost under variable costing: $12

Unit product cost under absorption costing: $12 + $30= $42

*$1,200,000/40,000 units

Year 2:

Unit product cost under variable costing: $12

Unit product cost under absorption costing: $12 + $24= $36

*$1,200,000/50,000 units

(2) Variable costing income statement:

problem-3-vaac-img3

(3) Reconciliation of net operating income:

problem-3-vaac-img4

(4) Just in time manufacturing method:

If the company had been using just in time manufacturing and inventory control methods in year 2 the difference in net operating income under variable costing and absorption costing would have been very little to zero. The central idea of just in time manufacturing is to eliminate inventories.  For better understanding of the impact of JIT read our article variable and absorption costing with just in time (JIT) manufacturing system.

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