Absorption and Variable Costing with Over- and Underapplied Overhead

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 (2 lbs. @ 1.35)	$2.70
Direct labor (0.4 hr. @ 16.00)	6.40
Variable overhead (0.4 hr. @ 4.00)	1.60
Fixed overhead (0.4 hr. @ 7.00)	2.80
Total	$13.50
Selling and administrative costs:
Variable	$1.80	per unit
Fixed	$218,500

During the year, the company had the following activity:

Units produced	26,500
Units sold	23,850
Unit selling price	$37
Direct labor hours worked	10,600

Actual fixed overhead was $12,800 less than budgeted fixed overhead. Budgeted variable overhead was $4,400 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.

	Unit Cost
Absorption costing	$
Variable costing	$

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

Flaherty, Inc.
Absorption-Costing Income Statement
For the First Year of Operations
Sales		$
Cost of goods sold	$
Less:
Overapplied overhead
Gross profit		$
Less: Selling and administrative expenses
Operating income		$

3. Prepare a variable-costing income statement. Round your answers to the nearest cent.

Flaherty, Inc.
Variable-Costing Income Statement
For the First Year of Operations
Sales		$
Variable cost of goods sold	$
Add:
Underapplied variable overhead
Variable selling expense
Contribution margin		$
Less:
Fixed factory overhead	$
Selling and administrative expenses		$
Operating income		$

4. Reconcile the difference between the two income statements. The absorption costing generates an income $ more than variable costing.