QUESTION ONE:

Absorption and Variable Costing: Prepare and Reconcile Variable costing Statements

Audiophonics Limited manufactures and sells high-quality and durable ear buds for use with personal electronics that are custom moulded to each customers ear. Cost data for the product follows:

Variable costs per unit:

Direct materials $12

Direct labour 24

Variable factory overhead 8

Variable selling and administrative 6

Total variable costs per unit $50

Fixed costs per month:

Fixed manufacturing overhead $240,000

Fixed selling and administrative 180,000

Total fixed costs per month $420,000

The product sells for $80 per unit. Production and sales data for May and June, the first two months of operations, are as follows:

Units Produced Units Sold

May 15,000 13,000

June 15,000 17,000

Income statements prepared by the Accounting Department using absorption costing are presented below:

May June

Sales $1,040,000 $1,360,000

Cost of goods sold:

Beginning inventory 0 120,000

Add cost of goods manufactured 900,000 900,000

Goods available for sale 900,000 1,020,000

Less ending inventory 120,000 0

Cost of goods sold 780,000 1,020,000

Gross margin 260,000 340,000

Selling and administrative expenses 258,000 282,000

Operating income $2,000 $58,000

REQUIRED:

1. Determine the unit cost under
   1. Absorption costing.
   2. Variable costing.

2. Prepare variable costing income statements for May and June using the contribution approach.

3. Reconcile the variable costing and absorption costing operating income figures.

4. The companys Accounting Department has determined the break-even point to be 14,000 units per month, computed as follows:

Fixed cost per month = $420,000 = 14,000 units

Unit contribution margin $30 per unit

On receiving this figure, the president commented, Theres something peculiar here. The comptroller says that the break-even point is 14,000 units per month. Yet we sold only 13,000 units in May, and the income statement we received showed a $2,000 profit. Which figure do we believe? Prepare a brief explanation of what happened on the May income statement.