Section B: Case study worth 10 marks.

ChalkTalk Ltd manufactures blackboard chalk for educational use. The company's product is sold by the box at $50 per unit. ChalkTalk uses an actual costing system, which means that the actual cost of direct material, direct labour and manufacturing overhead are entered into work in progress inventory. The actual application rate for manufacturing overhead is calculated each year; actual manufacturing overhead is divided by actual production (in units) to calculate the actual manufacturing overhead rate.

Information for ChalkTalk's first two years of operation is as follows:

Year 1

Year 2

Sales (in units)

2 500

2 500

Production (in units)

3 000

2 000

Production costs:

Variable manufacturing costs

$21 000

$14 000

Fixed manufacturing overhead

$42 000

$42 000

Selling and administrative costs:

Variable

$25 000

$25 000

Fixed

$20 000

$20 000

ChalkTalk had no beginning or ending work in progress inventories for either year. However, the following information relate to finished goods inventory.

Based on absorption costing

End of year 1

End of year 2

Finished goods inventory

$10 500

$0

Based on variable costing

End of year 1

End of year 2

Finished goods inventory

$3 500

$0

Required:

1.Prepare income statements for both years based on absorption costing.

2.Prepare income statements for both years based on variable costing.

3.Reconcile reported profit under absorption and variable costing, for each year by comparing the following two amounts on each income statement.

a.Cost of goods sold

b.Fixed cost (expensed as a period expense).

4.What was ChalkTalk's total profit across both years under

a.Absorption costing

b.Variable costing