Cool Sky reports the following costing data on its product for its first year of operations. During this first year, the company produced 42,000 units and sold 34,000 units at a price of $120 per unit.
Manufacturing costs
Direct materials per unit $48
Direct labor per unit $18
Variable overhead per unit $6
Fixed overhead for the year $420,000
Selling and administrative cost
Variable selling and administrative cost per unit $12
Fixed selling and administrative cost per year $110,000
1a. Assume the company uses absorption costing. Determine its product cost per unit.
Per unit product cost using: Absorption costing
Cost per unit
1b. Assume the company uses absorption costing. Prepare its income statement for the year under absorption costing.
COOL SKY
Absorption Costing Income Statement
Net income (loss)
2a. Assume the company uses variable costing. Determine its product cost per unit.
Per unit product cost using: Variable costing
Cost per unit
2b. Assume the company uses variable costing. Prepare its income statement for the year under variable costing.
COOL SKY
Variable Costing Income Statement
Net income (loss)

Cook Sky

1a. Per unit product cost using, Absorption costing :

Cost per unit

Manufacturing Costs:

  Direct materials     $48

  Direct labor            $18

  Variable overhead  $6

  Fixed overhead     $10 ($420,000/42,000)

Product cost per unit $82

1b. COOL SKY

Absorption Costing Income Statement

Sales                               $4,080,000 (34,000 x $120)

Cost of goods sold        $2,788,000 (34,000 x $82)

Gross profit                    $1,292,000

Other Expenses:

Variable selling & admin.($408,000) (34,000 x $12)

Fixed selling & admin.      ($110,000)

Net income (loss)             $774,000

2a. Per unit product cost using, Variable costing :

Cost per unit

Manufacturing Costs:

  Direct materials                $48

  Direct labor                       $18

  Variable overhead             $6

Product cost per unit        $72

2b. COOL SKY

Variable Costing Income Statement

Sales                               $4,080,000 (34,000 x $120)

Cost of goods sold        $2,448,000 (34,000 x $72)

Contribution                   $1,632,000

Other Expenses:

Manufacturing overhead ($420,000)

Variable selling & admin. ($408,000)

Fixed selling & admin.       ($110,000)

Net income (loss)              $694,000

Explanation:

a) Absorption costing includes all costs, including fixed costs, related to production.   This implies that the cost of a finished product includes the following costs: direct materials, direct labor, variable and fixed manufacturing overhead.

b) Variable costing includes only the variable costs directly incurred in production.  The cost of a finished product, therefore, includes the following costs: direct materials, direct labor, and variable manufacturing overhead.

The difference in the two is the inclusion of fixed manufacturing overhead in the absorption costing technique in order to arrive at the product cost.  Whereas, in variable costing, the fixed manufacturing overhead is regarded as a period cost and not a product cost.

Another difference is that with absorption costing, you arrive at the gross profit from which period costs are deducted to obtain the net income (loss).  With variable costing, you arrive at the contribution from which expenses are deducted to get the net income (loss).