The Charlotte Company produces a single product. The company had the following results for its first two years of operation:
Year 1 Year 2
Sales $1,200,000 $1,200,000
Cost of goods sold 800,000 680,000
Gross margin 400,000 520,000
Selling and administrative expenses 300,000 330,000
Net operating income (loss) $100,000 $220,000
Additional information about the company is as follows:
In Year 1, the company produced and sold 40,000 units of its only product. In Year 2, the company again sold 40,000 units, but increased production to 50,000 units. The company' variable production cost is $5 per unit and its fixed manufacturing overhead cost is $600,000 per year. Fixed manufacturing overhead costs are applied to the product on the basis of each year's unit production (i.e. a new fixed overhead rate is computed each year). Variable selling and administrative expenses are $2 per units sold.
a. Compute the unit product cost for each year under absorption costing and under variable costing.
b. Prepare an income statement for each year, using the contribution approach with variable costing.
c. Reconcile the variable costing and absorption costing income figures for each year.
d. describe why the net operating income for Year 2 under absorption costing was higher than the net operating income for Year 1, although the same number of units were sold in each year.