During its first year of operations, the McCormick Company incurred the following manufacturing costs: Direct materials, $5 per unit, Direct labor, $3 per unit, Variable overhead, $4 per unit, and Fixed overhead, $189,000. The company produced 21,000 units, and sold 15,500 units, leaving 5,500 units in inventory at year-end. Income calculated under variable costing is determined to be $325,000. How much income is reported under absorption costing?

Net operating income= 374,500

Explanation:

Giving the following information:

Direct materials= $5

Direct labor= $3 per unit

Variable overhead= $4 per unit

Fixed overhead= $189,000.

The company produced 21,000 units, and sold 15,500 units

Under the absorption costing method, the unitary product cost is calculated using the direct material, direct labor, and total unitary overhead.

First, we need to calculate the unitary fixed overhead:

Unitary fixed overhead= 189,000/21,000= $9

Now, we can calculate the unitary product cost

unitary product cost= 5+3+4+9= $21

We need to determine the sales, therefore, we will reverse engineer the variable costing income statement:

Net operating income= 325,000

Fixed costs= 189,000

Variable costs= (5+3+4)*15,500= 186,000

=total sales= $700,000

Finally, we determine the net operating income under absorption costing:

Sales= 700,000

Cost of goods sold= (21*15,500)= (325,500)

Net operating income= 374,500

$374,500

Explanation:

Variable costing consider all variable costs as production cost and Absorption costing consider all the cost incurred in production either variable or fixed as production cost.

Cost of Product

Direct materials,                 $5 per unit

Direct labor,                        $3 per unit

Variable overhead,            $4 per unit

Fixed overhead per unit    $9 per unit

Total Product cost              $21 per unit

Variable cost per unit

Direct materials,                 $5 per unit

Direct labor,                        $3 per unit

Variable overhead,            $4 per unit

Total Product cost              $12 per unit

Variable costing

Net Income = Sales - variable - Fixed Costs

$325,000 = Sales - (15,500 x $12 ) - $189,000

$325,000 = Sales - $186,000 - $189,000

$325,000 = Sales - $375,000

Sales = $325,000 + $375,000

Sales = $700,000

Fixed overhead per unit = $189,000 / 21,000 = $9 per unit

Under absorption costing

Sales = $700,000

Cost of Sales = (15,500 x $21 ) = $325,500

Net Income = $700,000 - $325,500 = $374,500