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    Absorption Costing Vs. Variable Costing

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    The Johnson Company produces a very popular product. The company had the following results for its the last two years:

    Year 2014
    Year 2015

    2014: $600,000
    2015: $600,000

    Cost of goods sold
    2014: $400,000
    2015: $340,000

    Administration Costs:
    2014: $150,000
    2015: $150,000

    Gross margin
    2014: $200,000
    2015: $260,000

    Net operating income (loss)
    2014: $50,000
    2015: $110,000

    Additional information about the company is as follows:

    In Year 2014, the company produced and sold 20,000 units of their product product. In 2015, the company also sold 20,000 units, but increased production to 25,000 units. The company' variable production cost is $6 per unit and its fixed manufacturing overhead cost is $300,000 per year. Fixed manufacturing overhead costs are applied to the product on the basis of each year's unit production. Variable selling and administrative expenses are $1 per units sold.

    - Compute the unit product cost for each year under absorption costing and under variable costing.
    - Prepare an income statement for each year, using the contribution approach with variable costing.
    - Reconcile the variable costing and absorption costing income figures for each year.
    - Explain why the net operating income for Year 2015 under absorption costing was higher than the net operating income for Year 2014, although the same number of units were sold in each year.

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