Question

9-22 ABSORPTION VERSUS VARIABLE COSTING. Electron Inc. is a semiconductor company based in Winnipeg. In 2018, it produced a new router system for its corporate clients. The average wholesale selling price of the system is 51,200 each. For 2018, Electron estimates that it will sell 10.000 router systems and so produces 10,000 units. Actual 2018 sales are 8,960 units. Electron's actual 2018 costs are: Variable costs per unit Manufacturing cost per unit produced $55 Direct materials Direct manufacturing tabour Manufacturing overhead Marketing cost per unit solo Fixed costs 1.471.680 Manufacturing costs 981,120 R&D 3.124.480 Marketing Required 1. Calculate the operating income under variable costing. 2. Each router unit produced is allocated 5165 in fixed manufacturing costs. If the production-volume variance is written off to cost of goods sold, and there are no price, rate, or efficiency variances, calculate the operating income under absorption costing. 3. Explain the differences in operating incomes obtained in requirement 1 and requirement 4. Electron's management is considering implementing a bonus for the supervisors based on gross margin under absorption costing. What incentives will this create for the supervisors? Do you think this new bonus plan is a good idea? Explain brieflv.

Answer 1

Solution:
1. Operating income under variable costing
Sales:	10752000	(8960 X 1200)
Less: Cost of goods sold
Direct Material	492800	(8960 X 55)
Direct Manufacturing Labour	403200	(8960 X 45)
Manufacturing Overhead	1075200	(8960 X 120)
Marketing Cost	672000	(8960 X 75)
Total Variable Cost	2643200
Gross Margin	8108800	(Sales - total variable cost)
Less: Fixed Cost
Manufacturing cost	1471680
R& D	981120
Marketing	3124480
Total fixed cost	5577280
Operating income	2531520	(Gross margin - total fixed cost)
Note: The unsold quantity will not have impact on operating income because its cost will be added to closing stock
2. Operating income under Absorption costing
Sales:	10752000	(8960 X 1200)
Less: Cost of goods sold
Direct Material	492800	(8960 X 55)
Direct Manufacturing Labour	403200	(8960 X 45)
Manufacturing Overhead	1075200	(8960 X 120)
Marketing Cost	672000	(8960 X 75)
Total Variable Cost	2643200
Gross Margin	8108800	(Sales - total variable cost)
Less: Fixed Cost
Manufacturing cost	1318625	(1471680/10000) X 8960. Allocated to all units whether sold or not
R& D	981120
Marketing	3124480
Total fixed cost	5424225
Operating income	2684575	(Gross margin - total fixed cost)
Note: Under absorption costing the fixed manufacturing overhead are allocated to all units and hence increases the closing stock value
3. Difference between Operating income under 1 and 2 above
In Variable costing the fixed manufacturing overhead are allocated only to the units sold and entire amount is treated as expense
In absorption costing the fixed manufacturing overheads are allocated to all units produced as opposed to sold and hence it is treated more like variable expense
The allocated amount of fixed manufacturing overhead is included in closing inventory value under absorption costing which is carried to next year
4. Bonus system
As in absorption costing the income would he on higher side due to having less expense allocation to cost of golds sold and high inventory value, so from supervisor perspective they are likely to get higher bonus under absorption costing . The new bonus plan is a good idea if the entity is confident of being able to sale off the closing inventory without any price deterioration in future. If the price of product is uncertain for future then bonus under absorption costing can be an expensive decision