Question

Problem 19-3A Income reporting, absorption costing, and managerial ethics LO P2, C1

Blazer Chemical produces and sells an ice-melting granular used on roadways and sidewalks in winter. It annually produces and sells about 100 tons of its granular. In its nine-year history, the company has never reported a net loss. However, because of this year's unusually mild winter, projected demand for its product is only 60 tons. Based on its predicted production and sales of 60 tons, the company projects the following income statement (under absorption costing).

Sales (60 tons at $21,000 per ton)	$	1,260,000
Cost of goods sold (60 tons at $16,000 per ton)		960,000
Gross margin		300,000
Selling and administrative expenses		318,600
Net loss	$	(18,600	)

Its product cost information follows and consists mainly of fixed cost because of its automated production process requiring expensive equipment.

Variable direct labor and material costs per ton	$	3,500
Fixed cost per ton ($750,000 ÷ 60 tons)		12,500
Total product cost per ton	$	16,000

Selling and administrative expenses consist of variable selling and administrative expenses of $310 per ton and fixed selling and administrative expenses of $300,000 per year. The company's president is concerned about the adverse reaction from its creditors and shareholders if the projected net loss is reported. The operations manager mentions that since the company has large storage capacity, it can report a net income by keeping its production at the usual 100-ton level even though it expects to sell only 60 tons. The president was puzzled by the suggestion that the company can report income by producing more without increasing sales.


Required:
1. Can the company report a net income by increasing production to 100 tons and storing the excess production in inventory? Complete an income statement (using absorption costing) based on production of 100 tons and sales of 60 tons.

Answer 1

Solution cost of goods sold is calculated as follower: Production revenue cost of goods sold Go tones 100 tone variable direct Labour cost per ton 3500 3500 12500 2500 16000 11000 fixed costs per ton ( 750000 / 60 tony) ( 750000/100 tons) Cost of goods sold per ton unit sold Total cost of goods sold [cost of goods sold per ton x unit sold ] | 60 tons 60 tone 960000 660000 Income statement : peroduction volume (in tony) 60 tons 100 tons 1260000 ( 960000) 1260000 (660000) 6ooooo (318600) 300000 ( 318600) Sales ( 60 tons X 21000) Lesse cost of goods sold gross margin Less: Selling & administrative expense Exo per ton x 60 ton]+[300000] Net operating Income / Lloss) under absorption costing can a company report a legher net Income by producting more units than sell ? (18600) 281400)

by reporting a production of 100 tons, we can Increase the profit by [281400 - (18600)] = 262800.