Question

Carlos Cavalas, the manager of Echo Products’ Brazilian Division, is trying to set the production schedule for the last quarter of the year. The Brazilian Division had planned to sell 69,190 units during the year, but by September 30 only the following activity had been reported: Units Inventory, January 1 0 Production 74,000 Sales 62,900 Inventory, September 30 11,100 The division can rent warehouse space to store up to 29,500 units. The minimum inventory level that the division should carry is 1,200 units. Mr. Cavalas is aware that production must be at least 6,660 units per quarter in order to retain a nucleus of key employees. Maximum production capacity is 45,300 units per quarter. Demand has been soft, and the sales forecast for the last quarter is only 19,200 units. Due to the nature of the division’s operations, fixed manufacturing overhead is a major element of product cost. Required: 1a. Assume that the division is using variable costing. How many units should be scheduled for production during the last quarter of the year? 1b. Will the number of units scheduled for production affect the division’s reported income or loss for the year? 2. Assume that the division is using absorption costing and that the divisional manager is given an annual bonus based on divisional operating income. If Mr. Cavalas wants to maximize his division’s operating income for the year, how many units should be scheduled for production during the last quarter?

Answer 1

Answer is given below with working and explanation

1 a) Sales forecast for last quarter Add: Closing inventory Total Needs Less: Opening inventory of Q4 Production for 4th Quarter 19,200 1,200 20,400 11,100 9,300 b) No affect on the division's reported income or loss for the year Under Variable costing product cost is Variable manufacturing cost Fixed manufacturing cost is treated as period cost and charged to the period in which it is incurred Hence there will be no affect on the division's reported income or loss for the period 2 Since Absorption costing system is followed and division operating income should be maximized Closing stock should be produced to the maximum possible extent. Closing inventory level can be increased to 29,500 units by renting external warehouse Sales forecast for last quarter Add: Closing inventory Total Needs Less: Opening inventory of Q4 Required production for 4th Quarter 19,200 29,500 48,700 11,100 37,600