Question

Mark Hancock Inc. manufactures a specialized surgical instrument called the HAN-20. The firm has grown rapidly in recent years because of the product’s low price and high quality. However, sales have declined this year primarily due to increased competition and a decrease in the surgical procedures for which the HAN-20 is used. The firm is concerned about the decline in sales and has hired a consultant to analyze the firm’s profitability. The consultant was provided the following information:

		2018		2019
Sales (units)		7,000		6,600
Production		7,120		6,120
Budgeted production and sales		7,800		7,200
Beginning inventory		1,000		1,120
Data per unit (all variable)
Price	$	2,095	$	1,995
Direct materials and labor		1,200		1,200
Selling costs		125		125
Fixed costs
Manufacturing overhead	$	1,365,000	$	1,260,000
Selling and administrative		120,000		120,000

Top management at Hancock explained to the consultant that a difficult business environment for the firm in 2018 and 2019 had caused the firm to reduce its price and production levels and reduce its fixed manufacturing costs in response to the decline in sales. Even with the price reduction, there was a decline in sales in both years. This led to an increase in inventory in 2018, which the firm was able to reduce in 2019 by further reducing the level of production. In both years, Hancock’s actual production was less than the budgeted level so that the overhead rate for fixed overhead, calculated from budgeted production levels, was too low, and a production volume variance was calculated to adjust cost of goods sold for the underapplied fixed overhead (the calculation of the production volume variance is explained fully in Chapter 15 and reviewed briefly below).

The production volume variance for 2018 was determined from the fixed overhead rate of $175 per unit ($1,365,000/7,800 budgeted units). Because the actual production level was 680 units short of the budgeted level in 2018 (7,800 − 7,120), the amount of the production volume variance in 2018 was 680 × $175 = $119,000. The production volume variance is underapplied because the actual production level is less than budgeted, and the production volume variance is therefore added back to cost of goods sold to determine the amount of cost of goods sold in the full costing income statement. The full costng income statement for 2018 is shown.

Sales				14,665,000
Cost of goods sold:
Beginning inventory	$	1,375,000
Cost of goods produced		9,790,000
Cost of goods available for sale	$	11,165,000
Less ending inventory		1,540,000
Cost of goods sold:			$	9,625,000
Plus unfavorable production volume variance				119,000
Adjusted cost of goods sold			$	9,744,000
Gross margin			$	4,921,000
Less selling and administrative costs
Variable	$	875,000
Fixed		120,000		995,000
Operating income			$	3,926,000

Required:

1. Using the full costing method, prepare the income statement for 2019.

2-a. Using variable costing, prepare an income statement for each period.

2-b. Prepare a reconciliation of the difference each year in the operating income resulting from the full- and variable-costing methods. (Negative amounts should be indicated by a minus sign.)

Please see bellow for order

1.

Cost of good sold
Cost of good sold available for sale
Cost of Good Sold
Adjusted Cost of good sold
Gross margin
Less selling and administrative cost
Operating income

2. 2018 2019

Cost of good sold
Cost of goods sold available for sale
Cost of good sold
Contribution margin
Less Selling and admin cost
Operating income

3.

	2018	2019
Change in inventory in units
Multiply times fixed overhead rate
Difference in net income

Answer 1

Answer-1:

$ 13,167,000 INCOME STATEMENT FOR THE YEAR 2019 Under Full Costing Method Sales (6,600 x $1,995) Cost of goods sold: Beginning inventory (1,120 x $1,375) $ 1,540,000 Cost of goods produced (6,120 x $1,375) 8,415,000 Cost of goods available for sale 9,955,000 Less: Ending inventory (640 x $1,375) 880,000 Cost of goods sold: Add: Unfavourable production volume variance (7,200 -6,120) $175 Adjusted Cost of goods sold Gross Margin Less: Selling and administrative costs: Variable (6,600 x $125) 825,000 Fixed 120,000 Operating income 9,075,000 189,000 9,264,000 3,903,000 945,000 2,958,000 $

Answer-2(a):

INCOME STATEMENT Under Variable Costing Method 2018 2019 (7,000 $2,095) $ 14,665,000 (6,600 x $1,995) $ 13,167,000 (1,000 x $1,200) (7,120 x $1,200) (1,120 x $1,200) Sales Less: Cost of goods sold: Beginning inventory Cost of goods produced Cost of goods available for sale Less: Ending inventory Cost of goods sold: Less: Variable selling and administrative costs Contribution Margin Less: Fixed costs: Manufacturing costs Selling and administrative costs Operating income 1,200,000 (1,120 x $1,200) 8,544,000 (6,120 x $1,200) 9,744,000 1,344,000 (640 x $1,200) 8,400,000 875,000 (6,600 x $125) 5,390,000 1,344,000 7,344,000 8,688,000 768,000 7,920,000 825,000 4,422,000 (7,000 $125) $ 1,365,000 120,000 1,260,000 120,000 1,485,000 3,905,000 1,380,000 3,042,000 $ $

Answer-2(b):

RECONCILIATION OF DIFFERENCE IN OPERATING PROFIT UNDER BOTH METHOD 2018 2019 Change in inventory in units |(1,120 - 1,000) 120 (1,120 - 640) Fixed overhead rate ($1,365,000/7,800) $ 175 $1,260,000/7,200) $ Difference in net income $ 21,000 $ 480 175 84,000

$ 13,167,000 INCOME STATEMENT FOR THE YEAR 2019 Under Full Costing Method Sales (6,600 x $1,995) Cost of goods sold: Beginning inventory (1,120 x $1,375) $ 1,540,000 Cost of goods produced (6,120 x $1,375) 8,415,000 Cost of goods available for sale 9,955,000 Less: Ending inventory (640 x $1,375) 880,000 Cost of goods sold: Add: Unfavourable production volume variance (7,200 -6,120) $175 Adjusted Cost of goods sold Gross Margin Less: Selling and administrative costs: Variable (6,600 x $125) 825,000 Fixed 120,000 Operating income 9,075,000 189,000 9,264,000 3,903,000 945,000 2,958,000 $

INCOME STATEMENT Under Variable Costing Method 2018 2019 (7,000 $2,095) $ 14,665,000 (6,600 x $1,995) $ 13,167,000 (1,000 x $1,200) (7,120 x $1,200) (1,120 x $1,200) Sales Less: Cost of goods sold: Beginning inventory Cost of goods produced Cost of goods available for sale Less: Ending inventory Cost of goods sold: Less: Variable selling and administrative costs Contribution Margin Less: Fixed costs: Manufacturing costs Selling and administrative costs Operating income 1,200,000 (1,120 x $1,200) 8,544,000 (6,120 x $1,200) 9,744,000 1,344,000 (640 x $1,200) 8,400,000 875,000 (6,600 x $125) 5,390,000 1,344,000 7,344,000 8,688,000 768,000 7,920,000 825,000 4,422,000 (7,000 $125) $ 1,365,000 120,000 1,260,000 120,000 1,485,000 3,905,000 1,380,000 3,042,000 $ $

RECONCILIATION OF DIFFERENCE IN OPERATING PROFIT UNDER BOTH METHOD 2018 2019 Change in inventory in units |(1,120 - 1,000) 120 (1,120 - 640) Fixed overhead rate ($1,365,000/7,800) $ 175 $1,260,000/7,200) $ Difference in net income $ 21,000 $ 480 175 84,000