Question

Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Results for the first three years of operations were as follows (absorption costing basis): Sales Cost of goods sold Gross margin Selling and administrative expenses Net operating income (loss) Year 1 $1,000,000 760,000 240,000 230,000 $ 10,000 Year 2 $ 730,000 512,000 218,000 198,000 $ 20,000 Year 3 $1,000,000 788.500 211,500 230,000 $ (18,500) In the latter part of Year 2, a competitor went out of business and in the process dumped a large number of units on the market. As a result, Starfax's sales dropped by 20% during Year 2 even though production increased during the year. Management hod expected sales to remain constant at 40,000 units; the increased production was designed to provide the company with a buffer of protection against unexpected spurts in demand. By the start of Year 3, management could see that it had excess inventory and that spurts in demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below: Production in units Sales in units Year 1 40,000 40,000 Year 2 50,000 32,000 Year 32,000 40,000 Additional information about the company follows: a. The company's plant is highly automated. Variable manufacturing expenses (direct materials, direct labor, and variable manufacturing overhead) total only $4.00 per unit, and fixed manufacturing overhead expenses total $600,000 per year. b. A new fixed manufacturing overhead rate is computed each year based that year's actual fixed manufacturing overhead costs divided by the actual number of units produced. c. Variable selling and administrative expenses were $4 per unit sold in each year. Fixed selling and administrative expenses totaled $70,000 per year. d. The company uses a FIFO inventory flow assumption (FIFO means first in first-out. In other words, it assumes that the oldest units in inventory are sold first.)

Answer 1

Answer is given below with working notes:

Starfax Inc. Income Statement- Variable Costing Year 1 Year 2 Opening stock Production Sales Closing stock 40,000 40,000 50,000 32,000 18,000 Year 3 18,000 32,000 40,000 10,000 $1,000,000 $730,000 $1,000,000 Sales Less : Variable Cost of Goods Sold Beginning Inventory - Finished Goods Variable Manufacturing Cost Variable Cost of Goods available for Sale Less: Closing stock Cost of Goods sold Variable Selling expenses Total Variable Expenses Contribution Margin Less: Fixed Cost Manufacturing overhead Non manufacturing overhead $160,000 $160,000 SO $160,000 $160,000 $320,000 $680,000 $200,000 $200,000 $72,000 $128,000 $128,000 $256,000 $474,000 $72,000 $128,000 $200,000 $40,000 $160,000 A $160,000 B $320,000 A+B $680,000 $600,000 $70,000 $600,000 $70,000 $600,000 $70,000 Operating Income $10,000 $196,000 $10,000 Closing inventory is valued at variable manufacturing cost $$ per unit working notes: Year 1 Year 2 $4.00 $4.00 Product cost - inventory valuation Variable manufacturing cost Total manufacturing cost per unit closing units Valuation of closing units $4.00 $4.00 18,000 $72,000 Year 3 $4.00 $4.00 10,000 $40,000 2 a) Product Unit Cost-Absorption Costing Year 2 $4.00 Variable manufacturing cost Fixed manufacturing cost Production units Fixed manufacturing cost per unit Total Product Cost closing units Valuation of closing units Year 1 $4.00 $600,000 40,000 $15.00 $19.00 $600,000 50,000 $12.00 $16.00 18,000 $288,000 Year 3 $4.00 A $600,000 32,000 $18.75 B $22.75 A+B 10,000 $227,500 Year 3 -$18,500 2b) Reconciliation of Profit (Loss) - Variable Costing and Absorption Costing Year 1 Year 2 Profit (Loss) as per Absorption Costing $10,000 $20,000 Difference in closing stock Closing stock as per Absorption costing $288,000 Closing stock as per Variable costing $72,000 Difference $0 -$216,000 $0 $227,500 $40,000 $187,500 Difference in Opening stock Opening stock as per Absorption costing Opening stock as per Variable costing Difference $288,000 $72,000 -$216,000 Sol $0 $0 Profit (Loss) as per Variable costing $10,000 $196,000 $10,000 5b If Lean production is used no inventory Starfax Inc. Income Statement-Absorption Costing Year 1 Production 40,000 Sales 40,000 Year 2 32,000 32,000 Year 3 40,000 40,000 Sales Less: Cost of Goods Sold Gross Profit Less: Operating expenses Selling and administrative expenses $1,000,000 $760,000 $240,000 $730,000 $728,000 $2,000 $1,000,000 $760,000 $240,000 $230,000 $198,000 $230,000 Operating Income $10,000 $196,000 $10,000 Product Unit Cost-Absorption Costing Variable manufacturing cost Fixed manufacturing cost Production units Fixed manufacturing cost per unit Total Product Cost Cost of Goods sold Year 1 $4.00 $600,000 40,000 $15.00 $19.00 $760,000 Year 2 $4.00 $600,000 32,000 $18.75 $22.75 $728,000 Year 3 $4.00 $600,000 40,000 $15.00 $19.00 $760,000