Question

Hongren's Cost Accounting, chapter 9, problem 23E If the first two years, the company produced and sold the same number. Therefore no ending inventory. There was equal profit in both years. However, in the third year, production was the same as the first 2 years. However, sales was lower, 10%. We had ending inventory now. The profit was lower in amount. Would this make sense?

Smart Safety, a three-year-old company, has been producing and selling a single type of bicycle helmet. Smart Safety uses standard costing. After reviewing the income statements for the first three years, Stuart Weil, president of Smart Safety, commented, “I was told by our accountants—and in fact, I have memorized—that our breakeven volume is 52,000 units. I was happy that we reached that sales goal in each of our first two years. But here’s the strange thing: In our first year, we sold 52,000 units and indeed we broke even. Then in our second year we sold the same volume and had a positive operating income. I didn’t complain, of course. . . but here’s the bad part. In our third year, we sold 20% more helmets, but our operating income fell by more than 80% relative to the second year! We didn’t change our selling price or cost structure over the past three years and have no price, efficiency, or spending variances. . . so what’s going on?!”

What denominator level is Smart Safety using to allocate fixed manufacturing costs to the bicycle helmets? How is Smart Safety disposing of any favorable or unfavorable production-volume variance at the end of the year? Please explain your answer.

HomeInsert Page Layout Formulas Data Review View 1 Absorption Costing 2013 52,000 2014 52,000 2015 3 Sales (units 4 Revenues 5 Cost of 62,400 $2 236,000 $2 236,000 $2,683 200 sold 0 405,600 2,028,000 2,433,600 2,028,000 2,028,000 2,433,600 2,433,600 7 Production 8 Available for sale 9Deduct 10 Adjustment for 2 0 405,600) 0 (260 0 ume variance Cost of 2,028,000 1,768,000 2,433,600 208,000468,600 249,600 208,000208,000 208,000 0 260,000 $ 41,600 12 Gross 13 Selling and administrative expenses (all fix 14 15 16 17 Production (units 18 Sales (units 19 Endi 20 Variable 21 Fixed 22 Fixed manuf. costs allocated per unit produced S income 10,400 52,000 52,00052,000 62,400 52,000 62,400 10,400 14 S 14 S cost per unit overhead costs $1,300,000 $1,300,000 $1,300,000 25 25 S 25 S

Answer 1

1. What denominator level is Smart Safety using to allocate fixed manufacturing costs to the bicycle helmets?

Smart safety is allocating the manufacturing overhead to the production based on production quantity.

2. How is Smart Safety disposing of any favorable or unfavorable production-volume variance at the end of the year?

Smart safety disposing favorable or unfavorable production-volume variance at the end of year on the basis of closing inventory. the amount of production overhead attributable to the closing inventory is deducted from the cost