Question

Absorption and variable costing Levine Manufacturing pays its production managers a bonus based on the company's profitability. During the two most recent years, the company maintained the same cost structure to manufacture its products. Units Produced Units Sold Production and Sales 2018 2019 4.000 5.000 4,000 4,000 CostData Direct materials Direct labor Manufacturing overhead variable Manufacturing overhead-fixed Variable selling and administrative expenses Fixed selling and administrative expenses $30 per unit 548 per unit $24 per unit $216,000 518 per unit sold $120,000 (Assume that selling and administrative expenses are associated with goods sold.) Levine sells its products for $216 per unit. Required a. Prepare income statements based on absorption costing for 2018 and 2019 b. Since Levine sold the same number of units in 2018 and 2019, why did net income increase in 2019? c. Discuss management's possible motivation for increasing production in 2019 d. Determine the costs of ending inventory for 2019. Comment on the risks and costs associated with the accumulation of inventory. e. Based on your answers to Requirements and suggest a different income statement format. Prepare income statements for 2018 and 2019 using your suggested format.

Answer 1

2018 Units Rate p.u Amount 4000 216 864000 difference 0 O a. Income Statement based on absorption costing 2019 Particulars Units Rate p.u Amount Sales 4000 216 864000 Less: Cost of Goods Sold Direct Material 4000 30 120000 Direct Labor 4000 48 192000 Manufacturing Overhead Variable 4000 24 96000 Manufacturing Overhead Fixed 4000 36 144000 552000 Less: Selling and Administrative Cost Variable 18 72000 Selling and Administrative Cost Fixed 120000 192000 4000 4000 4000 4000 30 48 24 54 120000 192000 96000 216000 624000 72000 72000 4000 4000 18 72000 120000 192000 0 Net Income 120000 48000 -72000 b Income increase because manufacturing overhead fixed reduced per unit from 54 to 36. Reduction was due to increase in production. Calculation of Manufacturing overhead fixed per unit 2019 2018 Total Cost 216000 216000 Total Production 6000 4000 Cost Per Unit 54 36 From the above table it is evident that increase in production leads decrease in cost of goods sold and decrease cost leads to higher profit and high bonus to production manager d Cost of Inventory for 2019 Direct Material Direct Labor Manufacturing Overhead Variable Manufacturing Overhead Fixed Units Rate p.u Amount 2000 30 60000 2000 48 96000 2000 24 48000 2000 36 72000 276000 Risk and Cost Associated with Inventory Carry Cost e.g. Warehouse rent, working capital loan Interest, safety and insurance etc. Risk of Obsolescence of Inventory Risk of decline in price of inventory or direct material Risk of theft and loss in quality if goods are perishable in nature