Navisky designs, manufactures, and sells specialized GPS (Global Positioning System) devices for commercial applications. For example, Navisky currently sells a system for environmental studies and is planning systems for private aviation and fleet management. The firm has a design team that identifies potential commercial GPS applications, then designs and develops prototypes. Once a prototype is deemed successful and senior management determines that a market exists for the new application, the new design is put into production and the firm markets the new product through independent salespeople, direct marketing, trade shows, or whatever channel is most appropriate for that market.
Currently, Navisky has one very successful system in production (for environmental studies) and several others in development. Navisky, located in Austria, is one of nine wholly owned subsidiaries of a large Swiss conglomerate. Andreas Hoffman, president of Navisky, expects to retire next year. He receives a fixed salary and a bonus based on reported accounting earnings. The bonus is 5 percent of earnings in excess of €850,000 for actual earnings between €850,000 and €1,400,000. If actual earnings exceed €1,400,000, the bonus is capped at €27,500 (5% X [€1,400,000 - €850,000]). (Earnings, both actual and target, are before taxes.)
The following data summarize Navisky’s current operations (in euros).
| Annual Fixed Costs | Variable Costs/unit | |
| Development costs | € 900,000 | |
| Selling and administration costs | 1,100,000 | €300 |
| Manufacturing overhead | 2,700,000 | 190 |
| Direct materials | 140 | |
| Manufacturing labor | 50 | |
| Total | €4,700,000 | €680 |
| Selling price/unit | € 5,500 |
Senior management at Navisky, including Mr. Hoffman, expects to sell about 1,200 units of the environmental GPS device this year. However, they have considerable discretion in setting production levels. Their plant has excess capacity and can produce up to 1,500 environmental devices without seeing any increase in the variable manufacturing costs per unit.
Navisky uses a traditional absorption costing system to absorb manufacturing overhead into product costs for inventory valuation and to calculate earnings for internal compensation purposes as well as external reporting. At the beginning of the current fiscal year, there was no beginning inventory of the environmental GPS devices.
Required:
a. How many units of the environmental GPS device would Mr. Hoffman like to see Navisky produce if he expects to sell 1,200 devices this year?
b. Suppose Mr. Hoffman’s bonus calculation was based on net income after including a charge for inventory holding costs at 20 percent of the ending inventory value. In other words, his bonus is 5 percent of net income in excess of €850,000 up to €1,400,000 where net income includes a 20 percent inventory holding cost. How many units of the environmental GPS device would Mr. Hoffman like to see produced if he expects to sell 1,200 devices this year?
c. Explain why your answers in parts (b) and (c) differ, if they do.
d. How many units of the environmental GPS device would Mr. Hoffman like to see produced assuming he expects to sell 1,200 devices this year if Navisky’s net income is calculated using variable costing and net income includes a 20 percent inventory holding cost?
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