Problem 5-17 Variable and Absorption Costing Unit ProductCosts and Income Statement

Nickelson Company manufactures and sells one product. Thefollowing information pertains to each of the company’s first three years ofoperations.

Variable costs per unit:

Manufacturing

\$25

Direct Labor

\$16

\$5

\$2

Fixed Cost per Year:

\$300,000

\$180,000

During the first year of operations Nickelson produced60,000 units and sold 60,000 units. During its second year of operations itproduced 75,000 units and sold 50,000 units. In its third year, Nickelsonproduced 40,000 units and sold 65,000 units. The selling price of the company’sproduct is \$56 per unit.

Required:

1. Compute the company’s break-even point in unitssold.

2. Assume the company uses variable costing:

a. Compute the unit product cost per year 1, 2, and3.

b. Prepare an income statement for year 1, 2, and3.

3. Assume the company uses absorption costing:

a. Compute the unit product cost for year 1, 2, and3.

b. Prepare an income statement for year 1, 2, and3.

4. Compare the net operating income figures thatyou computed in requirements 2 and 3 to the break-even point that you computedin requirement 1. Which net operating income figures seem counterintuitive?Why?

Problem 5-21 Prepare and Reconcile Variable CostingStatements

Linden Company manufactures and sells a single product. Costdata for the product follows:

Variable Cost Per Unit:

Direct materials

\$6

Direct Labor

12

4

3

Total variable costs per unit

\$25

Fixed costs per month:

\$240,000

180,000

Total fixed cost per month

\$420,000

The product sells for \$40 per unit. Production and salesdata for May and June, the first two months of operations, are as follows:

Units Units

Produced Sold

May  30,000  26,000

June 30,000 34,000

Income Statements prepared by the accounting department,using absorption costing, are presented below:

May June

Sales   \$1,040,000  \$1,360,000

Cost of goods sold \$  780,000  1,020,000

Gross margin 260,000 340,000

Selling and administrative expenses 258,000   282,000

Net Operating income 2,000 \$58,000

Required:

1. Determine the unit product cost under:

a. Absorption costing.

b. Variable costing.

2. Prepare a contribution format variable costingincome statements for May and June.

3. Reconcile the variable costing and absorptioncosting net operating incomes.

4. The company’s Accounting Department hasdetermined the break-even point to be 28,000 units per month, computed asfollows:

Fixed cost per month  =  \$420,000  = 28,000 units

Unit contribution margin  \$15 per unit

Upon receiving this figure, the president commented,“There’s something peculiar here. The controller says that the break-even pointis 28,000 units per month. Yet we sold only 26,000 units in May, and the incomestatement we received showed a \$2,000 profit. Which figure do we believe.”Prepare a brief explanation of what happened on the May income statement.

5-22 Absorption and Variable Costing; Product Constant,Sales Fluctuate

Sandi Scott obtained a patent on a small electronic deviceand organized Scott Products, Inc., to produce and sell the device. During thefirst month of operations, the device was very well received on the market, soMs. Scott looked forward to a healthy profit. For this reason, she wassurprised to see a loss for the month on her income statement. This statementwas prepared by her accounting service, which takes great pride in providingits clients with timely financial data. The statement follows:

Scott Products, Inc.

Income Statement

Sales (40,000 units)  \$200,000

Variable expenses:

Variable cost of goods sold \$80, 000

Variable selling andadministrative expenses 30,000   110,000

Contribution margin 90,000

Fixed expenses:

Fixed selling andadministrative expenses  20,000  \$(5,000)

Net operating loss

Ms. Scott is discouraged over the loss shown for the month,particularly because she had planned to use the statement to encourageinvestors to purchase stock in the new company. A friend, who is a CPA, insiststhat the company should be using absorption costing rather than variablecosting. He argues that if absorption costing had been used, the company wouldprobably have reported a profit for the month.

Selected cost data relating to the product and to the firstmonth of operations follow:

Unit produced   50,000

Units sold  40,000

Variable cost per unit:

Direct materials  \$1.00

Direct Labor \$0.80

Variable selling and administrative expenses  \$0. 75

Required:

1. Complete the following:

a. Compute the unit product cost under absorptioncosting.

b. Redo the company’s income statement for themonth using absorption costing.

c. Reconcile the variable and absorption costingnet operating income (loss) figures.

2. Was the CPA correct in suggesting that thecompany really earned a “profit” for the month? Explain.

3. During the second month of operations, thecompany again produced 50,000 units but sold 60,000 units. (Assume no change intotal fixed costs.)

a. Prepare a contribution format income statementfor the month using variable costing.

b. Prepare an income statement for the month usingabsorption costing.

c. Reconcile the variable costing and absorptioncosting net operating incomes.

Problem 6-16 Second Stage Allocations and Product Margins

AnimPix, Inc., is a small company that createcomputer-generated animations for films and television. Much of the company’swork consists of short commercials for television, but the company also doesrealistic computer animations for special effects in movies.

The young founders of the company have become increasinglyconcerned with the economics of the business- particularly because manycompetitors have sprung up recently in the local area. To help understand thecompany’s cost structure, an activity-based cost systems has been designed.Three major activities are carried out in the company: animation concept,animation production, and contract administration. The animation conceptactivity is carried out at the contract proposal stage when the company bids onprojects. This is an intensive activity that involves individuals from allparts of the company in creating storyboards and prototype stills to be shownto the prospective client. After the client has accepted a project, animationgoes into production and contract administration begins. Technical staff doalmost all of the work involved in animation production, whereas theadministrative staff is largely responsible for contract administration. Theactivity cost pools and their activity measures and rates are listed below:

Activity Cost Pool Activity Measure  ActivityRate

Animation concept…………………………….Number of proposals……………..  .\$6,000 per proposal

Animation production……………………….Minutes of animation……………….\$7,700 perminute of animation

These activity rates include all of the costs of thecompany, except for the costs of idle capacity and organization-sustainingcosts. There are no direct labor or direct material costs.

Preliminaryanalysis using these activity rates has indicated that the local commercialsegment of the market may be unprofitable. This segment is highly competitive.Producers of local commercials may ask several companies like AnimPix to bid,which results in an unusually low ratio of accepted contracts to bids.Furthermore, the animation sequences tend to be much shorter for localcommercials than for other work. Because animation work is billed at standardrates according to the running time of the completed animation, the revenuesfrom these short projects tend to be below average. Data concerning activity inthe local commercials market appear below:

Activity Measure    Local Commercials

Number of proposals………………………………………………………………………………20

Number  ofanimations……………………………………………………………………………12

Number of contracts…………………………………………………………………………………8

The total sales for local commercials amounted to \$240,000.

Required:

1. Determine the cost of serving the localcommercial market.

2. Prepare a report showing the margins earnedserving the local commercial market. (Remember,

3. What would you recommend to managementconcerning the local commercials market?

Problem 6-17 Comparing Tradition and Activity-Based ProductMargins

Precision Manufacturing Inc. (PMI) makes two types ofindustrial component parts- the EX300 and the TX500. An absorption costingincome statement for the most recent period is shown below:

Precision Manufacturing Inc. IncomeStatement

Sales……………………………………………………………………………………………………………….\$1,700,000

Cost of goods sold…………………………………………………………………………………………….1,200,000

Gross margins………………………………………………………………………………………………………500,000

Net operating loss………………………………………………………………………………………………  \$50,000

PMI produced and sold 60,000 units of EX300 at a price of\$20 per unit and 12,500 units of TX500 at a price \$40 per unit. The company’straditional cost system allocates manufacturing overhead to products usingoverhead rate and direct labor dollars as the allocation base. Additionalinformation relating to the company’s two product lines is shown below:

EX300  TX500  Total

Direct materials………………………………………..\$366,325  \$162,550  \$ 528,875

Direct labor………………………………………………\$120,000  \$42,500  162,500

Cost of goods sold  \$1,200,000

The company has created an activity-based costing system toevaluate the profitability of its products. PMI’s ABC implementation teamconcluded that the \$50,000 and \$100,000 of the company’s advertising expensescould be directly traced to EX300 and TX500, respectively. The remainder of theselling and administrative expenses was organization-sustaining in nature. TheABC team also distributed the company’s manufacturing overhead to fouractivities as shown below:

Manufacturing Activity

Activity Cost Pool (and Activity Measure)   Overhead  EX300  TX500  Total

Machining (Machine-hours)………………………………..\$198, 250  90,000  62,500  152,500

Setups (setup hours)……………………………………………..150,000  75   300  375

Product-sustaining (number of products)………………100,000  1  1  1

Other (organization-sustaining costs)………………………60,000  NA   NA  NA