Starfax, Inc., manufactures a small part that is widely used in various electron
ID: 2474573 • Letter: S
Question
Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Operating results for the first three years of activity were as follows (absorption costing basis):
Year 1
Year 2
Year 3
Sales
$
1,100,000
$
880,000
$
1,100,000
Cost of goods sold
850,000
600,000
900,000
Gross margin
250,000
280,000
200,000
Selling and administrative expenses
220,000
190,000
220,000
Net operating income (loss)
$
30,000
$
90,000
$
(20,000)
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 had expected sales to remain constant at 50,000 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 inventory was excessive and that spurts in demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below:
Year 1
Year 2
Year 3
Production in units
50,000
60,000
40,000
Sales in units
50,000
40,000
50,000
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 $5.00 per unit, and fixed manufacturing overhead expenses total $600,000 per year.
b.
Fixed manufacturing overhead costs are applied to units of product on the basis of each year’s production. That is, a new fixed manufacturing overhead rate is computed each year.
c.
Variable selling and administrative expenses were $3 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.
Starfax’s management can’t understand why profits doubled during Year 2 when sales dropped by 20%, and why a loss was incurred during Year 3 when sales recovered to previous levels.
Required:
1.
Prepare a contribution format variable costing income statement for each year.
Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Operating results for the first three years of activity were as follows (absorption costing basis):
Explanation / Answer
Given Information Year 1 Year 2 Year 3 Sales 1,100,000 880,000 1,100,000 Cost of goods sold 850,000 600,000 900,000 Gross margin 250,000 280,000 200,000 Selling and administrative expenses 220,000 190,000 220,000 Net operating income (loss) 30,000 90,000 (20,000) Variable costing Income Statement Year 1 Year 2 Year3 Sales in units 50000 40,000 50000 No. of Units produced 50000 60,000 40000 Sales 1100000 880,000 1100000 Less: variable Cost Cost of goods Maufactured Beginning Inventory 0 0 100000 Production 250000 300000 200000 Less: Closing Inventory 0 100000 50000 Cost of Good Sold 250000 200000 250000 Variable Selling and administrative expenses ($3*units sold) 150000 120000 150000 Total variable expenses 400000 320000 400000 Contribution Margin 700000 560000 700000 Fixed expenses Fixed manufacturing Overhead 600000 600000 600000 Selling and administrative expenses 70000 70000 70000 Total Fixed Expenses 670000 670000 670000 Net operating income (loss) 30000 -110000 30000 Ans 2a Unit product cost under absorption costing Year 1 Year 2 Year3 Sales in units 50000 40,000 50000 No. of Units produced N 50000 60,000 40000 Direct Materail, Direct labour & Variable overhead 5 5 5 Fixed manufacturing overhead= 600000/N F 12 10 15 Unit product cost 17 15 20 Ending stock in units E 20,000 10000 Fixed manufacturing part of Ending Cost deferred E*F 200,000 150,000 Reconciliation of Variable costing and Absorption costing Year 1 Year 2 Year3 Variable costing Net Opearting Income 30000 -110000 30000 Add: Manufacturing cost defferred in Year 2 and released in Year 3 0 200,000 Less: Manufacturing cost deferred in year 3 for future year -50000 Absorption costing net Opearting income or loss 30000 90000 -20000 Ans 4 Absorption costing Income Statement Year 1 Year 2 Year3 Sales in units 50000 40,000 50000 No. of Units produced 50000 60,000 40000 Sales 1100000 880,000 1100000 Less: Cost of good sold Cost of goods Maufactured Beginning Inventory 0 0 340000 Production 850000 1020000 850000 Less: Closing Inventory 0 340000 170,000 Cost of Good Sold 850000 680000 1020000 Gross Margin 250000 200000 80000 Selling and administrative expenses 220000 190000 220000 Net operating income (loss) 30000 10000 -140000 Year 1 Year 2 Year3 Sales in units 50000 40,000 50000 No. of Units produced N 50000 60,000 40000 Direct Materail, Direct labour & Variable overhead 5 5 5 Fixed manufacturing overhead= 600000/50000 12 12 12 Unit product cost U 17 17 17 Ending stock in units E 20,000 10000 Fixed manufacturing part of Ending Cost deferred E*u 340,000 170,000
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