BBG Corp is a manufacturer of a synthetic chemical. Gary Voss, president of the

Question

BBG Corp is a manufacturer of a synthetic chemical. Gary Voss, president of the company, has been eager to get the operating results for the just-completed fiscal year. He was surprised when the income statement revealed that income before taxes had dropped to $885,500 from $900,000, even though sales volume had increased by 100,000 kilograms. The drop in net income occurred even though Voss had implemented two changes during the past 12 months to improve the companys profitability: 1. In response to a 10 percent increase in production costs, the sales price of the companys product was increased by 12 percent. This action took place on December 1, 1994, the first day of the current fiscal year. 2. The managers of the selling and administrative departments were given strict instructions to spend no more in the current fiscal year than last year. BBGs accounting department prepared and distributed to top management the comparative income statements presented below. BBG Corp Statements of Operating Income for Year Ended Nov 30 ($000s) Last Year Current Year Sales Revenue $9,000 $11,200 Cost of Goods Sold $7,200 $ 8,320 Under/over absorbed overhead $ (600) $ 495 Adjusted Cost of Goods Sold $6,600 $ 8,815 Gross Margin $2,400 $ 2,385 Selling & Administrative Expenses $1,500 $ 1,500 Income before Taxes $ 900 $ 885 The accounting staff also prepared related financial information to assist management in evaluating the companys performance. BBG uses the FIFO inventory method for finished goods. Budgeted and fixed overhead are equal and the beginning inventory last year has $3.00/kg. of fixed overhead. BBG Corp Selected Operating and Financial Data Last Year Current Year Sales Price $10.00/kg $11.20/kg Material Cost $1.50/kg $1.65/kg Direct Labor Cost $2.50/kg $2.75/kg Variable Overhead Cost $1.00/kg $1.10/kg Fixed Overhead Cost $3.00/kg $3.30/kg Total Fixed Overhead Cost $3,000,000 $3,300,000 Normal Production Volume $1,000,000kg $1,000,000kg Selling & Admin (All Fixed) $1,500,000 $1,500,000 Sales Volume 900,000kg 1,000,000 kg Beginning Inventory 300,000kg 600,000kg Production 1,200,000kg 850,000kg A. Explain to Gary Voss why BBG Corps net income decreased in the current fiscal year despite the sales price and sales volume increases. B. A member of BBGs accounting dept suggested that the company adopt variable (direct) costing for internal reporting purposes. 1. Prepare an operating income statement through income before taxes for the current year ended Nov. 30 using the variable (direct) costing method. 2. Present a numerical reconciliation of the difference in income before taxes using the absorption costing method as currently employed by BBG and the proposed variable costing method. C. Identify and discuss the advantages and disadvantages of using variable costing for internal reporting purposes.

Explanation / Answer

Operating income statement under Variable costing method Previous year Current year Variable Units sold Variable Units sold Elements 900000 Elements 1000000 Sale value 10 9000000 11.2 11200000 Variable Costs Marerial cost 1.5 1350000 1.65 660000 Material out of old stock 600000 units 1.5 900000 Direct Labor 2.5 2250000 2.75 1100000 Material out of old stock 600000 units 2.5 1500000 Variable overhead 1 900000 1.1 440000 Material out of old stock 600000 units 1 600000 Total Variable cost 5 4500000 5200000 Contribution 4500000 6000000 Fixed Overheads 3000000 3300000 Selling and administration 1500000 1500000 Income befor taxes Nil 1200000

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