Starfax, Inc., manufactures a small part that is widely used in various electron

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 $ 1,040,000 $ 936,000 $ 1,040,000 Cost of goods sold 880,000 720,000 924,000 Gross margin 160,000 216,000 116,000 Selling and administrative expenses 150,000 142,000 150,000 Net operating income (loss) $ 10,000 $ 74,000 $ (34,000) 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 10% during Year 2 even though production increased during the year. Management had expected sales to remain constant at 40,000 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 40,000 45,000 36,000 Sales in units 40,000 36,000 40,000 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 $4.00 per unit, and fixed manufacturing overhead expenses total $720,000 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 $2 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 10%, 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. 2. Compute the unit product cost in each year under absorption costing. (Round your answers to 2 decimal places.) 3. Reconcile the variable costing and absorption costing net operating income for each year. 4. If Lean Production had been used during Year 2 and Year 3 and the predetermined overhead rate is based on 40,000 units per year, what would the company’s net operating income (or loss) have been in each year under absorption costing? (Losses should be indicated by a minus sign.)

Explanation / Answer

Answer:1

Answer:2

Answer:3

Starfax Inc Variable Costing Contribution Format income Statement For the year ended Particulars Year 1 Year 2 Year 3 Sales 1040000 936000 1040000 Less: variable expenses Beginning inventory 0 0 36000 Add: Cost of goods manufactured 160000 180000 144000 Goods available for sale 160000 180000 180000 Less: ending inventory 0 36000 20000 Variable cogs 160000 144000 160000 Variable selling and administrative exp 80000 240000 72000 216000 80000 240000 Contribution margin 800000 720000 800000 Less: Fixed expenses Manufacturing overhead 720000 720000 720000 Selling and administrative exp 70000 790000 70000 790000 70000 790000 Net operating income 10000 -70000 10000

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