Starfax, Inc., manufactures a small part that is widely used in various electron
ID: 2555740 • 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):
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:
The company’s plant is highly automated. Variable manufacturing expenses (direct materials, direct labor, and variable manufacturing overhead) total only $3.00 per unit, and fixed manufacturing overhead expenses total $630,000 per year.
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.
Variable selling and administrative expenses were $2 per unit sold in each year. Fixed selling and administrative expenses totaled $70,000 per year.
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.
If Lean Production had been used during Year 2 and Year 3 and the predetermined overhead rate is based on 50,000 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 with a minus sign.)
Year 1 Year 2 Year 3 Sales $ 1,000,000 $ 800,000 $ 1,000,000 Cost of goods sold 780,000 540,000 832,500 Gross margin 220,000 260,000 167,500 Selling and administrative expenses 170,000 150,000 170,000 Net operating income (loss) $ 50,000 $ 110,000 $ (2,500)Explanation / Answer
If Lean Production had been used in Year 2 and Year 3 means that there will be no inventory have been build up in year 2 and Year 3 So, Year 1 Year 2 Year 3 Sales In Units 50,000 40,000 50,000 Production in Units 50,000 40,000 50,000 Predetermined Overhead Rate = $630,000 (Fixed MOH) / 50,000 Units (Estimated Sales) Predetermined Overhead Rate = $12.60 So, Cost Per Unit Year 1 Year 2 Year 3 Variable Manufacturing Overhead 3.00 3.00 3.00 Fixed MOH 12.60 12.60 12.60 Total cost per Unit 15.60 15.60 15.60 No. of Units Sold 50,000.00 40,000.00 50,000.00 Cost of Goods Sold 780,000.00 624,000.00 780,000.00 Calculation of Overapplied / Underapplied Overhead: Year 1 Year 2 Year 3 Actual Fixed MOH 630,000.00 630,000.00 630,000.00 Applied Fixed MOH 630,000.00 504,000.00 630,000.00 Underapplied Overhead - 126,000.00 - Income Statement Year 1 Year 2 Year 3 Sales 1,000,000.00 800,000.00 1,000,000.00 Cost of Goods Sold: Cost of Goods Manufactured 780,000.00 624,000.00 780,000.00 Add: Underapplied Overhead - 126,000.00 - Adjusted Cost of Goods Sold 780,000.00 750,000.00 780,000.00 Gross Margin 220,000.00 50,000.00 220,000.00 Selling & Administrative Expenses 170,000.00 150,000.00 170,000.00 Net Operating Income (Loss) 50,000.00 (100,000.00) 50,000.00
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