Starfax, Inc., manufactures a small part that is widely used in various electron
ID: 2557264 • 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 $4.70 per unit, and fixed manufacturing overhead expenses total $600,000 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 $4 per unit sold in each year. Fixed selling and administrative expenses totaled $60,000 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.
Compute the unit product cost in each year under absorption costing.
Reconcile the variable costing and absorption costing net operating income for each year.
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?
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
Answer 2-a. Unit Product Cost Under Absorption Costing Year 1 Year 2 Year 3 Production in Units 50,000.00 60,000.00 40,000.00 Variable Manufacturing Expense per Unit 4.70 4.70 4.70 Fixed Manufacturing Overhead Year 1 - $600,000 / 50,000 Units 12.00 Year 2 - $600,000 / 60,000 Units 10.00 Year 3 - $600,000 / 40,000 Units 15.00 Total Cost per Unit 16.70 14.70 19.70 Note: Selling and administrative expenses (both variable and fixed) are not relevant for the computation of unit product cost in both absorption costing & variable costing. Answer 2-b. Unit Product Cost Under Variable Costing Year 1 Year 2 Year 3 Production in Units 50,000.00 60,000.00 40,000.00 Variable Manufacturing Expense per Unit 4.70 4.70 4.70 Total Cost per Unit 4.70 4.70 4.70 Income Statement Under Variable Costing Year 1 Year 2 Year 3 Sales in Units 50,000.00 40,000.00 50,000.00 Sales 1,100,000.00 880,000.00 1,100,000.00 Variable Expenses: Cost of Goods Sold 235,000.00 188,000.00 235,000.00 Selling & Admn Expenses 200,000.00 160,000.00 200,000.00 Total Variable Costs 435,000.00 348,000.00 435,000.00 Contribution Margin 665,000.00 532,000.00 665,000.00 Fixed Costs Manufacturing Costs 600,000.00 600,000.00 600,000.00 Selling & Admn Expenses 60,000.00 60,000.00 60,000.00 Total Fixed Costs 660,000.00 660,000.00 660,000.00 Net Operating Income 5,000.00 (128,000.00) 5,000.00 Reconciliation Statement Year 1 Year 2 Year 3 Variable Costing Operating Income (Loss) 5,000.00 (128,000.00) 5,000.00 Add: Fixed MOH deferred in inventory Under Absorption Costing Year 2- 20,000 Units X $10 200,000.00 Year 3- 10,000 Units X $15 150,000.00 Less: Fixed MOH released from inventory Under Absorption Costing Year 3 - 20,000 Units X $10 (200,000.00) - Absorption Costing Operating Income (Loss) 5,000.00 72,000.00 (45,000.00) Answer 5. 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 = $600,000 (Fixed MOH) / 50,000 Units (Estimated Sales) Predetermined Overhead Rate = $12per unit So, Cost Per Unit Year 1 Year 2 Year 3 Variable Manufacturing Overhead 4.70 4.70 4.70 Fixed MOH 12.00 12.00 12.00 Total cost per Unit 16.70 16.70 16.70 No. of Units Sold 50,000.00 40,000.00 50,000.00 Cost of Goods Sold 835,000.00 668,000.00 835,000.00 Calculation of Overapplied / Underapplied Overhead: Year 1 Year 2 Year 3 Actual Fixed MOH 600,000.00 600,000.00 600,000.00 Applied Fixed MOH 600,000.00 480,000.00 600,000.00 Underapplied Overhead - 120,000.00 - Income Statement Year 1 Year 2 Year 3 Sales 1,100,000.00 880,000.00 1,100,000.00 Cost of Goods Sold: Cost of Goods Manufactured 835,000.00 668,000.00 835,000.00 Add: Underapplied Overhead - 120,000.00 - Adjusted Cost of Goods Sold 835,000.00 788,000.00 835,000.00 Gross Margin 265,000.00 92,000.00 265,000.00 Selling & Administrative Expenses 260,000.00 220,000.00 260,000.00 Net Operating Income (Loss) 5,000.00 (128,000.00) 5,000.00
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