Q35PGB - Horngren'S Financial And Managerial Accounting

Question

Using variable and absorption costing, making decisions The 2018 data that follow pertain to Eli’s Electric Eyewear, a manufacturer of swimming goggles. (Eli’s Electric Eyewear had no beginning Finished Goods Inventory in January 2018.)

Number of goggles produced 245,000 Number of goggles sold 215,000 Sales price per unit \( 22Variable manufacturing cost per unit 8Sales commission cost per unit                  5Fixed manufacturing overhead 1,470,000 Fixed selling and administrative costs 250,000 Requirements 

1. Prepare both conventional (absorption costing) and contribution margin (variable costing) income statements for Eli’s Electric Eyewear for the year ended December 31, 2018.

 2. Which statement shows the higher operating income? Why?

3. Eli’s ElectricEyewear’s marketing vice president believes a new sales promotion that costs \)60,000 would increase sales to 220,000 goggles. Should the company go ahead with the promotion? Give your reasoning.

Step-by-Step Solution

Answer

1. Contribution margin is $1,935,000 and gross profit is $1,720,000.
2. Statement as per absorption costing show higher operating income because proportionate fixed cost allocated is low.
3. No, Company should not go ahead with promotion as it decreases the profit.

Step 1: Calculation of unit product cost using variable and absorption costing (a)

Particulars	Absorption costing	Variable Costing
Variable manufacturing overhead	$8	$8
Fixed manufacturing overhead ($1,470,000/245,000)	$6	-
Total unit product cost	$14	$8

Step 2: Income statement absorption costing format

Particulars	Absorption Costing
Net sales revenue ($22x215,000)	$4,730,000
Less: Cost of goods sold ($14x215,000)	$3,010,000
Gross profit	$1,720,000
Variable selling and administrative cost ($5x215,000)	$1,075,000
Fixed selling and administrative cost	$250,000
Operating Income	$395,000

 

Step 3: Income statement variable costing format

Particulars	Variable Costing
Net sales revenue ($22x215,000)	$4,730,000
Less: Cost of goods sold
Variable cost of goods sold ($8x215,000)	$1,720,000
Variable selling and administrative cost ($5x215,000)	$1,075,000
Contribution margin	$1,935,000
Less: Fixed costs
Fixed costs of goods sold	$1,470,000
Fixed selling and administrative cost	$250,000
Operating Income	$215,000

Step 4: Profitability Analysis (b)

Operating income is higher under absorption costing because units sold are less than the units produced because of that proportionate fixed cost allocated.

Step 5: Operating income if company go ahead with the promotion (c)

Particulars	Variable Costing
Net sales revenue ($22x220,000)	$4,840,000
Less: Cost of goods sold
Variable cost of goods sold ($8x220,000)	$1,760,000
Variable selling and administrative cost ($5x220,000)	$1,100,000
Contribution margin	$1,980,000
Less: Fixed costs
Fixed costs of goods sold	$1,470,000
Fixed selling and administrative cost($250,000+$60,000)	$310,000
Operating Income	$200,000

 

No, the company should not go ahead with the promotion because it will decrease the operating income.