Question

The annual data that follows pertain to

ShadyShady​,

a manufacturer of swimming goggles​ (the company had no beginning​ inventory):

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Requirements

1.	Prepare both conventional​ (absorption costing) and contribution margin​ (variable costing) income statements for ShadyShady for the year.
2.	Which statement shows the higher operating​ income? Why?
3.	The company marketing vice president believes a new sales promotion that costs $135,000 would increase sales to 205,000 goggles. Should the company go ahead with the​ promotion? Give your reason. Sales price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $47 Variable manufacturing expense per unit. . . . $19 Sales commission expense per unit. . . . . . . . $12 Fixed manufacturing overhead. . . . . . . . . . . $1,640,000 Fixed operating expenses. . . . . . . . . . . . . . . $245,000 Number of goggles produced. . . . . . . . . . . . . . 205,000 Number of goggles sold. . . . . . . . . . . . . . . . . . 193,000 Shady Income Statement (Absorption Costing) For the Year Ended December 31 Less: Less: Operating expenses

Answer 1

Requirement 1: Prepare the absorption costing income statement as follows

S Inc
Absorption Costing Income Statement
For the Year Ended December 31
Particulars	Amount
Service revenue (193,000 × $47)	$9,071,000
Cost of goods sold (193,000 × $27)	$5,211,000
Gross profit	$3,860,000
Operating expenses (193,000 × 12) + $245,000	$2,561,000
Operating income	$1,299,000

Notes: Compute manufacturing cost per unit as follows

Particulars	Amount
Total fixed manufacturing costs	$1,640,000
÷ Number of goggles produced	205,000
Fixed manufacturing cost per unit	$8
Add: Variable manufacturing cost per unit	$19
Manufacturing cost per unit	$27

Prepare the variable costing income statement as follows

S Inc
Variable Costing Income Statement
For the Year Ended December 31
Particulars	Amount	Amount
Service revenue (193,000 × $47)		$9,071,000
Deduct: Variable Expenses
Cost of goods sold (193,000 × $19)	$3,667,000
Sales commission (193,000 × $12)	$2,316,000	$5,983,000
Contribution margin		$3,088,000
Deduct: Fixed expenses
Manufacturing overhead	$1,640,000
Operating expense	$245,000	$1,885,000
Operating income		$1,203,000

Requirement 2: Operating income under absorption costing is higher when compared to that of variable costing due to the deferred fixed manufacturing overhead of $96,000. It is reported as ending inventory in assets section of balance sheet under absorption costing and expensed as incurred in the case variable costing system and therefore lower operating income.

Requirement 3: Compute the benefit from additional promotion expenses as follows

Particulars	Amount
Incremental contribution (205,000 − 193,000) × ($47 − $19 − $12)	$192,000
Deduct: Increase in promotion costs	($135,000)
Increase in operating income	$57,000

Yes, The company should promote the product to nudge the sales to 205,000 units.