Question

R and R Industries makes mattresses that are made from celliant-infused fabric. The fabric has been proven to promote restful sleep and increased comfort. R and R’s management team is determining manufacturing budgets for 2019 and has set the following standards for each mattress:

        Direct materials,                                      $250.00

        Direct manufacturing labour,                        $150.00

     Variable manufacturing overhead,                 $ 85.00

Fixed annual manufacturing costs for the year are budgeted for $1,140,000.

Management has determined that due to GAAP reporting requirements, normal capacity is the level of annual mattress production that should be used as the denominator to determine the overhead application rate. The following paragraph is a discussion the team had in relation to this.

Denominator activity levels:

To satisfy demand for the 2019 year the vice-president of production plans to produce 18,000 mattresses. However, the marketing manager has identified that the demand between 2016 and 2018 has averaged 20,000 mattresses per year. R and R’s manufacturing plant has the capacity to produce 30,000 mattresses annually assuming the plant is operating 365 days of the year. However, taking into consideration usual closures for such situations as weekends, holidays, and sick time, it is more likely the plant could produce 24,000 mattresses annually.

Required:

In preparation for 2019:

1. Based on the descriptions in the paragraph titled, “Denominator activity levels” above, select the production level of mattresses that is related to normal capacity. Using that activity level calculate the fixed manufacturing overhead application rate for 2019.
   
   
   
2. State which of the production levels described in the paragraph titled “Denominator activity levels” represents practical capacity. Identify what useful information could be used for decision making from applying fixed manufacturing overhead using practical capacity. Explain why it is useful.

QUESTION 4 – (continued)

At end of 2019:

At the end of 2019 it was determined that actual production for the year was 21,000 mattresses and 18,000 mattresses were sold. There was no beginning inventory of mattresses and unsold mattresses were recorded on the balance sheet at the standard cost determined at the beginning of the year.

All product costs for 2019 were at standard costs determined at the beginning of the year. As such there are no price, efficiency, or rate variances. Any production volume variance is written off to the cost of goods sold for the year.

Variable selling and administrative expenses were $45.00 per mattress sold.

Fixed selling and administrative expenses were $825,000

The selling price per mattress was $850.00

3. Prepare an income statement using absorption costing in the gross margin format.
   (Use the next page for your answer)
   
4. Prepare an income statement using variable costing in the contribution margin format.
   (Use the next page for your answer)
   
   
5. Provide the calculations (below) to reconcile the difference between the operating income calculated in part (c) and the operating income calculated in part (d)

                

Answer 1

a. Calculation the fixed manufacturing overhead application rate for 2019 using the normal capacity:

Given information

Fixed annual manufacturing costs for the year are budgeted for $1,140,000.

R and R’s manufacturing plant has the capacity to produce 30,000 mattresses annually assuming the plant is operating 365 days of the year.

Fixed manufacturing overhead application rate = Fixed annual manufacturing costs / Plant capacity

= $1,140,000 / 30,000 = $380 per mattress.

b. Denominator activity levels that represents practical capacity is:

It is given that the plant could produce 24,000 mattresses annually after considering usual closures for such situations as weekends, holidays, and sick time.

Hence this 24,000 mattresses will represent the practical capacity for appliying Fixed manufacturing overhead.

Question 4:

Fixed manufacturing overhead per unit = Fixed manufacturing overhead / Units Produced

= $1,140,000 / 21,000 = $54.29

Selling price per mattress = $850 per mattress

Computation of unit product cost under Variable Costing and Absorption Costing method:

	Variable Costing	Absorption Costing
Direct materials	$250	$250
Direct manufacturing labour	$150	$150
Variable manufacturing overhead	$85	$85
Fixed manufacturing overhead	$54.29
Total Unit Product Cost	$485	$539.29

a. Income statement using absorption costing in the gross margin format:

Absorption Costing Income Statement
	$	$
Sales (18,000 x $850)		$15,300,000
Less: Cost of Goods Sold
Cost of Goods Manufactured (21,000 x $539.29)	$11,325,090
(-) Ending Inventory (3,000 x $539.29)	$1,617,870	$9,707,220
Gross Profit ($15,300,000 - $9,707,220)		$5,592,780
Less: Selling and Administrative Expense
Variable Selling and Administrative Expense (18,000 x $45)	$810,000
Fixed Selling and Administrative Expense	$825,000	$1,635,000
Net Operating Income ($5,592,780 - $1,635,000)	$3,957,780

b. income statement using variable costing in the contribution margin format:

Variable Costing Income Statement
	$	$
Sales (18,000 x $850)		$15,300,000
Less: Variable Cost of Goods Sold
Cost of Goods Manufactured (21,000 x $485)	$10,185,000
(-) Ending Inventory (3,000 x $485)	$1,455,000	$8,730,000
Gross Contribution Margin ($15,300,000 - $8,730,000)	$6,570,000
Less: Variable Selling and Administrative Expense (18,000 x $45)	$810,000
Contribution Margin ($6,570,000 - $810,000)		$5,760,000
Less: Fixed Cost / Period Costs:
Fixed Manufacturing Overhead	$1,140,000
Fixed Selling and Administrative Expense	$825,000	$1,965,000
Net Operating Income ($5,760,000 - $1,965,000)	$3,795,000

c. Reconciliation statement for the profit under Variable Costing and Absorption Costing:

Reconciliation Statement
	$
Net operating income under Absorption costing	$3,957,780
Net operating income under Absorption costing	$3,795,000
Difference in Net Operating Income ($3,957,780 - $3,795,000)	$162,780
Change in inventory (21,000 - 18,000)	3,000 mattress
Fixed manufacturing overhead deferred in inventory (3,000 mattress * $54.29)	$162,870