Question

Waga Foods, Inc., was formed in March 2011 to provide prepackaged snack boxes for a new low cost regional airline beginning on April 1. The company has just leased warehouse space central to the two airports to store materials. To move packaged materials from the warehouses to the airports, where final assembly will take place, Waga must choose whether to lease a delivery truck and pay a full-time driver at a fixed cost of $5,000 per month, or pay a delivery service a rate equivalent to $0.40 per box. This cost will be included in either fixed manufacturing overhead or variable manufacturing overhead, depending on which option is chosen.

The company is hoping for rapid growth, as sales forecasts for the new airline are promising. However, it is essential that Waga managers carefully control costs in order to be compliant with their sales contract and remain profitable. Ron Spencer, the company’s president, is trying to determine whether to use absorption, variable, or throughput costing to evaluate the performance of company managers. For absorption costing, he intends to use the practical-capacity level of the facility, which is 20,000 boxes per month. Production-volume variances will be written off to cost of goods sold. Costs for the three months are expected to remain unchanged. The costs and revenues for April, May, and June are expected to be as follows:

Sales revenue	$6.00 per box
Direct material cost	$1.20 per box
Direct manufacturing labor cost	$0.35 per box
Variable manufacturing overhead cost	$0.15 per box
Variable delivery cost (if this option is chosen)	$0.40 per box
Fixed delivery cost (if this option is chosen)	$5000 per month
Fixed manufacturing overhead costs	$15000 per month
Fixed administrative costs	$28000 per month

Projected production and sales for each month follow. High production in May is the result of an anticipated

surge in June employee vacations.

Sales (in units)     Production

April              12,000                   12,200

May              12,500                    18,000

June             13,000                      9,000

Total             37,500                    39,200

REQUIRED:

1. Compute operating income for April, May, and June under absorption costing, assuming that Waga opts to use
   1. the leased truck and salaried driver.
   2. the variable delivery service.
2. Compute operating income for April, May, and June under variable costing, assuming that Waga opts to use
   1. the leased truck and salaried driver.
   2. the variable delivery service.
3. Should Waga choose absorption, OR variable costing for evaluating the performance of managers? Why? What advantages and disadvantages might there be in adopting each costing method; variable and absorption)?

Should Waga opt for the leased truck and salaried driver or the variable delivery service? Explain briefly.

Answer 1

Answer:

Workings: