Question

Please journal and manufaturing decisions!

Absorption costing does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost of goods sold.

Saxon, Inc.

Absorption Costing Income Statement

For the Year Ended December 31

1	Sales		$1,200,000.00
2	Cost of goods sold:
3	Beginning inventory	$0.00
4	Cost of goods manufactured	800,000.00
5	Ending inventory	(160,000.00)
6	Total cost of goods sold		640,000.00
7	Gross profit		$560,000.00
8	Selling and administrative expenses		289,000.00
9	Income from operations		$271,000.00

Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statement includes a computation of manufacturing margin.

Saxon, Inc.

Variable Costing Income Statement

For the Year Ended December 31

1	Sales		$1,200,000.00
2	Variable cost of goods sold:
3	Beginning inventory	$0.00
4	Variable cost of goods manufactured	560,000.00
5	Ending inventory	(112,000.00)
6	Total variable cost of goods sold		448,000.00
7	Manufacturing margin		$752,000.00
8	Variable selling and administrative expenses		224,000.00
9	Contribution margin		$528,000.00
10	Fixed costs:
11	Fixed manufacturing costs	$240,000.00
12	Fixed selling and administrative expenses	65,000.00
13	Total fixed costs		305,000.00
14	Income from operations		$223,000.00

/manufacturing decisions

Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing income from operations, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.

All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.

The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement panel and the Variable Statement panel, he notices that the net income is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the company’s capacity for manufacturing, in the coming year. He reasons that this will boost net income and satisfy the company’s owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow. If the answer is zero, enter "0".

1. Use the income statements on the Absorption Statement and Variable Statement panels to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.

Income From Operations
Original	Original	Additional	Additional
Production	Production	10,000	10,000
Level-Absorption	Level-Variable	Units-Absorption	Units-Variable

2. What is the change in net income from producing 10,000 additional units under absorption costing?

3. What is the change in net income from producing 10,000 additional units under variable costing?

4. What would be your recommendation to the production manager?

Produce the extra 10,000 units. It's always a good idea to have extra units on hand and keep the factory operating at capacity, even if all the units are not sold.

Do not produce the extra 10,000 units. Net income does not change under absorption costing when the additional units are produced.

Produce the extra 10,000 units. Net income will be increased, and the production manager will receive praise for creating higher profits.

Do not produce the extra 10,000 units. The increase in net income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.

For planning and control purposes, managers often compare planned and actual contribution margin. Variable costing is used as a basis for such analyses.

Examine the following contribution margin data, and then complete the Contribution Margin Analysis panel.

Contribution margin data Saxon, Inc.
Contribution Margin Data Schedule
	Actual	Planned
Sales	$1,200,000	$1,190,000
Variable cost of goods sold	$448,000	$462,000
Variable selling and administrative expenses	224,000	154,000
Total	$672,000	$616,000
Contribution margin	$528,000	$574,000
Number of units sold	16,000	14,000
Per unit:
Sales price	$75.00	$85.00
Variable cost of goods sold	28.00	33.00
Variable selling and administrative expenses	14.00	11.00

Contribution margin analysis focuses on explaining the differences between planned and actual contribution margins, considering the quantity factor and the unit price factor.

After reviewing the data on the Contribution Margin Data panel, complete the following contribution margin analysis. For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Saxon, Inc.

Contribution Margin Analysis

For the Year Ended December 31

1	Planned contribution margin
2	Effect of changes in sales:
3	Sales quantity factor
4	Unit price factor
5	Total effect of changes in sales
6	Effect of changes in variable cost of goods sold:
7	Variable cost quantity factor
8	Unit cost factor
9	Total effect of changes in variable cost of goods sold
10	Effect of changes in selling and administrative expenses:
11	Variable cost quantity factor
12	Unit cost factor
13	Total effect of changes in selling and administrative expenses
14	Actual contribution margin

Answer 1

	ans 1-4
	Absorption Costing Income Statement
	For the Year Ended December 31		Original	Additional
	No. of units			10000
	Sales		$1,125,000.00	750000
	Cost of goods sold:
	Beginning inventory	$0.00
	Cost of goods manufactured	840,000.00		420000	(10000*42)
	Ending inventory	-210,000.00
	Total cost of goods sold		630,000.00	420000
	Gross profit		$495,000.00	330000
	Selling and administrative expenses		275,000.00	140000	(10000*14)
	Income from operations		$220,000.00	190000
	Variable Costing Income Statement
	For the Year Ended December 31			Additional
				10000 units
	Sales		$1,125,000.00	750000
	Variable cost of goods sold:
	Beginning inventory	$0.00		0
	Variable cost of goods manufactured	600,000.00		300000	(10000*30)
	Ending inventory	-150,000.00
	Total variable cost of goods sold		450,000.00
	Manufacturing margin		$675,000.00	450000
	Variable selling and administrative expenses		210,000.00	140000	(10000*14)
	Contribution margin		$465,000.00	310000
	Fixed costs:
	Fixed manufacturing costs	$240,000.00		0
	Fixed selling and administrative expenses	65,000.00		0
	Total fixed costs		305,000.00	0
	Income from operations			310000
	Ans 2) Change in net income under absorption is $190000
	Ans 3) Change in net income under variable is $310000
	ans 4 Produce the extra 10,000 units. Net income will be increased, and the production manager will receive praise for creating higher profits.