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Absorption & Contribution Stmt: Mr. Rosen Jokkmok Industri

Mr. Rosen is the manager of a division of Jokkmok Industries. He is one of several managers being considered for the position of CEO, as the current CEO is retiring in a year.

All divisions use standard absorption costing. The division has the capacity to produce 50,000 units a quarter and quarterly fixed overhead amounts to $600,000. Mr. Rosen has been looking at the report for the first three months of the year and is not happy with the results.

Division Income Statement

For the Quarter Ending March 31, 2013

Production: 25,000 units
Sales (25,000 units) $2,500,000

Cost of goods sold 1,800,000

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Gross profit 700,000

Selling & general expenses 350,000

Net income $350,000

The sales forecast for the second quarter is 25,000 units. Mr. Rosen had budgeted second quarter production at 25,000 units but changes it to 50,000 units, which is total capacity for a quarter. The sales forecasts for each of the last two quarters of the year remain at 25,000 units. Actual fixed costs incurred remain constant in total and variable costs remain constant on per unit basis.

Required:

Computations:

Convert the divisional absorption income statement to a contribution margin income statement for the quarter. Click here for an example showing how to convert from one approach to another. This example is for guidance only and the numbers have no bearing on Jokkmok Industries. You can also find several videos on YouTube that explain the difference between the two types of income statements.

Prepare absorption and contribution margin income statements for the succeeding quarter for the division.

Compute production costs per unit for both approaches and for both quarters.

Discussion:

Did Mr. Rosen improve his performance for the second quarter? Indicate the information you used for your assessment.
Can you make any suggestions for reporting in the future?
Do you think Mr. Rosen should be seriously considered for the CEO position? Why or why not?
Discuss three shortcomings of the absorption approach for internal decision-making.

Solution Preview

Did Mr. Rosen improve his performance for the second quarter? Indicate the information you used for your assessment.

No, Mr Rosen did not improve his performance. First, he made twice as much as was need to fill the sales forecast. This creates risk because you may have obsolete or damaged items that don't sell well and you have to count and store unsold items. Second, by producing so many, the fixed costs are spread across a higher volume and giving you the illusion that costs were "saved" because they don't get charged against profits. They are not "saved." They are "stored" on the balance sheet and will be charged against profits when those excess units are sold. Mr. Rosen also created a cost illusion. The per unit cost for fixed manufacturing is $24 per unit in the quarter with the production of 25,000 but $12 per unit in the quarter with the production of 50,000 ...

Solution Summary

Your discussion is 528 words and explains that Mr. Rosen should NOT be considered for several reasons. Three shortcomings of absorption costing are given and a spreadsheet with a contribution margin statement, an absorption (traditional) statement, and computations of per unit costs are shown in Excel (click in cells to see calculations).

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