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Absorption Method: Calculating Bonuses and Subjects

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Basic Budget
Units in beginning inventory 0
Units produced 400,000
Units sold 400,000
Units in ending inventory 0

Variable costs per unit:
Direct materials $57.20
Direct labor 15.00
Variable manufacturing overhead 5.00
Variable selling and administrative 10.00

Total variable cost per unit $87.20

Fixed costs:
Fixed manufacturing overhead $6,888,000
Fixed selling and administrative 4,560,000

Total fixed costs $11,448,000

Budge Income Statement

Sales (400,000 units x $120 per unit) $48,000,000
Cost of goods sold (400,000 units x $94.42 per unit) 37,768,000
Gross Margin 10,232,000
Selling and administrative expenses:
Variable selling and administrative
(400,000 units x $10 per unit) 4,000,000
Fixed selling and administrative 4,560,000 8,560,000

Net operating income $1,672,000

-A profit goal of $2,000,000 for the upcoming year. To provide incentives, it has been agreed that bonuses for top managers of $10,000 to $25,000 each if the profit goal is met. They would be all or nothing. If the net operating income turned out to be $2,000,000 or more, the bonus would be paid.

1-assuming that the company does not build up its inventory and selling price and cost structure remain the same, how many devices would have to be sold to meet the net operating goal of $2,000,000?

2-Verify your answer by constructing a revised budget and budgeted absorption costing income statement that yields a net operating income of $2,000,000.

3-After realizing by October of the next year, it was clear the company would not make the $2,000,000 target goal. It looked like the company would wind up the year as planned with sales of 400,000 units, no ending inventories and a profit of $1,672,000.

-Managers pointed out that the present rate of sales there is enough capacity to produce tens of thousands of additional devices for the warehouse and thereby shift fixed manufacturing overhead costs to another year in order to still get their bonuses.

If sales are 400,000 units for the year and the selling price and cost structure remain the same, how many units would have to be produced in order to show a profit of at least $2,000,000 under absorption costing?

4-Verify the answer by constructing an absorption costing income statement.

5-Do you think the plan should be approved to build ending inventories in order to attain the target profit?

6-What advice would you share about giving bonuses in the future?

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This solution provides a complete computation of the given finance problem in Excel.

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