Convert Ekland absorption income statement to a contribution margin income statement
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Ystad Industries
Roland Andersson is the manager of the Ekland Division of Ystad Industries. He is one of several managers being considered for 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 $500,000. Variable production cost is $55 per unit. Roland has been looking at the report for the first three months of the year and is not happy with the results.
Ekland Division
Income Statement
For the Quarter Ending March 31, 2012
Production: 25,000 units
Sales (25,000 units)
$2,500,000
Cost of goods sold
Beginning inventory (10,000 units)
$650,000
Production costs applied
1,625,000
Total
$2,275,000
Less ending inventory
650,000
1,625,000
Gross profit
875,000
Selling & general expenses
400,000
Net income
$475,000
The sales forecast for the second quarter is 25,000 units. Roland 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 are also 25,000 units. Costs incurred in the second quarter are the same as budgeted, based on 50,000 units of production.
Required:
Computations:
Convert the Ekland absorption income statement to a contribution margin income statement for the first 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 not bearing on the Ekland case. 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 second quarter for Ekland.
Compute production costs per unit for both approaches and for both years.
Did Roland 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 Roland should be seriously considered for the CEO position? Why or why not?
Discuss three shortcomings of the absorption approach for internal decision-making.
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Solution Summary
Your tutorial is 809 words and includes computations, contribution margin income statement, absorption costing income statement (traditional income statement), production cost per unit, cost of goods sold analysis, and a reconciliation of quarter 1 to quarter 2 profits.
Solution Preview
Remember that this a draft as an illustration and must be re-written in your own words and meshed with you own thoughts and contributions. Experts are prohibited from creating essays. There is enough plagiarism so let's not add to it.
Your computations are in Excel, attached. Click in cells to see computations and better formatting for schedules.
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Did performance improve? Is Roland a good candidate for CEO?
Roland's performance has not improved. In fact, it might be said that he is manipulating income and building inventory which uses capital and exposes excessive inventory to risks of loss, obsolescence and expenses of storing and counting. Roland should be on the "watch list," not the CEO list. Here's why.
First, the actual cost structure has not changed. Variable costs are still $55 per unit and fixed costs are still $500,000 per month. That has not changed. The rules of generally accepted accounting principles requires that the variable and fixed costs of unsold items remain on the balance sheet in inventory. So, all of the fixed capacity charges from the second quarter did not "hit" the second quarter profits. But they are on the balance sheet and will reduce profits when sold. All Roland did was spread the fixed costs across a large volume of units to get the illusion that the cost per unit dropped. This builds up inventory which is risky and gives profits a temporary dip because some of the ...
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