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# Absorption Costing - Managerial Accounting

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Roland Andersson is the manager of the Ekland Division of Ystad Industries. His 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; normal capacity is the basis for application of fixed overhead. Normal capacity in the Ekland Division is 40,000 units per quarter, and quarterly fixed overhead is \$500,000. Variable production cost is \$50 per unit. Ralph has been looking at the report for the first three months of the year and is not happy with the results.

Cost of Goods Sold
Beginning Inventory (10,000 Units) \$625,000
Production Costs Applied 1,562,500
Total: 2,187,500
Less ending inventory 625,000
Gross Profit 1,562,500
Volume variance 187,500
Selling and general expenses 500,000
Net Income 875,000

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 practical 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.

For the second quarter,

1. Compute cost of good sold and gross profit

2. Compute variable costs of goods sold and contribution margin

3. Compute variance

4. Compute complete absorption income statement

5. Compute complete behavioral (contribution margin) income statement

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#### Solution Summary

The answers are attached as an Excel spreadsheet where calculations can be viewed by highlighting the cells.

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## Managerial accounting/absorption cost

Managerial accounting

Absorption and Variable Costing; Production Constant, sales fluctuate:

Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc. in order to produce and sell the device. During the first month of operations, the device was very well received on the market, so Ms. Scott looked forward to a healthy profit from sales. For this reason, she was surprised to see a loss for the month on her income statement. This statement was prepared by her accounting services, which takes great pride in providing its clients with timely financial data. The statement follows:

SCOTTS PRODUCTS, INC.
Income Statement

Sales (40,000).....................................................................\$200,000
Less variable expences:
Variable cost of goods sold...................................\$80,000
Variable selling and administrative expenses........... 30,000 110,000

Contribution margin............................................ 90,000
Less fixed expenses:
Fixed manufacturing overhead ...............................75,000
Fixed selling and administrative expenses.................20,000 95,000

Net operating loss...................................................................(5,000)

Ms. Scott is discouraged over the loss shown for the month, particularly since she had planned to use the statement to encourage investors to purchase stock in the new company. A friend, who is CPA, insists that the company should be using absorption costing rather than variable costing. He argues that if absorption costing had been used, the company would probably have reported a nice profit for the month.

Selected cost data relating to the product and to first month of operations follow:

units produced .........................................................50,000
units sold .................................................................40,000
Variable costs per unit:
Direct materials.......................................................\$1.00
Direct labor...............................................................0.80
Variable manufacturing overhead................................0.20
Varable selling and administrative expenses.................0.75

1. Complete the following:
A. Compute the units product cost under absorption costing.
B. Redo the company's income statement for the month using absorption costing.
C. Reconcile the variable and absorption costing net operation income figures.

2. Was the CPA correct in suggestion that the company really earned a profit for the month? Explain.

3. During the second month of operations, the company again produced 50,000 unit but sold 60,000 units. (Assume no change in total fixed costs.)
A. Prepare an income statment for the month using variable costing.
B. Prepare an income statment for the month using absorption costing
c. Reconcile the variable costing and absorption costing net operation income figures.

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