Cost Behavior

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 quater and quarterly fixed overhead amounts to $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.

Ekland Division

Income Statement

For the Quarter Ending March 31, 2011

Production: 25,000 units

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

Cost of goods sold

Beginning inventory (10,000 units)
$625,000

Production costs applied
1,562,000

Total
$2,187,000

Less ending inventory
625,000
1,562,000

Gross profit
938,000

Selling & general expenses
500,000

Net income
$438,000

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 above absorption income statement to a contribution margin income statement for the first quarter.
-Prepare absorption and contribution margin income statements for the second quarter.
-Compute production costs per unit for both approaches and for both years.

Discussion:

-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.