Profit Centers: Comparison of Variable and Full Costing (Underapplied Overhead) Mark Hancock, Inc. manufactures a specialized surgical instrument called the HAN-20. The firm has grown rapidly in recent years because of the product's low price and high quality. However, sales have declined this year due primarily to increased competition and a decrease in the surgical pro- cedures for which the HAN-20 is used. The firm is concerned about the decline in sales, and has hired a consultant to analyze the firm's profitability. The consultant has provided the following information:
|
|
2009
|
2010
|
|
Sales (units)
|
3,200
|
2,800
|
|
Production
|
3,800
|
2,300
|
|
Budgeted production and sales
|
4,000
|
3,400
|
|
Beginning inventory
|
800
|
1,400
|
|
Data per unit (all variable)
|
|
|
|
Price
|
$2,095
|
$1,995
|
|
Direct materials and labor
|
1,200
|
1,200
|
|
Selling costs
|
125
|
125
|
|
Period cost (all fixed)
|
|
|
|
Manufacturing overhead
|
$700,000
|
$595,000
|
|
Selling and administrative
|
120,000
|
120,000
|
Hancock explained to the consultant that the unfavorable economic climate in 2009 and 2010 had caused the firm to reduce its price and production levels and reduce its fixed manufacturing costs in response to the decline in sales. Even with the price reduction there was a decline in sales in both 2009 and 2010. This led to an increase in inventory in 2009, which the firm was able to reduce in 2010 by further reducing the level of production. In both years Hancock's actual production was less than the budgeted level so that the overhead rate for fixed overhead, calculated from budgeted production levels, was too low and a production volume variance was calculated to adjust cost of goods sold for the underapplied fixed overhead (the calculation of the production-volume variance is explained fully in Chapter 15, and reviewed briefly below).
The production-volume variance for 2009 was determined from the fixed overhead rate of $175 per unit ($700,000/4,000 budgeted units). Since the actual production level was 200 units short of the budgeted level in 2009 (4,000-3,800), the amount of the production-volume variance in 2009 was 200 X $175 = $35,000. The production-volume variance is underapplied (since actual produc- tion level is less than budgeted) and is therefore added back to cost of goods sold to determine the amount of cost of goods sold in the full-cost income statement. The full-cost income statement for 2009 is shown below:
|
Sales
|
|
$6,704,000
|
|
Cost of goods sold:
Beginning inventory
|
$1,100,000
|
|
|
Cost of goods produced
|
5,225,000
|
|
|
Cost of goods available for sale
|
$6,325,000
|
|
|
Less ending inventory
|
1,925,000
|
|
| Cost of goods sold: |
|
$4,400,000 |
|
Plus underapplied production- volume variance
|
|
35,000
|
|
Adjusted cost of goods sold
|
|
$4,435,000
|
| Gross margin |
|
$2,269,000 |
|
Less selling and administrative costs Variable
|
$ 400,000
|
|
|
ixed
|
120,000
|
520,000
|
|
Net income
|
|
$1,749,000
|
Required
1. Using the full-cost method, prepare the income statements for 2010.
2. Using variable costing, prepare an income statement for each period, and explain the difference in income from that obtained in requirement 1.
3. Write a brief memo to the firm to explain the difference in operating income between variable costing and full costing.